Old-timers here in Israel may remember something called inflation. Until the 1990s it was a part of day-to-day life, just like figuring out how to get from Point A to Point B with a roadmap, buying music at a record store, or thinking first “the Black Plague” when someone mentioned the word “pandemic.”
Except for a small jump between 2008 and 2011 and chronic increases in the housing market, prices in Israel have been rising at most slowly, and in some years have even fallen. But that changed in 2021. Earlier this week the Central Bureau of Statistics reported that the consumer price index rose 2.8 percent last year.
That 2.8 percent should be put into perspective. Yes, it is the highest in a decade and consumer price rises have been gathering pace for more than a year, but inflation is still safely within the target of 1 percent to 3 percent the Bank of Israel targets as an acceptable level (meaning it doesn’t start thinking about taming it by raising interest rates). Moreover, Israel’s CPI is rising slowly compared to many others. America’s CP surged 7 percent higher last year, the biggest increase since 1982, while Eurozone inflation rose 5 percent, a record high for the currency bloc.
The big debate in the economics world today is whether this inflation is transitory or heralding a longer bout of price rises. In most of the world, the transitory camp is on the defensive, if not in full retreat, but here in Israel it remains ascendant, at least in the hallowed halls of the Bank of Israel. “I want to be clear—we are in a different place than countries with inflationary pressures, and this is an important advantage for Israel’s economy at this time,” central bank governor Amir Yaron said two weeks ago.
What makes Israel so special? Let’s start with where it’s not. COVID is far from over, but its economic impact has gradually weakened as the world has learned to live with it and avoid the most onerous countermeasures, namely lockdowns. People who saved money by not going to restaurants or flying on holiday during the first year of the pandemic socked away more savings, and started spending it in the second year.
The result has been surging consumer demand for products, catching the global supply chain unprepared and raising the price of oil – two things that have lifted prices all over the world.
The transitory-inflation model assumes that the supply chain will right itself, consumer demand will eventually moderate and, voila, inflation will return to pre-COVID levels.
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So far, that is turning out not to be the case. In the United States and in Israel, rising prices are spreading beyond the product categories directly affected by supply chain snafus.
In Israel, for instance, the biggest rises in the December CPI included imported products like clothing and furniture but also housing-related services and food. The price of homes, which isn’t included in the CPI and lags it by a month, jumped 1.4 percent.
The case for Israel being different starts with the strong shekel, which gained 3 percent against the dollar and 10 percent against the euro last year. That has only begun to feed into lower prices for imported goods on store shelves. Structural changes, most notably Israeli consumers turning to online shopping to buy lower-priced goods abroad, are also pressing prices lower.
But here’s the first problem. The supply chain problem may not resolve itself as quickly as expected. A lot depends on omicron and whether the world, in particular China, succeeds in ridding itself of the variant without a new one on a similar scale or worse emerging.
A new variant is anyone’s guess. But vis a vis China, things are not looking that promising: China makes a disproportionate share of the world’s stuff, but about 1.5 percent of the population is in lockdown (and that’s real lockdown, not the kind of lockdown-lite Israelis have had to live with in the past). Manufacturers in China and the ones abroad that rely on Chinese components are warning that another round of shutdowns at Chinese factories and ports will exacerbate the existing supply-chain upheaval.
Inside Israel, meanwhile, the picture isn’t looking particularly favorable for transitory inflation either. The economy is in many ways ripe for the imported supply-chain and oil inflation to create a truly inflationary environment, where higher prices spur higher wages and another round of higher prices.
The downside of Israel’s impressive COVID rebound is that the labor market is strong, even too strong. Unemployment in December was 4.1 percent, a low figure by historic standards and moving close to the pre-COVID level of 3.1 percent. The labor market is tight, as evidenced by the growing number of job openings.
The only ingredient missing is rising wages. Wages in October were about 3 percent higher than they were pre-COVID, but up a lot less than that in real terms given the intervening inflation. The labor shortage, however, is going to leave employers little choice but to start offering higher pay. That has already happened big-time in the tech sector, where gaping shortages boosted pay more than 8 percent in 2021. All other things being equal, higher pay inevitably leads to higher prices.
None of this adds up a nightmare scenario of 1970s/1980s-style hyperinflation. The mitigating factors the Bank of Israel likes to point to are for real and the government today is fiscally responsible. If it had the will, it could even undertake structural changes needed to boost labor productivity and bring down costs and prices.
The worrying thing is that policymakers, like the rest of us, are so used to seeing inflation as something for the history books, that they don’t see history repeating itself. The U.S. Federal Reserve woke up to the inflation problem late and is now sending shivers through the financial markets with talk of three interest rate hikes this year, slowing economic recovery. The Bank of Israel should learn the lesson.