Bank of Israel Annual Report 2022
Governor's Letter
6 Nisan, 5783
March 28, 2023
To:
The Government and the Knesset Finance Committee
Jerusalem
I am honored to hereby present the Bank of Israel Annual Report for 2022, pursuant to Section 54 of the Bank of Israel Law, 5770–2010.
The year 2022 was characterized by two main processes that began in 2021, in view of the rapid recovery from the effects of the COVID-19 pandemic: rapid growth, alongside increased inflationary pressures. The inflationary pressures began with international supply shocks, that were then joined by domestic demand pressures that increased during the year. As the negative effects of the pandemic subsided, other factors appeared that had a negative impact on the economy. These included the war in Ukraine.
GDP grew rapidly this year, by 6.4 percent, further to the high growth of 8.6 percent in 2021. The level of GDP during 2022 was higher than the level derived from its trend of the years prior to the COVID-19 crisis. This growth was based on the rapid increase in private consumption, exports, and investment—mainly in residential construction. In the area of private consumption, the rapid growth of services consumption was prominent, in view of the removal of all activity restrictions on the proximity services industries. The significant savings that households had accumulated since the beginning of the COVID-19 crisis did not erode this year. Such erosion would have led to an even greater increase in private consumption. The rapid growth of exports continued to rely mainly on the export of high-tech services, but in the last two years, there has also been strong growth in goods exports. The rapid growth was also reflected in the tight labor market, where the employment rate increased, the unemployment rate decreased, and both returned to their precrisis levels.
Inflation totaled 5.3 percent in 2022, exceeding the upper bound of the target range for the first time in the past decade. The acceleration of inflation began in 2021, following many years in which it was very low. Similar to what is taking place in many countries, the acceleration of inflation was influenced at first mainly by global supply constraints in view of the exit from the COVID-19 crisis. Those supply constraints were exacerbated during the year in view of the war in Ukraine, the effects of which were mainly felt in energy and food prices. During the year, the contribution of robust domestic demand to inflation also increased. However, inflation in Israel this year was lower than in most advanced economies—largely due to Israel’s reliance on its own natural gas reserves, the prices of which are fixed in long-term contracts. Following a prolonged appreciation, the shekel depreciated by 4 percent during the year in terms of the nominal effective exchange rate—a process that has continued at the beginning of 2023.
With the exit from the COVID-19 crisis and the appearance of inflationary pressures, the Bank of Israel was among the first central banks in the world to taper its monetary accommodation in 2021, by halting the use of the special monetary tools that were applied during the crisis. At the beginning of the year, the interest rate was still kept low in view of the broad morbidity of the Omicron wave and the uncertainty surrounding the decline of the COVID-19 pandemic, and in order to support the economy’s recovery from it. It quickly became clear that economic activity was recovering at an accelerated pace, and that inflation was accelerating—increasingly due to demand pressures. Global inflation further accelerated when the war in Ukraine broke out in February, leading to a shortage of raw materials and a sharp increase in global commodity prices. The Monetary Committee therefore announced as early as February its assessment that the conditions would soon be ripe for a gradual increase in the interest rate. In April, the Committee began a rapid process of increasing the interest rate, from 0.1 percent to 3.25 percent at the end of the year—its highest level since 2010. The Committee has continued increasing the rate at the beginning of 2023. The rapid and determined increase in the interest rate, also similar to other countries, is intended to prevent the entrenchment of inflation at a high level.
The effect of the change in monetary policy has been noticeable in the financial markets. The interest rate on bank credit, both to business and to households (housing and nonhousing), increased during the year as the Bank of Israel interest rate increased. Over the course of the year, total credit in the economy increased rapidly, but while the sharp increase in credit continued in the first half of the year, the pace of that increase slowed in the second half. In the Israeli financial markets, asset prices declined this year, influenced both by the interest rate increases in Israel and by the interest rate increases and financial market declines abroad. The declines in the Israeli financial markets continued at the beginning of 2023, and were sharper than those recorded in most markets abroad. The capital raised by high-tech companies declined during the year from the peak levels of 2021, reaching levels at the end of 2022 that were similar to those from before COVID-19. However, the share of those employed in the high-tech sector continued to increase in 2022, and wages in the sector increased by a higher rate than in the rest of the business sector.
