Summary: KEY ISSUES Context. The economy is growing at a moderate pace. Abstracting from the impact of new large-scale natural gas production, GDP growth is estimated to have moderated to about 2½ percent in 2013, owing in large part to weak investment and exports. Some pick up is expected in 2014, but the underlying momentum is weaker than before. Despite notable progress, Israel’s public debt (68 percent of GDP) remains high, while continued house price increases pose risks of a boom-bust cycle in the housing market. Policy priorities. The key policy challenge is to maintain near-term growth at potential, while preventing the build-up of imbalances, strengthening resilience to shocks, and ensuring long-term sustainability. Monetary policy. Given the still uncertain external environment and headwinds to growth from an appreciation of the shekel and planned fiscal tightening, monetary policy should remain accommodative for now. Macroprudential policy measures should be further tightened to minimize the risk of a boom-bust cycle in the housing market. If growth prospects improve more than expected, the policy stance should be gradually normalized. Fiscal policy. Bold fiscal consolidation measures embedded in the 2013–14 Budget are welcome, but further adjustment will be required for 2015 and beyond to anchor sustainability, along with a strengthening of fiscal institutions. Financial stability. The financial system remains relatively sound. In line with the recommendations of the 2012 FSAP Update, a Financial Stability Committee needs to be established, with a clear focus on macroprudential policies in normal times. Legal reforms aimed at strengthening the framework for bank resolution should be legislated as soon as practicable. Structural reforms. Further action is required to improve the business climate and boost competition in the non-tradable sector. In addition, it will be important to enhance the participation of rapidly growing Israeli-Arab and Ultra-Orthodox Jewish (Haredi) populations in the labor force to bolster the economy’s long-term potential and to reduce poverty and inequality.

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