Fiscal Rules Eldad Shidlovsky, Head of Economics and Research Department. Ministry of Finance May 2009 Ministry of Finance

2 Fiscal Rules - Historical Perspective  The “Deficit Reduction Law” was enacted in  In the first few years, it addressed only the level of the deficit.  In 2005 an expenditure limit was added.

3 Fiscal Rules - Historical Perspective Central Government's Budget Deficit )As Percent of GDP(

4 The Use of Fiscal Rules in other Countries The rules vary among countries:  The rules refer to the public sector as a whole or to the central government budget.  The rules focus on the size of the deficit, on public debt, size of public expenditure etc.  Some countries set rules for one year, some use multi-year rules, and some apply rules over the course of the business cycle.

5 Why are Fiscal Rules Necessary?  Creation of budgetary anchors that prevent sliding into a loss of fiscal control.  Increased stability and credibility of economic policy in the eyes of the public.  Increased budgetary transparency.  Support for improved efficiency of the public sector.

6 Difficulties in Applying Fiscal Rules  Difficulty in applying anti-cyclical policy.  Postponement of expenditures.  The need to abstain from solutions that bypass the budget.

7 Guidelines for the Proposed Fiscal Rule  Avoiding as much as possible the use of economic forecasts.  The rule should be as simple and transparent as possible.  The rule should maintain the credibility of budgetary policy.  The rule should prevent the need for frequent changes, exceptions (such as the "boxes"), and solutions that bypass the budget.  The rule should not create a pro-cyclical policy.

8 Key Objectives in Establishing the Fiscal Rule  The key objective in the short term is a return to fiscal stability by committing to a downward deficit trend.  The key objective in the medium and long term is to achieve a decrease of the debt-to-GDP ratio to around 60 percent by the end of the next decade.

9 Reasons for Reduction of the Debt-to-GDP Ratio Gross Public Debt percent of GDP, estimates 2008* *Source: OECD, November 2008, Israel: MoF

10 Reasons for Reduction of the Debt-to-GDP Ratio  Increases the economy's resilience to external shocks.  The burden of defense spending.  Population aging.  Debt reduction decreases interest expenses and financing costs.

11 The Proposed Rule The fiscal rule will be based on two components:  A restriction of real expenditure growth.  Future increase in expenses will be a function of the debt-to-GDP ratio.  A budget deficit ceiling – the budget deficit ceiling will decrease gradually.

12 The Proposed Rule Development of the debt-GDP ratio simulation, Growth assumptions: GDP growth will be -1% in 2009, 1.5% in 2010 and 3.5% thereafter