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Opinion Freezing prices will harm economic growth Israel today

2023-01-08T07:24:41.563Z


Excess demand and supply problems are the real causes of inflation • This is not the time for superficial and harmful moves


These days, the Ministry of Finance, together with the Prime Minister and his advisors, is discussing the possibility of subsidizing certain products and services in order to prevent them from becoming more expensive.

The supporters of such a subsidy claim that the water, electricity, property tax and fuel are, among other things, "inflation generators".

These, according to them, cause a wave of price increases for many other products in the economy - and if we just freeze them - inflation will stop (or at least moderate).

There are two main factors that generate the current inflation.

The first is excess local demand, resulting from a strong labor market with a high demand for workers alongside low unemployment and significant wage increases in most sectors of the economy.

This excess demand is expressed in an increase in private consumption and in the purchase of properties, including apartments, which ultimately raise housing prices as well.

The second factor is problems on the supply side, which mainly stem from the global situation: the war between Russia and Ukraine, the exit from the Corona crisis, and other reasons that caused problems in the global supply chains.

These also cause many raw materials to become more expensive, including coal used to produce electricity and oil used to produce fuel.

The combination of these two factors - the strong demand here and the problems on the supply side in the world - caused a continuous increase in prices and inflation.

The responsibility for fighting inflation lies mainly with the Bank of Israel, and its main tool for lowering inflation is raising interest rates.

A higher interest rate reduces consumption and investments in the economy in the short term, thereby weakening inflationary pressures.

The government, for its part, can help the Bank of Israel in its work, or hinder it.

If the government decides to subsidize the price of electricity and the like, while increasing government spending, it will produce an additional increase in local demand.

As a result, inflationary pressures will increase, not decrease.

In addition to this, the "freezing of the generators of inflation" will also create many distortions in the economy, which will harm growth, thus reducing the disposable income of households.

The prices of the various products and services are used in a modern economy as an important signal for consumers and producers.

When a factory can produce the same product with two different technologies, the first is electricity-intensive and the second is capital-intensive (for example using a more advanced machine, which consumes less electricity), it may choose the first technology if the price of electricity is low and the second technology if the price of electricity is high.

The majority of the public tends to believe that a policy of "freezing the causes of inflation" will help stop inflation, and is unaware that such a policy will only exacerbate the pressures and harm the public itself. The role of economists is to reflect this to the public, and to convince the policy makers not to be tempted by superficial and harmful moves. 

The writer is the head of the Ecclesiastical Forum for Economics, formerly the Chief Economist at the Ministry of Finance

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Source: israelhayom

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