Analytical essay on the Norwegian economic policies Written by: Jozsef Gazso Module leader: Peter Barczy Module: Economic Policies Wordcount: 3200 Introduction The purpose of this essay is to examine Norway from the perspective of its economic policies. I am trying to pay special attention to its recession resolution technique in order to understand better why this country could preserve itself against the most severe financial crisis of the last few decades. The reason why I picked Norway as a topic is because I lived half-a-year there as an exchange student.
Apparently, I was there when the crisis was the most threatening to all the European countries (in the autumn semester of 2008). However, I did not notice huge changes in the standards of living. Due to the country’s extensive reserves, it could protect the economy by keeping the prices relatively stable so the changes in demand could remain almost the same because of the purchasing power of the consumers. Apart from that, the recession had a favourable effect as well on the economy, since the price of oil doubled over a short period of time, so Norway, as a country which is heavily related to oil, could gain significant revenues.
For Norway and other countries that are dependent on exports of oil, gas and other commodities, government revenues and current account surpluses are reduced. This will most likely curb the growth of sovereign wealth funds in the near-term future. As Landon T. Jr. (2009) emphasizes, the recession in Norway turned out to be much milder than in most other European countries. This is probably both a result of good economic policies, good financial regulation, and good luck. The monetary policy has been very expansionary since December 2008.
Furthermore, the effects of monetary policy on aggregate demand are probably greater in Norway than in most other European countries due to the combination of large household indebtedness and floating mortgage rates. Fiscal policy also became much more expansionary in 2009 on top of the effects of automatic fiscal stabilisers. Good policies and conservative financial regulation are also – at least partly – factors that explain why there has been neither banking crisis, nor severe problems in any Norwegian bank in 2009.
Norway’s fiscal position is solid. Its large oil and gas revenues, as well as the policy of saving these revenues and investing them abroad through the Government Pension Fund – Global have allowed Norway to run large budget surpluses and government assets. The international financial crisis did temporarily cut off many Norwegian banks from international funding, but this problem was manageable, and was fixed without any sizeable credit crunch.
Finally it was good luck that the oil price doubled in the year of 2009 and that the Norwegian manufacturing sector is relatively small, quite capital intensive, and not much involved in producing consumer durables. Regulatory institutions I find it important to mention, that Norges Bank is Norway’s central bank. The Bank shall promote economic stability in Norway. Norges Bank has executive and advisory responsibilities in the area of monetary policy and is responsible for promoting robust and efficient payment systems and financial markets.
Norges Bank manages Norway’s foreign exchange reserves and the Government Pension Fund Global. The objectives of the Bank’s core activities are price stability, financial stability and added value in investment management. They are a good source of information, because all the materials are perfectly translated into English so the whole policy system is extremely transparent. The basis of this essay is provided by the articles and publications of Norges Bank. The other most valuable source of information is the Statistiks Sentralbyra, in other words the Statistics Norway.
Statistics Norway prepares and publishes all official statistics on Norway and also engages in extensive research. Statistics Norway covers virtually all areas of life in Norway and prepares statistics and analyses on the economy, industrial develpments and demographics. It is responsible for the national accounts and other important economic statistics used in preparing the National Budget and the Government’s long-term program. Other examples of economic statistics are the figures for foreign trade, tax revenues, price inflation, production, employment and unemployment.
Statistics Norway also co-ordinates and collates statistics collected by other institutions, and participates in international co-operation on statistics. A comparison of the forecasts by Norges Bank with those by Statistics Norway show that already in the beginning of 2009, both institutions quickly understood that the Norwegian recession would be much milder than the great international recession. However, there has been a clear tendency that Statistics Norway forecast a persistently lower inflation than Norges Bank for the period 2009 – 2011.
Monetary policy After evaluating Norges Banks monetary policy, Norges Banks assessment of the Norwegian economy over all to be well balanced in the first half of 2009. The two rate cuts in February and March reflected well the deterioration of the outlook of the Norwegian economy. The approved 2009 Fiscal Budget is the most expansionary fiscal budget in more than 30 years, and overall fiscal stimulus in 2009 is estimated at 3 per cent of non-oil GDP. Norges Bank has reduced its key policy rate by a total of 4. 50 percentage points since October 2008 to 1. 5 per cent. Various schemes to provide extraordinary liquidity to the financial sector and various measures to safeguard the credit system have also been implemented. The largest controversy regarding monetary policy in 2009 was probably the rate cut in June, and to a lesser extent in May. By then, the economy had begun showing signs of improvement, the government’s expansionary fiscal policy was just starting to have an impact, and the financial markets had improved rapidly on the back of lower interest rates, government guarantees and ample liquidity.
Along with the strong signs that the economy was improving, there were growing concerns that the extraordinarily low interest rates could initiate a housing market bubble. House prices started to increase in January 2009, and have continued to climb gradually back to their pre-crisis levels. Some leading indicators and the strong recovery in the financial and asset markets suggested an earlier recovery than what Norges Bank emphasized at that time. After the August meeting, Norges Bank communicated clearly its intention to start its exit strategy.
