Classical economics, a field of study built on assumptions and rationality, often finds itself challenged in non-routine situations like wars. In such cases, economic forecasts become incredibly complex due to the high level of uncertainty surrounding how the conflict will unfold and its potential impact on the economy. This is what Israel is dealing with right now in the aftermath of the October 7 tragedy. The current position raises concerns about the war’s duration, its consequences, and the involvement of other parties such as Hezbollah or Iran. Uncertainty like this can have far-reaching economic implications.
To address these challenges, economists look to past wars and operations for guidance. By analyzing historical data, experts attempt to estimate the expected damages. Alex Zabezhinsky, the chief economist at Meitav, estimated that in the case of a 60-day war without Hezbollah’s massive involvement, Israel could incur approximately NIS 68 billion in damages. This would result in a 1.5% loss of GDP, a 3% deficit in 2023, and a 4% deficit in 2024, not to mention the harm to overall economic growth.
According to BDO’s chief economist, Chen Herzog, the weekly direct military expense is at least NIS 1.5 billion. Therefore, as this expense was not factored in during budget planning, it will need to be dealt with by readjusting state finances in the coming weeks.
The Israeli government has two key tools at its disposal for managing such a crisis: fiscal policy and monetary policy. The “iron rule” of economics suggests that during times of economic crisis, the government should employ expansionary policies to stimulate economic activity. However, choosing between fiscal or monetary measures and determining the appropriate dosage can be challenging.
The Bank of Israel, responsible for monetary policy, focuses on maintaining inflationary stability and price stability. They are cautious about devaluation, as it can accelerate inflation. Nevertheless, some argue that the central bank’s fear of an inflationary outbreak might be overstated, especially when considering factors like an economic slowdown, public sentiment, and other moderating influences on inflation.
The Bank of Israel’s stance places the primary responsibility for addressing the current crisis on fiscal policy. Their recommendations include reallocating coalition funds, opening the 2024 budget to fund growth-generating areas, and injecting funds into the economy responsibly.
The challenge lies in the Bank of Israel’s optimism regarding Israel’s economic future, based on strong pre-war economic indicators, and their recommendation for caution. In times of uncertainty, it might be more prudent to err on the side of caution by directing more resources into the economy, as the potential costs of not doing enough could be much higher in the long run.
Timeliness is essential. Delaying financial support can lead to disruptions in trust, causing businesses and households to suffer, as we saw during the COVID-19 pandemic. Additionally, raising taxes to increase state revenue and reduce deficits is not a recommended solution, as it can harm the overall economy. Instead, the government should focus on cutting or reducing certain government expenses while financing any deficit through state bonds.
In conclusion, the cost associated with conducting war is multifaceted, with economic uncertainties and policy dilemmas at the forefront. The government must carefully navigate the complex economic landscape by considering historical data, policy options, and the ever-present need for timely and decisive action to minimize the long-term economic impact of the conflict.
Main article photo: F-35 arrives in Israel after being purchased from Lockheed Martin (photo credit: LOCKHEED MARTIN)