The Bank of Israel published a box from its forthcoming Annual Report for 2024 examining how the rise in the government budget deficit relative to the pre-war period affected inflation expectations. It estimates the deficit increase contributed around 0.5–1 percentage points to the increase in inflation expectations. Government spending was elevated in 2024, mainly due to the war, resulting in a high deficit and a significant increase in public debt. The analysis notes that expansionary fiscal policy can raise inflation through stronger domestic demand, particularly when supply constraints are present, and that a high deficit can also push up inflation expectations if markets assess that future debt repayment will be difficult via taxation or spending cuts. By focusing on inflation expectations rather than actual inflation, the box uses high-frequency data to identify the deficit’s inflationary impact and frames the effect as a fiscal-policy-related risk channel for higher inflation given the role of expectations in shaping actual inflation.
Bank of Israel 2025-03-23
Bank of Israel research estimates wartime deficit increase lifted inflation expectations by 0.5–1 percentage points
The Bank of Israel's 2024 Annual Report highlights that the rise in the government budget deficit, mainly due to war-related spending, contributed 0.5–1 percentage points to increased inflation expectations. The analysis underscores that expansionary fiscal policy can elevate inflation through heightened domestic demand and that a high deficit may raise inflation expectations if markets doubt future debt repayment feasibility.