Mr Gjedrem focuses on monetary policy challenges in Norway  (Central Bank Articles and Speeches, 3 May 1999)
Central bank: norges | Type: speech | Date: 1999-05-03

## Mr Gjedrem focuses on monetary policy challenges in NorwayArticle by Mr. Gjedrem, Governor of Norges Bank, the Norwegian central bank, publish the Norwegian daily Aftenposten on 3 May 1999.In

Norway, fiscal policy has a prominent role in stabilising growth in produc employment.

The Government Petroleum Fund shall serve as a buffer so that fluctuati the government's oil revenues do not influence the mainland economy, but only have an on capital exports.

The local and centralised income settlements determine wage Monetary policy instruments are oriented with a view to maintaining a stable krone e rate against European currencies.If the government budget stabilises the domestic economy, wage growth is kept on a p the level in Europe, and fluctuations in oil revenues are absorbed by the Petrol Norges Bank stands a good chance of ensuring exchange rate stability through mon policy.However, this has not been the case since 1996.

The government budget has not ma sufficient contribution to smoothing growth in domestic demand and production, wage has been substantially higher than in other countries, and oil revenues have fluctua Furthermore, it seems that the krone is easily exposed to the contagion effects of t international markets.

The krone exchange rate has fluctuated in spite of Norges Ban use of instruments.

Developments in recent years indicate that Norges Bank cannot f movements in the krone exchange rate.

## InstrumentsExtensive and persistent exchange-market interventions to influence the krone excha have, in Norges Bank's experience, yielded poor results.

Market participants may such transactions as an interesting opportunity to make a profit, which may trigger capital movements.The interest rate is therefore Norges Bank's most important instrument.

Higher inte normally lead to a strengthening of the krone exchange rate.

However, interest rates such a high level that this contributes to a cyclical downturn.

This would under credibility of monetary policy and result in downward pressures on the krone.

In this lower interest rates may contribute to stability and strengthen the krone.Along the same lines, lower interest rates will normally lead to a weakening of the if interest rates are so low that this contributes to inflation, this will also und policy credibility, and the krone will be unstable.

## The objective and the mandateMonetary policy can provide a nominal anchor for the economy.

Since 1986 the autho have focused on exchange rate stability.

Price inflation has been low.

Yields on securities indicate no expectations of rising inflation.

The perception of market seems to be that Norway will not resume a policy resulting in high inflation.The political authorities formulate Norges Bank's mandate for the conduct of monetar policy.

The mandate, formulated in the regulation issued in the spring of 1994, states: monetary policy to be conducted by Norges Bank shall be aimed at maintaining a stable exchange rate against European currencies, based on the range of the exchange rate maintained since the krone was floated on 10 December 1992.

In the event of significant changes in the exchange rate, policy instruments will be oriented with a view to returning the exchange rate over time to its initial range.

No fluctuation margins are established, nor is an appurtenant obligation on Norges Bank to intervene in the foreign exchange market' (m italics).The regulation is based on the fact that we have a floating exchange rate.

The first se means that this is a managed float.

Instruments are to be oriented towards maintaining a krone exchange rate against European currencies.

Norges Bank chose to define the referen European currencies as the euro from 1 January 1999.The last sentence in the regulation distinguishes our system from a fixed exchange rate r in that no fluctuation margins have been established around a central rate.

To the exte system calls forth associations with a fixed exchange rate regime, the concept initial range should be interpreted as a broad indication of a central rate around which the krone fluctuate.The second sentence refers to significant changes in the exchange rate in relation to the initial range.

It is important to note that no specific values have been defined for significant changes , such as the fluctuation margins of 2¼ per cent, 6 per cent and 15 per cent used by th countries in their exchange rate regime.

Significant must be given an economic content.

A reasonable interpretation is that exchange rate movements must not influence expectati concerning price and cost inflation to the extent that changes in the exchange rate b self-reinforcing.The expressions with a view to, over time, aimed at and based on also show that Norges Bank has considerable scope for exercising discretion.

## Exercising discretionIn exercising this discretion, Norges Bank places emphasis on the fundamental conditions achieving exchange rate stability over time.

Price and cost inflation must be brought do the level aimed at by the euro countries.

At the same time, monetary policy must not in contribute to a deflationary recession.The regulation's requirement with regard to returning the exchange rate to its initial may - if stretched - imply an element of 'parity policy' * .

For example, in a scenario with a sharp and prolonged fall in oil prices, the krone exchange rate may remain outside the i range for a longer period.

If Norges Bank responds by raising interest rates in order t the krone back to its initial range, monetary policy could lead to a recession tha undermine confidence in the krone.

Similarly, after an appreciation a situation may whereby a movement of the exchange rate back to the initial range may require that inte rates be reduced to such a low level that this results in higher inflation.

However, thi weaken the basis for exchange rate stability over time.

Hence, Norges Bank cannot with o eyes orient its policy instruments towards triggering higher inflation or a deflat recession.

If a situation arises whereby Norges Bank is not able to return the exchangeits initial range without such consequences, the Bank will inform the government au that measures other than those available to the central bank are required.The present exchange rate range has more or less prevailed for more than ten years basis of its analyses, Norges Bank does not find grounds to maintain that this range appropriate one.

## Interplay between policy areasThere

are considerable differences between Norway and other industrial countries structure of the economy, the organisation of decision-making processes and the for of economic policy.

In Norway, income and wage determination is fairly centrali number of fora to foster cooperation between the social partners have been establish special legislation which makes it easier to resolve labour conflicts than in countries.

The central government budget is used more actively to stabilise e developments, partly because the Norwegian state has substantially greater economic than other countries.A salient feature of the Norwegian economy is the importance of oil revenues, whi fluctuate considerably from year to year.

The Government Petroleum Fund was establis serve as a buffer against fluctuations in oil revenues.

It dampens the impact of ch prices on the Norwegian krone.In recent years, a number of countries have switched to a monetary policy regime ba target of low inflation.

With a passive fiscal policy, monetary policy then in pract a greater role in the stabilisation of economic developments.In Norway, we have a different institutional structure and monetary policy objecti the krone has been stable and inflation shows signs of rising, Norges Bank's first r inform the political authorities that measures other than those available to the cen required.

Norges Bank would do the same if the requirement of returning the krone initial range could no longer apply.

In a country with an inflation target, the would deal with this itself, without first consulting with the government authoritie as mentioned, Norges Bank cannot with open eyes inflate or deflate the economy.Norges Bank's mandate must be viewed in the light of the emphasis placed by the gover authorities on conducting a disciplined, but active fiscal policy.

The mandate giv Bank a basis for conducting a monetary policy that provides a nominal anchor f Norwegian economy.*As used in the Norwegian debate, 'parity policy' refers to the monetary policy of the 1920s, Norwegian krone was forced back to its former gold parity by means of highly deflationary p (Footnote not included in Norwegian text).