Norges Bank wanted to withdraw the extraordinary measures first and then hike rates. On October 28, Norges Bank hiked rates by 25 basis points to 1. 5 per cent and signalled that rates would be hiked by a further 25 basis points either in December 2009 or February 2010 as for the monetary policy reports is the following: Due to strong economic data, recovering financial markets, rising house prices and a lack of pass-through from the previous policy rate hikes to mortgage and corporate rates, Norges Bank hiked rates in December by 25 basis points to 1. 75 per cent.
The operational target of monetary policy is low and stable inflation, with annual consumer price inflation of approximately 2. 5% over time. During 2009 Norges Bank has given the housing market a great deal of attention in speeches, interviews and other communication. Norges Bank at the end of the year put more weight on the role of house prices in increasing private demand than earlier. This does not mean that Norges Bank is targeting house prices in itself, but rather that sharp movements in house prices gives valuable information about the outlook for aggregate demand.
Monetary policy needs to return to normality. As the economic survey of Norway, provided by OECD (2010) emphasizes, this has in fact already begun and the extraordinary liquidity measures have been phased out, as financial markets no longer need them in order to function. The appropriate pace of tightening will depend on the development of the Norwegian economy and associated inflationary pressures, the fiscal stance and, since Norway is small and very open, the pace of tightening in Europe.
The inflation targeting framework is well adapted to the task, and the authorities should continue to pay attention to the developments of housing and commercial property prices when setting policy interest rates. Norges Bank – example of a transparent Central Bank One important implication of having an inflation targeting Central Bank is that current economic behaviour will depend on expectations about monetary policy. The credibility and transparency of the central bank therefore becomes extremely important.
Norges Bank has the last few years approached the frontier in monetary policy transparency by publishing the projected interest rate path (Monetary Policies of Norges Bank 2009) Since the effect of a monetary policy decision depends on expected future decisions, the projected policy path is an integral part of the monetary policy stance. As Qvigstad J. F, the deputy Governor of Norges Bank stated in seminar (2008), the projected interest rate path, as well as the forecast of the other macroeconomic variables, are updated and published in the monetary policy eports three times a year. Norges Bank has argued against writing a report every quarter, as it leaves very little time for the staff to digest new information and conduct thorough analyses. Yet, Norges Bank Executive Board meets eight times a year. Only on the three occasions that they publish the Monetary Policy report do they update the forecasts. The exception was in December 2008, when the unexpected depth of the financial crisis required new forecast for the expected policy stance.
Norges Bank has also decided not to publish minutes. Rather than voting they have a “collegial”, monetary policy committee, where the members of the Executive Boards make unanimous decisions. Currently, Norges Bank has decided to “speak with only one voice”. This has implied that only internal members (the Governor and Deputy Governor) have discussed the monetary policy decisions or issues related to the operation of monetary policy in public. Implication of inflation targeting in Norway
As the world economy appears to be emerging from the worst financial crisis and deepest, global downward move in 75 years, policymakers, regulators, and academics are focusing intensely and appropriately on ‘lesson to be learned’, with particular attention paid to how movements in asset prices should influence the conduct of monetary policy. In the years leading up to the crisis, there had developed a broad consensus among monetary policy makers on the role that asset prices should play in an inflation targeting strategy.
As Bernanke, et al (2001) writes in his study, inflation targeting is a recent monetary policy strategy that encompasses five main elements: 1) the public announcement of medium-term numerical targets for inflation; 2) an institutional commitment to price stability as the primary goal of monetary policy, to which other goals are subordinated; 3) an information inclusive strategy in which many variables, and not just monetary aggregates or the exchange rate, are used for deciding the setting of policy instruments; 4) increased transparency of the monetary policy strategy through communication with the public and the markets about the plans, objectives, and decisions of the monetary authorities; and 5) increased accountability of the central bank for attaining its inflation objectives. The list should clarify one crucial point about inflation targeting: it entails much more than a public announcement of numerical targets for inflation for the year ahead.
According to this consensus, asset prices will affect monetary policy to the extent that they are deemed to affect the forecasts of the central bank’s target variables that is, inflation and the output gap. A central bank following this approach may well wish to lean against swings in asset prices, but only if these swings influence the forecast of inflation or possibly, the output gap. Over the last decade monetary policy in Norway has gradually evolved from exchange rate targeting to fexible inflation targeting. In addition, globalization has affected the Norwegian economy substantially over the last decade. Monetary policy has increasingly been challenged on how to respond to supply side shocks, including shocks to productivity, the degree of competition both in product and labour markets, and terms of trade shocks.
Norway have assessed how is the best to design and implement regulatory authority in the wake of the financial crisis. The responsibility for financial stability was divided between the Ministry of Finance, Finanstilsynet and Norges Bank. Norges Bank publishes its assessment of the outlook for financial stability in semi- annual reports. In addition the Bank holds meetings with Finanstilsynet and the Ministry of Finance to discuss the status of the financial system and the need for government measures. Finanstilsynet is an independent government agency that builds on laws and decisions emanating from the Parliament (Stortinget), the Government and the Ministry of Finance and on international standards for financial supervision and regulation.
