If You Want to Cut, Cut, Don’t Talk: The Role of Formal Targets in Israel’s Fiscal Consolidation Efforts, 1985-2007

Abstract

Each of the seven governments in Israel since the successful 1985 stabilization program stated a commitment to reducing the deficit, easing the public debt burden and curtailing the share of public expenditure in GDP. Beginning in 1992, formal multi-year declining deficit ceilings were also adopted. However, only two periods during the last 22 years, 1985-92 and 2003-06, can be characterized as episodes of sustainable consolidation, and one of them preceded the introduction of the ceilings. The formal targets were often missed, and they underwent frequent revisions, including each time there was a cabinet change. Furthermore, in the 10 years that followed the introduction of the ceilings, little progress, if any, was made toward fiscal consolidation. In light of these developments, this paper concludes that the contribution of fiscal rules to fiscal consolidation or policy credibility in Israel was minor, at most. We also find that the two successful consolidation episodes followed programs that included - at the outset - specific measures sufficient to cut expenditure substantially over the short and medium terms. This absolved future policymakers from the political responsibility for adopting the specific measures needed to meet the formal aggregate targets set by their predecessors. The key lesson, at least in the Israeli context, is that setting formal macro-fiscal targets for future governments is not an effective pre-commitment measure; credibility requires the current policymaker to take all the "heat" and implement the specific - even if gradual - measures that will lower expenditure over the medium term. The pessimistic finding is that such measures were adopted only at times of crisis and after less comprehensive policy changes failed. The optimistic observation is that once implemented, these measures appear to survive cabinet changes and economic fluctuations.