The end of the COVID-19 crisis and the increased economic activity led to a sharp improvement in the fiscal aggregates. There was a government budget surplus of 0.6 percent of GDP (compared to a deficit of 4.4 percent of GDP in 2021), and public debt declined to 60.7 percent of GDP, just slightly higher than its pre-COVID-19 level. The halt in support payments that were required during the crisis led to a sharp decline in public expenditure as a share of GDP, and public revenue grew, mainly thanks to a sharp increase in direct tax revenue. The moderation of the increase in public expenditure (excluding COVID-19 expenditures) in recent years was due in part to the delay in signing new public sector wage agreements. In addition to rapid economic growth, the rapid increase of tax revenues also reflected one-off factors such as increased cash flow to the high-tech sector and strong real estate activity.
As stated, the high level of investment in residential construction contributed to rapid economic growth this year. Despite the expansion of the supply of dwellings and the high level of building starts in the past two years, home prices continued to increase rapidly throughout most of the year. However, toward the end of the year, the price increases moderated, and there were even declines in the prices of new homes. The moderation of the increase in home prices was also affected by the decline in transactions, which took place partly against the background of more expensive mortgages.
The growth of labor productivity in Israel, which is essential to ensure sustainable economic growth, accelerated in the past decade, and the gap relative to other OECD countries has started to narrow. However, labor productivity in Israel remains low compared to those countries, and increasing it is one of the main challenges faced by the economy. To do so, we must act along a number of strategic paths, including the development of human capital, investment in physical infrastructure—mainly for public transit—and in digital infrastructure, promotion of the use of digital tools in the government’s work, and advancement of competition and innovation in the financial system, while continuing to maintain its stability. The program that the Bank of Israel presented to the incoming government upon its establishment discusses these issues in detail, and also relates to dealing with other main challenges such as housing and the energy and climate issue.
The Bank of Israel Annual Report by its very nature surveys the year that has passed. At the same time, I find it proper to briefly refer to the developments in recent months. The current period, in which global and domestic economic conditions are changing, requires particularly responsible management of fiscal policy. As a matter of fact, at the end of February, the government approved a State budget proposal that is consistent with the tightening monetary policy during this period. The public sector wage agreements that were recently signed are also consistent with restraining inflation and returning it to the target range. At the same time, the government is advancing legislative amendments concerning the judicial system in Israel. The existence of strong and independent institutions is essential for the stability and prosperity of the economy over time, which is also shown by economic research literature. Those institutions become even more important in an era of globalization and in light of the characteristics of the Israeli economy. A number of developments in the financial markets, and the discussion by international economic entities of the legislative processes currently being debated in Israel underline the need to ensure the independence and professionalism of Israeli institutions, as well as the need for significant changes to be made by broad agreement.
Professor Amir Yaron
Governor of the Bank of Israel
Contents
Chapter 1 - The Economy and Economic Policy in View of Two Global Crises
- GDP grew by 6.4 percent in 2022, which was higher than the long-term pace of growth. This followed the high growth rate in 2021, by the end of which the level of GDP had already converged with the precrisis growth trend.
- The labor market continued to tighten in 2022. The job vacancy rate was higher than in the period prior to the COVID-19 crisis, in parallel with an increase in the employment rate and a decline in the unemployment rate.
- Inflation increased during 2022, reaching 5.3 percent at the end of the year. At the beginning of the year, it was mainly influenced by disruptions in international supply due to the COVID-19 crisis and the war between Russia and Ukraine. During the year, high demand made an increasing contribution to inflation.
- Israel enjoys the independence of natural gas production for electricity generation, as well as prices and quantities ensured by long-term contracts. It has therefore been affected only moderately by the global energy crisis that broke out in the wake of the war.
- The shekel depreciated by 4 percent in terms of the nominal-effective exchange rate during the year, with high volatility.
- In the summer of 2021, the Bank of Israel was among the first in the world to stop the use of the monetary accommodation tools that it had used during the COVID-19 crisis. At the beginning of 2022, the Bank also halted its foreign exchange purchases.
- Following the high level of uncertainty that remained at the beginning of 2022 regarding the development of the pandemic and its economic impacts, in April, the Monetary Committee began raising the Bank of Israel interest rate. This followed seven years in which it ranged between 0.1 and 0.25 percent. By the end of the year, the interest rate had reached 3.25 percent, its highest level since the beginning of the previous decade.
- Inflation in most advanced economies was higher than in Israel. In view of the uncertainty at the beginning of 2022 regarding the recovery from the crisis and the impact of the war in Ukraine, the assessments of the major central banks were that inflation was due to temporary supply chain disruptions. As such, they began to raise interest rate only once inflation had increased considerably.
- In view of the increase in interest rates, bond yields increased and share prices declined. Accordingly, in the middle of the year there was a change in direction in the development of credit in all segments, and its growth rate slowed, sharply in some segments.
