Øystein Olsen: Monetary policy from the perspective of a
commodityexporting country
Dinner speech by Mr Øystein Olsen, Governor of Norges Bank (Central Bank of Norway), at
the European Central Bank, Frankfurt am Main, 19 November 2012.
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Please note that the text below may differ from the actual presentation.
I would like to thank the ECB for hosting this conference on a topic that is a core interest for
us in Norges Bank. It is a pleasure to visit the ECB in Frankfurt. In my remarks tonight, I will
give you a glimpse into the historical background for our economic framework and the
conduct of monetary policy in Norway today.
As you know, Norway is in the fortunate position of having ownership rights to large natural
resources. Oil was discovered in the North Sea in 1969. Back then, it soon became clear that
oil and gas would be a source of substantial wealth - and government expenditure and social
programmes expanded rapidly.
By 1977, a surplus on the current account had turned into a deficit of 12 percent of GDP. The
deficit was three times larger than that of Italy and Spain last year. Predictably, we also
experienced a contraction in the non-oil tradable sector. Fiscal policy had fuelled a
boom-bust economy and had to be reversed and tightened. Many Norwegians experienced a
decline in real income.
When oil prices fell in 1986, the Norwegian economy was hit again. We experienced a
collapse in house prices, as well as a severe banking crisis, a foreign exchange crisis, fiscal
deficits and high inflation. Hermod Skånland, the Norwegian central bank governor at that
time, summarised the causes of the crisis as "bad banking, bad policy and bad luck."
Efforts were now focused on bringing public spending under control, while large parts of the
banking system were nationalised. Unemployment soared. Monetary policy aimed at a stable
krone exchange rate, resulting in high real interest rates. But with a binding commitment to a
fixed exchange rate, inflation was brought under control.
The banking crisis and the downturn in the early 1990s made clear how vulnerable our small
open economy was to terms-of-trade shocks and that our banks needed to be properly
regulated. Furthermore, it became evident to policymakers how hard it is to conduct
countercyclical economic policy, or even to avoid being procyclical.
In the following years, structural reforms were implemented in order to increase growth
capacity, including a major general tax reform. The tax code had already been tailored to
capture the economic rent in the petroleum sector - the petroleum company tax rate is about
80 percent. Confidence in monetary policy gradually gained a firmer footing, after a
succession of devaluations had come to a halt. Inflation and the real interest rate declined,
and cost competitiveness improved considerably.
Norway has not experienced a really pronounced economic downturn since the crisis around
1990. We have been helped by good luck, in terms of favourable terms-of-trade shocks and
a relatively flexible labour market, which has allowed labour supply to grow. The economy
was fairly robust when the financial crisis hit in 2008, in sharp contrast to our situation back in
the 1980s. A more robust policy framework has improved the functioning of the economy.
The Act relating to the Government Petroleum Fund was passed in 1990. At the time, in the
midst of a deep recession, many doubted that any petroleum revenues would ever be saved.
Projections indicated that offshore petroleum production would peak in the early 1990s.
However, the government's cash flow from the petroleum sector started to increase sharply,
and a strategy for the management of the fund was needed. The policy guidelines were
clarified in 2001, and rules governing the interaction between Norway's petroleum wealth and
fiscal policy were established:
All government revenues from the oil sector are to be transferred to the fund.
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• According to the fiscal rule, the government must only spend, on average over the
cycle, the expected real return on the fund - stipulated at 4 per cent - in the annual
budget.
• All of the fund's capital is to be invested in international markets.
After nearly three decades of spending the petroleum revenues more or less as they came
in, the fiscal rule enabled the government to save for future generations. At the same time,
the rule made fiscal policy more robust: By decoupling spending from current petroleum
revenues, the fiscal rule provides for a gradual and sustainable phasing-in of petroleum
revenue spending. The guidelines ensure the necessary flexibility to allow automatic
stabilisers to work, and they allow for careful countercyclical policy. The savings plan has
remained intact and the Fund has now reached a size of nearly NOK 4 trillion, or 130 percent
of GDP.
When the fiscal rule was introduced in 2001, Norges Bank was charged with the task of
keeping inflation low and stable. Thus, our traditional fixed exchange rate policy was
abandoned. A clear division of responsibilities between monetary and fiscal policy was now
established.
Norges Bank's conduct of monetary policy is geared towards low and stable inflation. The
operational target of monetary policy is consumer price inflation of close to 2.5 per cent over
time. When setting the key policy rate, we also take into account the impact of the interest
rate on output and employment. In addition we give weight to the risk that a prolonged period
of low interest rates can lead to elevated risk-taking and excessive debt accumulation in the
household and business sectors. Inflation targeting has become more flexible.
The present economic situation in much of the rest of Europe stands in contrast to ours. In
Norway, domestic activity is high, and particularly so in the oil industry and the construction
sector. Unemployment remains low and stable. But the Norwegian economy is not
unaffected by the turbulence abroad. Weak demand from Europe and a strong krone
exchange rate are holding back some segments of the Norwegian export industry.
Even though capacity utilisation is above a normal level, the key policy rate in Norway is low
because inflation is low and interest rates abroad are very low. These factors are limiting how
quickly the key policy rate in Norway can be raised.
Despite some disturbances to the economy over the past decade, inflation in Norway has
been low and stable, showing that monetary policy has functioned effectively. With firmly
anchored inflation expectations, Norges Bank has also been able to consider economic
stability when setting the key policy rate. We are constantly learning more about the
interaction between monetary policy and financial stability, and as mentioned inflation
targeting in Norway has become more flexible. At the same time, we cannot overburden
monetary policy. In balancing the various considerations, we will adhere to the primary
objective of monetary policy - low and stable inflation.
It is too early to say whether Norway has really managed to contain the Dutch disease. Our
framework has still not been tested against a large and persistent negative oil price shock.
From a high starting point, wages have grown faster in Norway than among our trading
partners for the past ten years. Our currency has appreciated considerably in real terms. I
believe the real test of our framework will come when the present boom in the petroleum
industry - at some point - is reversed.
Thank you for your attention.