Last month, the government raised fuel prices by 40 percent overnight. Israel's severe housing shortage will not be eased when the purchase price of apartments goes up by an estimated 20 percent this month. That many more buyers will simply have to go on living in substandard housing or meet the higher prices, which already range from high to staggering, even by American standards.

THE PRICES of a variety of food and household goods are expected to go up 10 to 20 percent this month as well. The minister of energy is asking for a 35 to 40 percent increase in electricity rates and probably will get his way.

The government seems unable to come to grips with the economic situation. In fact, the economic crisis has triggered an internal crisis within the governing Likud coalition.

Finance Minister Simcha Ehrlich reportedly attempted to resign from the government last month, but was dissuaded by Prime Minister Menachem Begin on the grounds that if Ehrlich resigned, Begin would also resign and the government would fall.

Ehrlich, whose Liberal Party holds 15 Knesset seats and four Cabinet posts in the Likud coalition, has received intense criticism from his own party because of the economic situation.

Begin's hospitalization and extended recuperation from a stroke appear to have dampened the political crisis, but there is little expectation that the problem has disappeared. A no-confidence vote in the Knesset July 31 failed 55-48, with the government unable to command a full majority of the parliament's 120 members.

The Liberals appear to have patched things over for the time being after a stromy meeting at the end of last month, but the political situation is tenuous at best.

LIFE, OF COURSE, GOES ON HERE. The streets of the urban centers are busy with traffic despite a gasoline price of about $2.30 a gallon. The shops are well stocked with consumer goods - color televisions, stereos, refrigerators. The prices are exorbitant - $10,000 for a very small, simple car, almost $1,000 for a refrigerator - but people are buying. With inflation running rampant, saving money makes little sense.

The country seems in a kind of fin de siecle mood. Everyone knows the merry-go-round cannot go on indefinitely and that a crunch is coming, but no one seems to know what to do about it.

All of this is played out against a background of deeper, subtler malaise. The furor that erupted here earlier in the summer over the government's policy of permitting new settlements on the West Bank subsided after the Supreme Court temporarily stopped work on the Eilon Moreh settlement near Nablus. But that issue will be revived if the court decides to let the government proceed.

Political polarization seems to be increasing. Critics of the government's settlement policy find their patriotism called into question by the political right, while the government's critics are not averse to using terms such as "fascist" to describe those within and outside the government who want to press forward with settling the West Bank.

Older Israelis, some of whom played important roles in the founding of the state 31 years ago, now wonder aloud where things went wrong. Whether this sense of disillusionment is well-placed or simply the exhaustion of advancing age remains an open question.

PEACE NEGOTIATIONS with Egypt proceed - too slowly for some, too fast for others. Beneath the surface is apprehension that Egyptian President Anwar Sadat is playing a clever game and that Israel, in its eagerness to make peace with its Arab neighbors, is being taken for a ride.

The United States' revival of the prospect of recognizing the Palestine Liberation Organization in return for the PLO's moderating its position only serves to heighten anxieties here at a time when relations between the United States and Israel seem to be deteriorating.

From an Israeli perspective, Special Ambassador Robert Strauss' raising the question of Jerusalem for negotiation sooner rather than later is puzzling. If there is one question on which Israelis of almost all persuasions more or less agree, it is that Jerusalem - divided from 1948 until 1967 - must remain united.

"If Jerusalem is divided again," one woman said last week, while arguing with feeling that Jews and Arabs must come to terms with each other, "I don't want to live."

These clearly are not the best of times for Israel. Whether they are the worst, despite peace and the illusion of prosperity, is something else.

"We've had difficult times in the past and gotten over them," Jerusalem's ebullient mayor, Teddy Kolleck, said not long ago. "One thing for sure: it's never dull here."