ECONOMIC PERSPECTIVES
THURSDAY
Annual address by Governor
17 FEBRUARY
Øystein Olsen to the Supervisory
2022
Council of Norges Bank
perspectives 2022
INTRODUCTION
Today, nearly to the day, a hundred years have passed since the first annual address
was delivered. The governor at that time, Nicolai Rygg, painted a gloomy picture. The
speculative boom in Norway during the First World War had created a bubble that
burst. A wave of losses ensued. The economy was marred by stagnation and
bankruptcies. The problems in the business sector spread to the banks.1
If banks had failed, the problems facing businesses would have intensified. It was
therefore crucial to make sure the banking system weathered the crisis. There was no
disagreement about that. The main issue under heated debate was who should bear the
losses and who should guarantee new capital.
Not many weeks after the first annual address, Norges Bank had to step in to rescue
one of the big banks. When the next big bank encountered problems, Norges Bank was
again called upon to intervene. But Nicolai Rygg now put his foot down. The loans
provided should be guaranteed by the State and not by Norges Bank.
Not only did Nicolai Rygg have to deal with a banking crisis, but also an erosion in the
value of the Norwegian krone due to periods of excessive money supply. He was
determined to return the value of the krone back to its initial gold value, the nominal
anchor of the time. That goal was achieved, albeit at a cost, namely weaker
competitiveness, recession and high unemployment (Chart 1).2 The policy of gold
parity illustrates that it can be costly for monetary policy to have its eye overly
focused on a numerical target.
Chart 1 Gold parity led to weaker competitiveness and higher unemployment
ECONOMIC
PERSPECTIVES
Real exchange rate Unemployment. Percent
Real exchange rate. Unemployment. Percent
17 FEBRUARY 2022
120 120 10 10
115 115
8 8
110 110
105 105
6 6
100 100
4 4
95 95
90 90
2 2
85 Weaker competitiveness 85
80 80 0 0
1924 1925 1926 1927 1928 1929 1924 1925 1926 1927 1928 1929
Source: Eitrheim et al. (2016) Source: Grytten (2008)
Source: Eitrheim et al. (2016) Source: Grytten (2008)
The events around the time of the first annual address raised issues that are still
relevant today. What is the role of the central bank, and how far does it extend in
normal times and at times of crisis?
NORGES BANK IS BANKER TO THE BANKS
The central bank's overarching goal is to promote economic stability. That lies at the
core of our mission to serve the public interest. Low and stable inflation is a
precondition for economic stability. Other important preconditions are stability in the
financial system and a safe and efficient payment system. The banks' settlement
system, the very core of the payment system, is operated from the central bank.
Norges Bank is banker to the banks. Banks can turn to us as lender of last resort when
other credit channels dry up. Norges Bank conducts continuous oversight of the
financial system. When large shocks hit the economy, our workday abruptly changes.
The central bank then takes on a key role in stabilising the markets.
Shocks stem from various sources. In the 1920s the problem was insolvent banks. The
2008 financial crisis engulfed the entire global financial system. Frozen capital
markets threatened even solvent banks. At an early stage, there were fears that the
pandemic that hit us in 2020 might also trigger a financial crisis. Three different
situations, but one common endeavour for central banks: The financial system had to
be protected.
At the start of the pandemic, access to market liquidity was narrow, and the price of
available capital was disproportionately high. Norges Bank stepped in and provided
additional liquidity support to the banks (Chart 2). The purpose was to contribute to
smooth market functioning and ensure that the policy rate cuts passed through to the
interest rates faced by households and businesses.
Chart 2 Additional liquidity support during the pandemic
ECONOMIC
F-loans. In billions of NOK
PERSPECTIVES
17 FEBRUARY 2022
200 200
Ordinary F-loans
Extraordinary
F-loans
150 150
100 100
50 50
0 0
Jan-20 Apr-20 Jul-20 Oct-20 Jan-21 Apr-21 Jul-21
Source: Norges Bank
The actions taken build on several important principles:3
First, the risk transferred to the central bank should be as low as possible. If the
support schemes are too favourable, we risk undermining the banks' own motivation
to maintain sound credit and liquidity policies. Those who take risks must also be
prepared to bear the losses.
