This document presents the forecast of macroeconomic developments
compiled by the Bank of Israel Research Department in July 2017. The forecast
was presented to the Monetary Committee on July 9, 2017, during its meeting
prior to the decision on the Bank of Israel interest rate reached on July 10,
2017. According to the staff forecast, gross domestic product (GDP) is
projected to increase by 3.4 percent in 2017 and by 3.3 percent in 2018. The rate
of inflation over the next year (ending in the second quarter of 2018) is
expected to be 0.8 percent. The Bank of Israel interest rate is expected to
remain at its current level of 0.1 until the first quarter of 2018, and to increase
gradually from the second quarter of 2018.




The Bank of Israel Research Department compiles a staff forecast of
macroeconomic developments on a quarterly basis. The staff forecast is based on
several models, various data sources, and assessments based on economists’
judgment. The Bank’s DSGE (Dynamic Stochastic General Equilibrium) model
developed in the Research Department—a structural model based on microeconomic
foundations—plays a primary role in formulating the macroeconomic forecast.[1] The model
provides a framework for analyzing the forces that have an effect on the
economy, and allows information from various sources to be combined into a
macroeconomic forecast of real and nominal variables, with an internally
consistent "economic story".



The global environment

Our assessments of expected developments in the global economy are based
mainly on projections by international institutions (the International Monetary
Fund and the OECD) and by foreign investment houses. These institutions revised
their forecasts for growth in advanced economies and for world trade slightly upward.
Accordingly, our forecasts are for growth in advanced economies of about 2
percent in both 2017 and 2018. As for the world trade, we project growth of 4.6
percent in 2017 and 3.8 percent in 2018.


Based on assessments derived from the capital market (assessments based
on interest rate futures contract prices), the US federal funds rate is
expected to increase to 1.25 percent at the end of 2017 and 1.5 percent at the
end of 2018. In contrast, the interest rate on deposits with the central bank in
Europe is expected to increase very moderately from its current level of -0.4
percent, and to remain negative at -0.3 percent at the end of 2017 and -0.2
percent at the end of 2018.


The international financial institutions revised their forecasts of
inflation in the advanced economies upward. Accordingly, our assessment is that
inflation in the advanced economies will reach about 2 percent in 2017 and in
2018. The price of Brent crude oil declined during the second quarter, to about
$47 per barrel.[2]


Real activity in Israel

GDP is expected to grow by 3.4 percent in 2017 and by 3.3 percent in
2018 (Table 1)
. The expected growth rate for 2017 was revised upward from
the previous forecast, because National Accounts data for the first quarter and
initial activity data for the second quarter show that exports and investments
increased more than our assessment in the previous forecast.  Our assessment is that in the forecast
horizon (the next year-and-a-half), we will see a continued increase in the
growth rate of exports, inter alia due to the expected recovery in world trade,
and of investments in the various industries. 
In contrast, the growth rate of private consumption is expected to moderate
after having been higher than the growth rate of the other uses and of GDP for
a long time.  Essentially, the forecast
reflects a gradual transition to growth based less on private consumption and
more on exports.  It should be noted that
the development of the real economic variables in recent quarters was
influenced by vehicle purchases being brought forward due to changes in vehicle
taxation that took effect in January 2017.[3] This is
reflected, inter alia in the fact that the annual growth rate in 2017 is lower
than it was in 2016, but our assessment is that net of this effect, it will be
similar to the growth rate in 2016, and will be slightly higher than 3.5
percent.  Further changes in vehicle
taxation are expected in January 2019, and our assessment is that they will
also lead to purchases being brought forward, which will increase the growth
rate in 2018.[4]



Table 1

Economic Indicators

Research Department Staff Forecast for 2017 to 2018

(rates of change, percent, unless
stated otherwise; previous forecast in parentheses.)


Figures for

Bank of Israel

Bank of Israel









Civilian imports (excluding diamonds, ships, and aircraft)




Private consumption




Fixed capital
formation (excluding ships and aircraft)




Public sector
consumption (excluding defense imports)




Exports (excluding
diamonds and start-ups)




Unemployment ratea




Inflation rateb




Bank of Israel
interest ratec




a) Annual average of unemployment in the primary
working ages (25–64). 

b) Average CPI reading in the final quarter of the
year compared with the final-quarter average in the previous year.

c) End of the year.

Source: Bank of Israel.