- Following the COVID-19 years, which featured large fiscal expansion, 2022 ended with a government budget surplus of 0.6 percent, and public debt fell to 60.7 percent of GDP—the environment in which it was prior to the COVID-19 crisis. Among other things, anomalous tax revenues, the delay in public sector wage agreements, and the acceleration of inflation all contributed to this.
- The construction and planning volumes in the housing market continued to increase in 2022, but the number of transactions declined from its 2021 peak. Home prices increased rapidly over most of the year, with the increases slowing toward the end of the year.
- The Israeli high-tech sector grew rapidly in 2022. However, the job vacancy rate in the sector, as well as fundraising by startup companies, declined relative to their peak levels of 2021, and the decline intensified during the year.
Chapter 2 - Aggregate Activity: GDP and Employment
- Gross Domestic Product grew at a rapid4 percent pace in 2022—on the heels of 8.6 percent growth in 2021—due to increases in private consumption, exports, and fixed capital formation.
- GDP exceeded its precrisis trend throughout the year, reflecting the resilience of the economy. The main contributors were exports of business services and of goods—supported by demand from abroad despite the global energy crisis—and residential construction. Private consumption and exports of tourism services dampened national output relative to the trend.
- Although private consumption increased rapidly in 2022, it did so from a relatively low base because it had been severely limited during the pandemic, particularly with regard to services. Therefore, its level remained below the precrisis trend and, for this reason, had a downward effect on GDP relative to the trend.
- Services exports remained the main growth engine in 2022 and goods exports also increased fairly rapidly, led by the computers and electronics industry and the chemicals industry. The trend changed direction in the second part of the year as exports of both services and goods declined.
- Private savings surged in 2020–2022 due to weak consumption and high private income relative to the precrisis levels of both, allowing excess savings of more than 10 percent of GDP to accumulate. As of 2022, the cumulative excess savings had not been drawn down.
- Employment returned to its precrisis rate and demand for labor surpassed its precrisis level by far. Employment growth outpaced GDP growth, causing labor productivity to fall to approximately the precrisis trend.
- Affected by the inflation rate and the tight labor market, nominal wages increased moderately and real wages fell. The GDP labor share declined, suggesting that the labor market was not the leading cause of the higher pace of inflation.
- The surplus in the current account of the balance of payments remained high at9 percent of GDP, but dropped slightly due to higher fuel prices and an increase in the negative net tourism balance.
- The Consumer Price Index increased by 5.3 percent in 2022—above the inflation target of 1–3 percent. This increase continued the acceleration in the pace of inflation that began in 2021. As a result, the Bank of Israel increased the interest rate markedly—from 0.1 percent to 3.25 percent—during the year. The interest rate increases continued into 2023.
- Inflation in 2022 encompassed many CPI components. As in 2021, inflation in 2022 was influenced by supply limitations, including disruptions in global supply chains with the exit from the COVID-19 crisis. These were joined at the beginning of the year by supply disruptions in the energy and food markets due to the unexpected and prolonged war between Russia and Ukraine.
- In addition to the supply factors, the increase in inflation was also influenced by strong domestic demand, in view of the recovery from the COVID-19 crisis and the accommodative monetary and fiscal policies adopted during the crisis. Domestic demand’s contribution to inflation increased during the year.
- One-year inflation expectations increased at the beginning of 2022, but remained around the upper bound of the inflation target range throughout most of the year. Expectations for between the first and third years crossed the upper bound of the target range during the year, but toward the end of the year they returned to within the range. Longer-term expectations remained anchored within the target range.
- Despite the acceleration of inflation, its rate in Israel remained lower than in other OECD countries. Some of this gap is due to the fact that the Israeli economy was not exposed to increases in the price of natural gas, and its exposure to shortages of energy products as a result of the war in Ukraine was limited. The increase in food prices in Israel was also more moderate than in the other OECD countries.
- In view of the increase in inflation, central banks, including the Bank of Israel, raised their monetary interest rates significantly during the year. The rapid increase in interest rates was intended to accelerate monetary tightening in order to deal with the risk of inflation becoming entrenched. Furthermore, the Bank of Israel was among the first central banks to stop the use of special monetary accommodation tools that were employed in recent years.
- Following a number of years in which the real interest rates in Israel were negative, they increased during the year to positive levels throughout the yield curve.
- In 2022, the shekel depreciated by 4 percent in terms of the nominal effective exchange rate, following a trend of appreciation that lasted for about a decade. The depreciation was supported by foreign exchange purchases by institutional investors due to the decline in equity prices abroad, as well as by the expansion of the monetary interest rate gap with the United States.