Second, loans should only be given to banks that are solvent. The central bank's role is
not to help recapitalise banks. Again, there is an important underlying principle here.
If we are to take risk with our collective public money, then government funds must be
used. And the decision to do so must be taken by a democratically elected body.
Third, both the scale and duration of support measures targeting financial markets
should be limited. Large-scale and protracted support schemes can impair normal
market mechanisms.
In keeping with the third principle, the extraordinary measures that Norges Bank
introduced to support the smooth functioning of financial markets during the pandemic
have now been unwound.
THE PRIMARY OBJECTIVE OF MONETARY POLICY IS LOW
AND STABLE INFLATION
Low and stable inflation is a main objective for Norges Bank. Persistently high
inflation is costly for society. It leads to uncertainty about the value of money and is an
obstacle to planning. At the same time, some inflation is beneficial because it provides
economic flexibility.
During Nicolai Rygg's time the krone was pegged to gold, the anchor. Today, we aim
to keep annual consumer price inflation at close to 2 percent over time (Chart 3). But
our eye is not focused on the inflation target alone. As long as there is confidence that
inflation will remain low and stable over time, variations around the inflation target
entail limited economic and social costs.
Chart 3 Low and stable inflation is a primary objective
ECONOMIC
Consumer price index. Twelve-month change. Percent
PERSPECTIVES
17 FEBRUARY 2022
16 16
Inflation
Inflation target
Five-year moving
average
10 10
4 4
-2 -2
1980 1985 1990 1995 2000 2005 2010 2015 2020
Sources: Statistics Norway and Norges Bank
Norway has a flexible inflation targeting regime.4 Monetary policy also aims to
promote high and stable employment and mitigate the build-up of financial
imbalances. High employment is beneficial for economic growth, for financing social
benefit schemes and for the financial and living situation of individuals. Financial
imbalances can lead to a pronounced economic downturn. This is why we will,
especially in an environment of very low interest rates, also take into consideration the
risk of imbalances building up in the credit and housing markets. Even so, monetary
policy cannot take primary responsibility for maintaining financial stability, which
must be ensured by means of regulation and supervision of financial institutions.
MONETARY POLICY CAN CONTRIBUTE TO PROMOTING
EMPLOYMENT
The inflation target is symmetric. We seek to avoid both too high inflation and too low
inflation. On the other hand, the objective of high and stable employment is
asymmetric - the more people in employment, the better. Since unemployment more
readily moves up than down, we should respond quickly by cutting the policy rate
when economic activity abruptly declines.
For the same reason, we should be patient about raising the policy rate to avoid
restraining the recovery too early. Chart 4 shows the probability of finding a job one
year after being registered as unemployed - whether as short-term or long-term
unemployed, on a labour market programme, on initial time-limited benefit or
permanent disability.
Chart 4 More people find work when demand is high
ECONOMIC
Transition to work by labour status. Percent
PERSPECTIVES
17 FEBRUARY 2022
60 60
Normal situation
High demand
50 50
40 40
30 30
20 20
10 10
0 0
Short-term Long-term Labour market On time-limited On disability
unemployed unemployed measures benefit benefit
Sources: Norwegian Labour and Welfare Administration (NAV), Statistics Norway and Norges Bank
Persons aged 20-60. Average for the years 1996-2017. Time of measurement: Q4
Long-term unemployed: Persons who were also unemployed in the two previous quarters.
There are two things to note. First, there is a higher probability of finding a job in
periods of high labour demand than in a normal situation. Second, this also applies to
those that are not registered as unemployed, which may include persons at risk of
being permanently excluded from the labour market.
High and stable employment is therefore not only about keeping unemployment low,
but also about the size of the labour force. We must prevent periods of economic
decline from leaving scars in the form of lower labour supply. By slowing the rate
tightening cycle somewhat so that labour demand increases, the central bank can
contribute to promoting employment.
