Policy lessons from Israel 1
This paper provides an overview of the role of the fiscal deficit and the ensuing public debt in explaining major episodes in Israel’s contemporary economic history. We focus on the inflation and disinflation episodes in the 1980s, and the more recent experience of massive immigration in the 1990s. These episodes can serve as a testing ground for old and new theories concerning the role of fiscal policies in economies which are subject to various external and domestic shocks. Main topics of analysis are: how relevant is the unpleasant arithmetic of deficit and inflation? What is the differential effect of inflation on various tax bases? Is there evidence for debt neutrality or tax smoothing? Can a fiscal contraction be expansionary? How do inflation and disinflation affect the distribution of income between capital and labor? What determine post disinflation business cycles, exchange rate policy or tax policy, or both? Should an efficient absorption of massive immigration necessarily worsen government finances?
The chapter is organized as follows. The first section overviews the theoretical underpinning of the macroeconomic effects of fiscal policies. The subsequent section highlights the main features of the inflation process in Israel. The section beginning on p. 448 analyses the links between fiscal contractions and aggregate demand. The income distribution issues associated with inflation and disinflation are considered in the section on pp. 451-4. Post disinflation cycles are considered in the following section, the role of tax smoothing and the labor market in the success of the absorption of immigrants are analysed in the section on pp. 457-61. The next section looks at the issue of the burden of government deficit in the presence of growth and it is followed by a brief concluding section.