Chapter 3 - Inflation and Monetary Policy
- The Consumer Price Index increased by 5.3 percent in 2022—above the inflation target of 1–3 percent. This increase continued the acceleration in the pace of inflation that began in 2021. As a result, the Bank of Israel increased the interest rate markedly—from 0.1 percent to 3.25 percent—during the year. The interest rate increases continued into 2023.
- Inflation in 2022 encompassed many CPI components. As in 2021, inflation in 2022 was influenced by supply limitations, including disruptions in global supply chains with the exit from the COVID-19 crisis. These were joined at the beginning of the year by supply disruptions in the energy and food markets due to the unexpected and prolonged war between Russia and Ukraine.
- In addition to the supply factors, the increase in inflation was also influenced by strong domestic demand, in view of the recovery from the COVID-19 crisis and the accommodative monetary and fiscal policies adopted during the crisis. Domestic demand’s contribution to inflation increased during the year.
- One-year inflation expectations increased at the beginning of 2022, but remained around the upper bound of the inflation target range throughout most of the year. Expectations for between the first and third years crossed the upper bound of the target range during the year, but toward the end of the year they returned to within the range. Longer-term expectations remained anchored within the target range.
- Despite the acceleration of inflation, its rate in Israel remained lower than in other OECD countries. Some of this gap is due to the fact that the Israeli economy was not exposed to increases in the price of natural gas, and its exposure to shortages of energy products as a result of the war in Ukraine was limited. The increase in food prices in Israel was also more moderate than in the other OECD countries.
- In view of the increase in inflation, central banks, including the Bank of Israel, raised their monetary interest rates significantly during the year. The rapid increase in interest rates was intended to accelerate monetary tightening in order to deal with the risk of inflation becoming entrenched. Furthermore, the Bank of Israel was among the first central banks to stop the use of special monetary accommodation tools that were employed in recent years.
- Following a number of years in which the real interest rates in Israel were negative, they increased during the year to positive levels throughout the yield curve.
- In 2022, the shekel depreciated by 4 percent in terms of the nominal effective exchange rate, following a trend of appreciation that lasted for about a decade. The depreciation was supported by foreign exchange purchases by institutional investors due to the decline in equity prices abroad, as well as by the expansion of the monetary interest rate gap with the United States.
Chapter 4 - Development of Sources of Financing for the Nonfinancial Private Sector
- In 2022, against rising inflation and interest rates in Israel and globally, there were significant declines in the financial asset markets. Equity prices declined sharply, and bond yields of public companies (which constitute approximately half of the economy’s business sector debt) rose, resulting in higher costs of debt and capital raising.
- Interest rates on bank credit rose in response to the increase in the Bank of Israel interest rate in the second half of 2022. Interest rates for businesses rose for all business sizes and industries, while interest on credit for households rose with respect to both housing credit and nonhousing credit.
- In 2022, developments in the field of credit were not uniform. In the first half of the year, the sharp increase in the credit balance continued the trend that had begun in 2021, while in the second half of 2022 the credit supply contracted, with a slowdown in the growth rates of bank and nonbank credit to both businesses and households.
- The effect of tighter financial conditions and declining equity prices was evident in the IPO market, where the wave of IPOs that had begun in 2022 was cut off. The economic developments reduced high-tech firms’ capital raised from venture capital funds both in and outside Israel.
Chapter 5 - Labor Productivity in Israel in the Past Decade
- The growth of GDP per worker (labor productivity) in Israel accelerated in the past decade, and the gaps relative to other OECD countries have begun to narrow. This trend intensified with the exit from the COVID-19 crisis.
- The growth of economy-wide productivity in the past decade was mainly due to an increase in industry productivity, particularly in the services industries. In contrast, the change in the distribution of employees among the industries made almost no contribution.
- By international comparison, the change in productivity in the Israeli services industries made a larger contribution than the OECD average, thanks to a greater increase in productivity in the Israeli services industries and due to their greater weight in GDP.
- The increases in productivity and employment in the services industries were not only due to the activity of the high-tech sector, but also encompassed additional industries. Productivity in the trade, communications, and banking industries increased due to streamlining as a result of reforms to encourage competition, as well as improved service through the implementation of online technologies.
Chapter 6 - The Public Sector and its Financing
- In 2022, the general government deficit declined sharply to 1.6 percent of GDP, from 5.5 percent of GDP in 2021. The central government had a budget surplus of 0.6 percent of GDP.
- The surplus in central government operations, along with higher GDP and higher inflation, resulted in a sharp decline in public debt in 2022, by 7.2 percent of GDP, to 60.7 percent of GDP, similar to its pre-COVID-19 level.