But when employment rises sharply and rapidly, wage growth has a tendency to
accelerate. Inflation usually follows suit. As shown in the Chart 5, we have previously
experienced that the rise in prices for domestically produced goods and services
accelerates in the wake of a sharp rise in employment.
Chart 5 When employment rises rapidly, inflation tends to follow suit
Four-quarter change. Percent
5 5
Employment growth,
moving average
4 4
Domestic goods and
services inflation
3 3
six quarters later
2 2
1 1
0 0
-1 -1
-2 -2
1993 1996 1999 2002 2005 2008 2011 2014 2017
Sources: Statistics Norway and Norges Bank
social benefit system and labour market policy. An increase in labour supply will
create more room in the next round for an increase in employment without causing
inflation to accelerate.
THE LABOUR MARKET IMPROVED RAPIDLY
Monetary policy is a first line of defence in stabilisation policy. Economic downturns
are countered by rate cuts (Chart 6). But if severe shocks hit the economy, other areas
of economic policy must play a key role. When the pandemic hit Norway, we cut the
policy rate to zero. At the same time, fiscal support measures were implemented on a
scale unprecedented in modern Norwegian history. The aim was to cushion the
downturn and support households' and firms' income.
Chart 6 Economic downturns are countered by rate cuts
Norges Bank policy rate. Percent
1.75 1.75
1.5 1.5
1.25 1.25
1 1
0.75 0.75
0.5 0.5
0.25 0.25
0 0
-0.25 -0.25
2015 2016 2017 2018 2019 2020 2021 2022
Source: Norges Bank
The actions taken could not, however, prevent a situation where a large number of
workers were suddenly out of work. The risk that the pandemic would leave lasting
scars on the labour market was an important reason why we kept the policy rate at a
historically low level for more than a year.
Now that we can look at the years 2020 and 2021 in the rear view mirror, we can see
that employment in Norway picked up more quickly than expected (Chart 7).
Employment exceeded the pre-pandemic level in autumn 2021, and the same degree of
monetary policy stimulus was no longer needed. We have now raised the policy rate
twice, and we have signalled a further rise.
Chart 7 Activity picked up faster than expected
ECONOMIC
Number of employed excluding furloughed. In thousands
PERSPECTIVES
2950 2950 17 FEBRUARY 2022
Projections
May 2020
2900 2900
Projections
December 2021
2850 2850
2800 2800
2750 2750
2700 2700
2650 2650
2600 2600
2015 2016 2017 2018 2019 2020 2021 2022 2023 2024
Sources: Statistics Norway and Norges Bank
INFLATION IS RISING
Two years after the outbreak of the pandemic, we can see that activity in the
Norwegian economy has recovered firmly. The same can be said for many of our
trading partner countries.
But something might be changing. Following many years of low inflation, we are
again seeing high inflation figures both in Norway and among our trading partners
(Chart 8). A key driver of domestic inflation has been unusually high electricity prices
through winter, which have resulted in high electricity bills for both households and
firms. Much of the increase is likely to be temporary, and electricity prices are
expected to come down in spring. But the winter's electricity prices may serve as an
early warning. The green transition probably means that we will be seeing higher and
more volatile energy prices than we have been used to.
Chart 8 High inflation in many countries
Consumer prices. Twelve-month change. Percent
8 8
US
7 7 UK
Euro area
6 6 Norway
5 5
4 4
3 3
2 2
1 1
0 0
-1 -1
2015 2016 2017 2018 2019 2020 2021 2022
Sources: Refinitiv Datastream and Statistics Norway
of goods. Freight rates and commodity prices have surged, and the associated increase
in costs is being passed on to other prices. Labour markets have also tightened in
many countries. Wage growth in the United States has accelerated after many years of
moderate pay increases for US workers.
There is therefore growing international concern about whether inflation will remain
elevated, and several central banks have started the tightening cycle sooner than
indicated earlier.
The longer the mismatch between supply and demand persists, the greater the risk of
higher inflation. With fewer pandemic-related restrictions, some of the demand will
likely shift back from goods to services, which could dampen pressures in goods
markets. On the other hand, households have substantial savings that can be used to
increase consumption when society reopens.
