Here are two vital statistics regarding the Israeli economy that have been published in recent days. GDP contracted by 3.6% in the first quarter of 2009 on an annualized basis, while the Consumer Price Index (CPI) rose by 1% in April, which brings annual inflation to 3.1%. In other words, the Israeli economy is deep in the throes of recession, which is far from over, but at the same time it is experiencing a wave of inflation. This stagflation is uniquely Israeli. Other countries, which are also suffering from a fall in GDP, have seen prices stabilize, or fall in recent months.
If the CPI figures are examined, compared with April 2008, the difference between Israel and the rest of the world really stands out. In Israel the CPI rose by 3.1% between April 2008 and April 2009. Over the same period in the US the CPI fell by 0.7% - the largest fall there in the past 50 years. In the Euro zone prices remained stable on average, but in Ireland for example, the CPI fell in a way not seen since the 1930s. 3.5% in the past 12 months. All this happened as GDP in the first quarter of 2009 fell by 2.5% on an annualized basis. In other words, less than in Israel.
Logical Data
Inflation figures in Europe and the US are logical when the strength of the recession is taken into account. So what is happening in Israel? Here are two more numbers, which demonstrate the uniqueness of the present situation. Firstly, personal consumption in Israel fell by 4.3% on an annualized basis in the first quarter. In other words, domestic demand shrank even though the level of prices rose. The second figure relates to salaries. According to the latest figures available, salaries in the Israeli economy have not risen but have fallen or remained constant. So the rise in prices cannot be explained by rising salaries.
So the situation is that the economy is deep in recession with personal consumption falling, imports down by 22%, investment falling and a decline in work output. Despite all this the CPI has risen by 1.5% in the past two months. Those who relate this to the cost of energy, or the price of fruit and vegetables, or the foreign exchange rate are mistaken. Each of these factors can explain some of the rise, but for sure not all of it. The fact is that prices rose across the entire spectrum of products and services from leisure to clothing and footwear right through to tomatoes.
The Bank of Israel today provided an additional explanation to put onto the inflation bonfire. According to data about the policy of monetary expansion of the Bank's Governor Stanley Fischer, there is a dramatic rise in the amount of money in the economy - 51% more in April 2009 compared with April 2008. One has to ask, in this instance, where is the demand that monetary expansion is meant to create? Where is the credit, which was supposed to flow from the banks to the business sector and households, following this increase in liquidity. A rise in the amount of money does not in itself create inflation but rather generates a rise in demand, whi h results in inflation.
At the same time, expanding monetary policy creates expectations, or at least a feeling, that inflation is about to return and it is not worthwhile lagging behind it. Therefore, one possible explanation, which is worth examining, is that beyond the influence of the exchange rate, energy and seasonal factors there is also the desire of corporations and service providers "to defend" the level of their prices, in both absolute and relative terms, compared with the average price in the economy. There might also some influence from the "end of the recession" atmosphere which has hit the headlines in recent weeks. Perhaps this is connected to the rises in the stock market, which points towards an expansion of economic activity in the future.
If such a phenomenon is happening, then it is very likely that we will again see falling prices in the second half of the year, in the absence of demand that can strengthen the current level of prices. In this context it is worth quoting the press release from the Central Bureau of Statistics. "In the last two quarters there was a relative increase in the size of the product, materials and works inventory that are in the process of being ordered by companies abroad but have not yet been supplied." So far this is the same language as the Bank of Israel, if we make the reasonable assumption that these inventories will continue increasing in the future, we will see that the recent rise in prices will not be sustained for long. Perhaps this is the reason that inflationary expectations in the capital market are for a rise of less than one percent over the next year.
This development, if it happens, will be linked to expectations in growth in the coming months. Meanwhile, there is no factor that can push the economy forward, Israeli or global, and bring the deep recession to an end in the coming months. Israeli exports have fallen at an annualized rate of 20%, investment is down and the standard of living is not recovering. This is not the environment in whih to talk about inflation which is rising. It is much more logical to think that in the second half of 2009 things will look very different.
Published by Globes [online], Israel business news - www.globes-online.com - on May 17, 2009
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