Inflation and interest rate

In our assessment, the inflation rate in the four quarters ending in
the second quarter of 2018 will be 0.8 percent and in 2018 it will be 1.5
The prices of domestic products are expected to continue increasing
moderately, as a result of moderating forces—including increased competition
and government measures to lower the cost of living—that are expected to
continue slowing the rate of price increases. In contrast, the fact that the
labor market is near full employment is expected to continue supporting increased
wages, which may lead to an increase in domestic inflation. The prices of
imported products are expected to increase at a higher rate than that of the
past two years, as inflation worldwide continues to increase.  Expected inflation for the coming year is about
0.2 percentage points lower than the previous forecast for the equivalent period,
mainly due to the expected effect of the decline in oil prices.



Table 2

Inflation and interest rate forecasts for the coming year



Bank of Israel Research Department

Capital marketsa

Private forecastersb

Inflation ratec




(range of forecasts)




Interest rated




(range of forecasts)




a) Daily average for the month of June.
Seasonally adjusted inflation expectations.

b) Inflation and interest rate forecasts are
those published after the publication of the CPI reading for May.

c) Inflation rate over the next year (Research
Department: in the four quarters ending in the second quarter of 2018).

d) The interest rate in one year (Research
Department: the interest rate in the second quarter of 2018). Capital markets
forecast derived from Telbor rates.

Source: Bank of Israel.


According to the Research Department’s assessment, the Bank of Israel
interest rate is expected to be 0.1 percent until the first quarter of 2018, and
to start increasing in the second quarter of 2018.
The interest rate is
expected to remain at its current level in the coming year, in order to support
the return of inflation to within the target range. The interest rate is
expected to increase in the second quarter of the 2018, to 0.25 percent, following
a number of quarters in which the inflation rate is expected to exceed 1
percent, and as one-year inflation expectations draw close to the center of the
target range. The interest rate is expected to increase again in the fourth
quarter of 2018 to 0.5 percent.


Table 2 indicates that the forecasts compiled by the Research Department
regarding the interest rate and inflation in the coming year are slightly
higher than the projections of private forecasters and expectations derived
from the capital markets.


Balance of risks in the

Several factors may lead to the domestic economy developing differently
than in the baseline forecast. These include uncertainty concerning the future
development of the exchange rate and the extent to which the appreciation of
the shekel thus far will roll over to prices, as well as uncertainty concerning
the extent to which government measures to reduce the cost of living will roll
over to prices and regarding the possibility that the government may take
further measures of this kind.


Regarding the global environment, even though the international
institutions note that downward risks to growth and world trade have decreased,
uncertainty remains regarding the pace of recovery of these variables. One of
the main challenges facing policy-makers around the world is the creation of
inclusive growth, the absence of which may lead to strengthening calls for
pulling out of trade agreements and for implementing isolationist economic


Figures 1 to 3 present fan charts around the inflation rate, interest
rate and GDP growth forecasts. (The broken line represents the baseline
forecast from April.) The width of the fan is derived from the estimated
distributions of the shocks in the Research Department’s DSGE model.



Figure 1
Actual Inflation and Fan Chart of Expected Inflation

(Cumulative increase
in prices in the previous four quarters)





Research Department Staff Forecast, July 2017



Figure 2
Actual Bank of Israel Interest Rate and Fan Chart of Expected Interest Rate


Research Department Staff Forecast, July 2017


Figure 3

Actual GDP Growth Rate in the Past
Four Quarters and Fan Chart of Expected Growth Rate

(Total GDP over the past four quarters
relative to GDP in the preceding four quarters)


Research Department Staff Forecast, July 2017




The center of
the fan chart (the white line) is based on the Bank of Israel Research
Department assessment. The width of the fan is based on the Department’s
medium-scale DSGE (dynamic stochastic general equilibrium) model. The full fan
covers 66 percent of the expected distribution. The dotted line corresponds to
the previous staff forecast (published in April 2017). In terms of GDP growth
(Figure 3), until March 2017, the dotted line reflects the data and estimates
that were known at the time when the previous forecast was formulated, while
the solid line reflects the updated data and estimates (the difference between
them derives from new and data and revisions by the Central Bureau of
Statistics to the data).

of Israel Research Department.

[1]  An explanation of the macroeconomic staff forecasts compiled by the
Research Department, as well as a review of the models on which they are based,
appear in Inflation Report number 31 (for the second quarter of 2010), Section
3c.  A Discussion Paper on the DSGE model
is available on the Bank of Israel website, under the title: “MOISE: A DSGE
Model for the Israeli Economy,” Discussion Paper No. 2012.06.

[2] According to the
average of the last two weeks of June.

[3] According to the
National Accounts recording rules, taxation on imported vehicles is included in
GDP.  These imports also contribute to
GDP through their effect on importers’ added value.

[4] Our estimate is that
the growth rate net of this effect will be about 3.0% in 2018.