The Effect of Fiscal Policy and its Components on GDP in Israel

This article is the first attempt to use the VAR technique to investigate the effect of fiscal policy in Israel on GDP, aggregate demand in the private sector, private consumption and private investment. The research is carried out using quarterly cross-section data for the period 1986-2008. Among the key findings: • A positive shock of one percent in public consumption is expected to increase GDP by 0.2 percent, aggregate demand in the private sector by 1 percent, private consumption by 0.3 percent and private investment by 1.3 percent. In terms of level, an increment of 1 shekel in public consumption will increase GDP by 70 agorot, which means that the main finding supports the Neo-classical model based on it the level of the fiscal multiplier is less than 1. • A positive shock of one percentage point in the statutory indirect tax rate is expected to reduce aggregate demand in the private sector by 1.3 percent, private consumption by 0.6 percent and private investment by 2 percent. In contrast, most of the tests found that a shock in the statutory direct tax rate had no effect on these variables. Various components of public consumption have different effects. A positive shock in government local defense consumption has a moderate but persistence effect, in contrast with a positive shock in civilian government consumption, which has a sharp but short-term effect. A positive shock in public sector purchases has a more persistent and larger effect than that of a positive shock in total public sector wages.