In the conduct of monetary policy, central banks look through temporary changes in
inflation. An increase in individual prices, as we recently experienced with electricity
prices, reflects shortages that monetary policy cannot, and should not, attempt to
counteract. There is also a tradition in Norway for the social partners to largely look
through unexpected fluctuations in prices and costs. Inflation is only likely to
accelerate if broad groups, whether price setters or wage earners, demand
compensation for higher costs. In that case, the central bank's task is to tighten
monetary policy.
The rise in the inflation rate has come after several decades of low global inflation.
Increasing international trade and competition is one important reason for the slow rise
in prices in that period. High labour force growth, partly owing to labour immigration,
has also had a dampening impact on wage growth in many countries.
These drivers may be changing direction. We saw signs that globalisation was slowing
down even before the pandemic. The pandemic may also have amplified a trend
whereby an increasing number of businesses see the need to secure their own supply
lines and locate more of their production chain closer to their customers. At the same
time, labour supply is growing more slowly in advanced economies as the population
ages.
The period where some countries struggled with too low inflation appears to be over,
and central banks may be facing more demanding trade-offs between meeting the
inflation target and supporting employment.
VOLATILITY IN THE VALUE OF THE SOVEREIGN WEALTH
ECONOMIC
FUND MUST BE TAKEN INTO CONSIDERATION
PERSPECTIVES
17 FEBRUARY 2022
Alongside its central banking tasks, Norges Bank has another important mission,
namely the management of Norway's sovereign wealth held in the Government
Pension Fund Global (GPFG).
Since the first capital transfer in May 1996, the GPFG has grown larger than anyone
had imagined (Chart 9). And the investments have paid off handsomely. Cumulatively
over the entire period, we have now earned more on investments abroad than the
transfers to the GPFG. We have more than doubled our money.
Chart 9 The money is more than doubled
GPFG. In billions of NOK
16000
16000
Total value
Deposits
Returns
12000 12000
Petroleum revenue
spending
Exchange rate
8000
8000
4000
4000
0
0
-4000 -4000
1998 2001 2004 2007 2010 2013 2016 2019
Sources: Ministry of Finance and Norges Bank
The fiscal rule ties petroleum revenue spending to the value of the GPFG. As its value
has increased sharply, petroleum revenue spending has followed suit (Chart 10). In the
years prior to the pandemic, one krone in six of government expenditure was covered
by the GPFG.
Chart 10 The GPFG finances a large portion of government expenditure
Structural non-oil deficit as a share of government expenditure. Percent
30 30
25 25
20 20
15 15
10 10
5 5
0 0
2001 2006 2011 2016 2021
Sources: Ministry of Finance and Norges Bank
, p g pi
substantial government wealth also entails challenges that must be addressed.
ECONOMIC
PERSPECTIVES
17 FEBRUARY 2022
More than 50 years as an oil nation have taught us an important thing: Oil prices are
volatile. This is why it was important to establish the petroleum fund mechanism and
the fiscal rule. We have succeeded in shielding government budgets from widely
fluctuating oil revenues.
Today a large portion of Norway's oil and gas wealth has been transformed into
investments in global securities markets. The risk to the nation's wealth that oil price
volatility previously posed has been replaced by the risk of financial market volatility.
Chart 11 quantifies the expected normal volatility of the GPFG's value, as a measure
of the risk we are facing. The calculation shows that we can expect that GPFG returns
will normally vary within a range of plus or minus 10 percent, which amounts to about
NOK 1 200 billion at current market value. But not that infrequently, every six years
or so, we can expect to lose more than that.
Chart 11 We are not immune to volatilty
GPFG. Expected absolute volatility. Percent and in billions of NOK
20 1400
Risk in percentage
terms (l.h.s.)
1200
Risk in NOK terms
(r.h.s.)