- The decrease in the broad government deficit this year primarily reflects a sharp decrease, by 3.2 percent of GDP, in the weight of public expenditure as a percentage of GDP, which primarily reflects a decline in the COVID-19-related support required last year. Primary civilian expenditure, as percentage of GDP, fell to below its pre-COVID-19 level, and is among the lowest in the advanced economies.
- Public revenues increased by 0.7 percent of GDP this year, primarily due to sharply higher direct tax revenue. Some of the causes for this rapid growth are of a temporary nature, such as unusual income tax revenues and higher real estate tax revenues.
- One of the causes for the moderate growth in public expenditure in recent years (excluding COVID-19-related expenses) is the slow increase in wages in the public sector, due to the freeze imposed on negotiations for a new framework wage agreement during COVID-19. The new agreement, signed in March 2023, should gradually increase public expenditure.
- The wage agreement with the Teachers Union, signed in October, improved employment terms for new teachers, added incentives in the wage system, and somewhat increased schools’ administrative flexibility. The cost of this agreement is NIS 4.9 billion per year, mostly applicable as early as the 2023 budget. However, this agreement provides only a limited resolution for key structural issues that may have an impact on the education system's achievements.
- During the COVID-19 pandemic, digitalization of government services was accelerated, in order to expand and improve the quality of such services. Improvements in Israel were more significant than in some other advanced economies, primarily reflected in the expansion of the range of online services. However, significant investment is still required to improve the public’s technology literacy, in order to make these digital services also accessible to population groups that currently have difficulty using them.
Chapter 7 - Welfare Issues and the Distribution of Income
- There are significant disparities in per capita disposable income between Arab and Haredi (ultra-Orthodox) households and non-Haredi Jewish households. The disparities between Haredi Jews and non-Haredi Jews are larger in the 25–44 age group than in the 45–64 age group, while the disparity between Arabs and non-Haredi Jews has narrowed in the younger group.
- The main causes of the gaps relative to non-Haredi Jews are low labor income in Arab and Haredi households and the fact that there are more members in those households. In the Arab sector, the gaps in labor income are primarily the result of the low labor force participation rates among women. In the Haredi sector, low labor income is primarily due to the difference in the proportion of university graduates and in employment rates among men.
- An examination of the trends in the older age group reveals a narrowing of gaps between Arab women and non-Haredi Jewish women both in education and in employment rates while among Haredi men the gap in education has widened while that in employment has narrowed somewhat.
- There are wage gaps between Arab and Haredi university graduates and non-Haredi Jewish university graduates. These gaps partly reflect a higher representation of Arabs and Haredim in occupations with low average wages, such as education, and underrepresentation in high-wage occupations, such as high-tech and managerial occupations.
- A high proportion of Arab university graduates are employed in occupations with a high percentage of positions in the public sector, particularly education and healthcare. In healthcare, significant proportions of Arab men and women are employed in the paramedical professions, which are characterized by a relatively low average wage. However, a high proportion of Arab men are employed in the medical profession, which is characterized by a high average wage.
- It appears that the geographic dispersion of the Arab population, which includes a significant concentration of population in the periphery, is not a major factor in the distribution of occupations among Arab university graduates.
Chapter 8 - The Housing Market
- The supply of housing expanded in 2022 as a result of the growth in housing starts during the past two years, which followed a record number of building permits issued. The planning inventory and the marketing of land also continued to grow.
- Home sales declined in 2022 relative to the previous year, as a result of more expensive mortgages, the bringing forward of purchases by investors to 2021, and the renewal of reduced-price lotteries in 2022.
- The decline in home sales continued throughout the year. Nonetheless, relative to the period prior to the pandemic there was a high number of sales in 2022.
- Home prices continued to climb rapidly during the first three quarters of the year. However, in the fourth quarter the upward trend was halted. This was led by the decline in new home prices, which was due to the increased inventory of new homes that are intended for sale. That increase in inventory was a result of the growth in housing starts on the one hand and lower sales of new homes, on the other.
- The demand for rental housing continued to expand, as a result of the high rate of population growth and other factors, including the high proportion of new homes sold with a long period until the end of construction; the fact that some households have given up on the idea of buying a home and remained in the rental market; and the increased scope of urban renewal, which requires the demolition of the old buildings.
- In 2022, the price of land in Israel Land Authority tenders fell and the price increases in inputs for residential construction moderated.
- An analysis of home sales during the 2015–2022 period shows that the Buyer’s Price program was beneficial to those eligible, since they were able to purchase a home at a discount of between 26 and 40 percent. Home buyers in high-demand areas benefited from the largest discounts. In addition, the prices of homes in the open market increased more in areas where there was a higher proportion of home sales that were subsidized by the government.