Through its supervision of enterprises and markets, Finanstilsynet strives to promote financial stability and orderly market conditions and to instil confidence that financial contracts will be honoured and services performed as intended. However the recession is more or less over, Norges Bank continues and enhance its responsibility for analyzing, reporting, and communicating information about significant interactions between and risks among financial institutions, as part of its Financial Stability Report. By having regular meetings with Finanstilsynet and the Ministry of Finance, it will enhance and contribute to the macro prudential supervision in Norway.
Nevertheless, these institutions have developed a few models that can serve as tools to enhance this lately mentioned macro prudential supervision in Norway. As Brubakk et al (2006) underlines in their memo the fact that, a “macro model cannot provide definitive answers”. It is more likely to help to ensure that the projections are consistent within the organisation and the policymakers’ judgement calls are thought through and consistent over time. The authors also mention that, no single model can be superior for all purposes. For example, it is unlikely that a single model would be preferred for forecasting developments in both the very near term and the medium- to long term.
Thus, there are benefits to a suite of models approach, where the comparative advantages of different model types are exploited. In practice, current information about economic developments, various economic models and judgment are all employed in the forecasting process. NEMO – the medium-term forecasting model Since November 2005, all macroeconomic forecasts from Norges Bank have been based on their own predictions regarding expected future interest rate setting. This forecasting analysis makes use of a structural model (NEMO), but this model is primarily suited for medium term analysis of the effects of monetary policy on the macroeconomy.
Norges Bank’s forecasts for the first few quarters are largely based on current statistics, information from Norges Bank’s regional network and forecasts obtained from a number of short-term statistical and econometric models. The published projections in the monetary policy reports are the result of an overall assessment based on both models and judgment. SAM – Short-term forecasting From the memorandum of Jore A. S, et al (2008) we can get a clear picture about that Norges Bank has the last few years developed and implemented forecasting methods of model combinations used in the monetary policy operations. These forecasts are unconditional forecasts. At the heart of the evaluation and combination of short-term forecasts is a set of programs collectively referred to as SAM – the System for Averaging Models.
Forecast combination become popular in central banks as a mean to improve forecasts and to alleviate the risk of selecting poor models.. Government Pension Fund Global I think that Government Pension Fund is so closely related to the economic policies of Norway that is definitely worth to mention when it comes to discuss how could this country avert the biggest threats of the financial crisis. Without this organization, probably policies would have not been enough to resolve the financial difficulties. The Fund is operating through the Norges Bank as an investment bank that enables Norway to generate high level of income independent from non-renawable sources.
According to Jafarov, et al (2007), The Fund was established as a tool to support prudent management of Norway’s petroleum wealth. One purpose is to shield the non-oil economy from price fluctuations. The Fund is also a long-term savings instrument. It will help to cope with future financial commitments linked to an ageing population. Accumulation of capital in the Fund reflects the depletion of a non-renewable resource, which is exchanged for financial assets through the Fund’s investments. By setting up the Fund, it became possible to establish a path for production of oil and gas that is independent of the profile for petroleum revenue spending.
Norges Bank manages the fund on behalf of the Ministry of Finance. In 1998, the Bank established a separate investment management unit, Norges Bank Investment Management (NBIM), which manages the fund. The alternative to a fund would have been to directly regulate production by putting a conservative upper limit on annual extraction. Furthermore, to effectively shield the non-oil economy, and to make sure that private sector investment decisions could be made independently of the public sector’s saving of petroleum wealth, the Fund is only invested abroad. This also enhances the expected return on government wealth and contributes to diversification of risk.
As the IMF Staff describes the preliminary findings on the changes of Norwegian fiscal policy in 2001, the Norwegian parliament approved tge fiscal policy guidelines stipulating that the annual transfer from the Fund to the fiscal budget – that is annual spending of oil money – should correspond to the expected real return on the Fund. The expected real return is estimated at 4 per cent. The point of reference for the spending rule is a normal cyclical situation. In the event of particularly high capacity utilisation, spending should be lower than 4 per cent, whereas in a cyclical downturn, somewhat higher spending may be appropriate. By this rule, Norway could reach a position, where it can hedge itself against most of the bad consequences of changes in global economy. The government now owns a fair share of the global business sector.
This represents real value that will provide a return reflecting both global economic growth and the risk related to fluctuations in the invested equity prices. Since summer 2008, the Ministry of Finance has allowed the Fund to hold up to 10 per cent of a company’s shares. The largest ownership interests were in British Mondi (8. 7 per cent), Australian Babcock & Brown Infrastructure Group (7. 8 per cent) and Finnish UPMKymmene (5. 8 per cent). As you can see from this list, these companies are not those who were mostly affected by the crisis. This implies a thoughtful selection process of prospective companies that the Pension Fund would invest money in. In bond markets, the largest issuers are sovereign states.