15
1000
800
10
600
400
5
200
0 0
2013 2015 2017 2019 2021
Source: Norges Bank
We cannot shield ourselves from such an outcome. Volatility is the normal state of
equity and other securities markets. Nor are there any guarantees that markets will
recover quickly and capital be built up again in the years following a fall. The GPFG
is invested in a wide range of assets, countries and companies. We can therefore
benefit from broad-based market upturns, but we must then also ride out the
downturns.
The certain knowledge that the GPFG's value will fluctuate has important
consequences for the fiscal stance. The fiscal rule provides for spending on average the
expected real return over time. As long as the GPFG is growing, it is tempting to
increase spending in tandem. It is not as easy to reduce spending in years with
negative returns. In the event of steep declines, nor would that be sensible.
The fiscal rule still has a role to play as a long-term guideline for fiscal policy. The rule
supports the idea of the GPFG as an intergenerational fund. But rather than aiming for
the 3 percent path, we would be wise to set petroleum revenue spending below the
expected real return. Otherwise, we run the risk of regularly eating away at the
GPFG's capital.
equities bull market may be nearing an end. In a transitional period, higher interest
rates will also reduce the value of the GPFG's fixed income portfolio.
Developments ahead may also be marked by demographic changes, tension between
countries and lower global trade integration. Moreover, we are facing a necessary
transition to a low-carbon economy.
Whatever happens abroad will still leave its mark on the GPFG. No investment is
completely safe, as history has shown.
In 1904, the Norwegian government set funds aside in the State Reserve Fund to be
used only "in extraordinary circumstances or in an emergency". When it was dissolved
in 1925, it was nearly empty. Creative accounting must take some of the blame. Yet it
didn't help either that it was invested in only a few assets - mainly UK, French and
German government bonds - investments regarded at the time as absolutely safe. After
the First World War, the value of German and French government bonds was close to
zero, wiping out much of the State Reserve Fund's assets.5
The investment strategy behind the GPFG stands in stark contrast. The fundamental
principle underlying the strategy is risk diversification. This lessens the potential for
an across-the-board value decline in GPFG assets. Underlying this principle is also the
recognition that we cannot predict how the world will evolve.
We must be open to and prepared for the unexpected. We have seen how sudden
events, such as the Global Financial Crisis and more recently the pandemic can lead to
a fall in the value of the GPFG. Looking ahead, our management model may face new
challenges. Analysing different scenarios of possible outcomes is certainly useful, but
making major strategic changes based on a particular vision of the future is still a risky
undertaking. Broad diversification should continue to be a pillar of the strategy.
CONCLUSION
Nicolai Rygg delivered his final annual address on 12 February 1940. When the
tradition was reinstated after the war, it was under a new governor. The time also
represents an important turning point in Norwegian economic policy.
The ideal of an independent central bank with decision-making authority over the
instruments at its disposal had been abandoned. The Bank's primary task was to carry
out the Government's decisions, and the policy rate was geared towards objectives
other than low and stable inflation. It was to take forty years for the pendulum to
swing back. In 1986, responsibility for setting the policy rate was returned to Norges
Bank. The Bank was tasked with maintaining a fixed exchange rate. Again, the
objective was price stability.
economic policy guidelines adopted in 2001: the fiscal rule for fiscal policy and an
inflation target for monetary policy.
This system has served us well for more than 20 years, during a period when the
economy has also been buffeted by severe shocks. But we have learned lessons along
the way. One lesson is that strictly rule-bound economic policy is not fit for purpose.
For interest rate setting, this means that the conduct of monetary policy must be
flexible and manage trade-offs between the outlook for inflation and developments in
output and employment. And the fiscal rule can no longer serve as a strict budget
guideline from one year to the next.
Norges Bank has faced different challenges in its 206-year history. A lot has changed
since Nicolai Rygg's day. But economic cycles will continue to shift, and we need to
be prepared for new, unforeseen crises. The central bank's primary mission remains
the same: to promote economic stability and ensure confidence in the monetary
system.
Thank you all for your kind attention during my time as Governor of Norges Bank.
Central bank governors come and go,
But not the central bank, as you well know.
Come what may.