Svein Gjedrem: The economic outlook
Address by Mr Svein Gjedrem, Governor of Norges Bank (Central Bank of Norway), to
invited foreign embassy representatives, Norges Bank, Oslo, 8 April 2010.
* * *
The address is based on the assessments presented at Norges Bank's press conference following the Executive
Board's monetary policy meeting on 24 March, Monetary Policy Report 1/10 and previous speeches. Please note
that the text below may differ slightly from the actual presentation.
Excellencies, Ladies and Gentlemen,
Since our meeting a year ago, the international economy has begun to recover from the
financial crisis. Norway has weathered the crisis better than most countries. In my
presentation today, I would therefore like to discuss how underlying economic forces have
benefitted the Norwegian economy through two "golden decades". I will comment on the
Government Pension Fund Global and how the financial crisis has influenced its investments
and returns. A key lesson from the crisis has been the need for international cooperation and
collective action. Before concluding, I will therefore highlight the importance of multilateral
and statutory-based institutions for sound international economic governance.
The Norwegian economy - two golden decades
The economic downturn in Norway proved to be mild. Norway has not experienced a
pronounced downturn since the crisis around 1990, when a cost crisis, an employment crisis
with a sharp increase in unemployment and a decline in output, a currency crisis, a fall in
property prices and a banking crisis all occurred at the same time.
A long upturn followed from 1992 to 2008. National income rose by an annual rate of 5.4 per
cent in this period, far higher than the rate of output growth in the mainland economy. Income
growth was even higher than in the post-war period in the 1950s and 1960s.
Major structural reforms
Behind these favourable developments were the major structural reforms of the 1980s and
1990s that resulted in an expanded production capacity in the Norwegian economy. Capital
and credit markets were liberalised. It became easier to establish and build up new
businesses. The EEA and WTO agreements resulted in stronger competition and increased
flows of goods and services, labour and capital. As a result of the 1992 tax reform, the
welfare state could be funded with reduced impact on wealth creation. The framework
conditions for the electricity market, telecom market, aviation and broadcasting were
changed. Trade was liberalised. State-owned companies were listed on the stock exchange
and new forms of managing public agencies were developed. Industrial policy no longer kept
unprofitable enterprises afloat. Subsequently, the business sector experienced a long period
of high productivity growth.
Moreover, shifting forces have driven the economy. In the wake of the crisis around 1990,
labour costs decreased to a low level compared with Norway's trading partners and wage
settlements were moderate. In 1995, the cost level was 10 to 12 per cent below Norway's
average for the oil age from 1970 until now.
In addition, real interest rates in Norway fell markedly through the 1990s from high levels.
This was because the fixed krone exchange rate regime maintained through the period
managed to bring down inflation and inflation expectations.
Moreover, growth in public spending was rapidly reduced once business sector activity had
recovered.
Economic shift
Over the past decade Norway experienced an economic shift. The cost level began to rise.
This was related to the sharp improvement in Norway's terms of trade at the time and a
gradual pickup in growth abroad. Prices for Norwegian exports such as oil, gas, metals,
minerals, fish and freight, rose markedly, while prices for imported goods fell. From 2003 to
2008, terms-of-trade gains alone pushed national income up by more than 20 per cent, or a
good 4 per cent per year.
Institutions and mechanisms had also been put in place to manage the sharp increase in
income. Norway's sovereign wealth fund, the Government Pension Fund Global, and the
fiscal guidelines were established with the express purpose of making the mainland economy
less susceptible to fluctuations in the oil price. Improved terms of trade, higher revenues and
increased government spending contributed to a stronger krone and a shift in real resources
towards sheltered sectors. At the same time, the fiscal rule provided a basis for growth in
business sectors other than the oil industry and the public sector through the decade.
Norway had a plentiful supply of labour from new EU member countries and experienced
several years of high output growth. At the same time, the inflation target for monetary policy
adopted in 2001 provided a sound anchor for inflation expectations.
Autumn 2008
In 2008, the expansionary period was drawing to a close. Costs had risen sharply, credit
growth had been strong, the key policy rate had been raised and house prices had started to
fall. Petroleum revenue spending over the central government budget had increased, but
employment in traditional industries was still high. Despite Norway's high cost level,
merchandise exports and supplies of goods and services to the oil industry held up well due
to strong demand.
Instead of a gradual slowdown, economic growth came to an abrupt halt in autumn 2008
when the global financial crisis peaked. Demand for Norway's exports fell markedly.
Norwegian banks proved to be sensitive to the credit freeze in global money markets and
stopped providing new loans.1
However, Norwegian banks were not as exposed to loan losses - at home and abroad - as
banks in other countries. The economic downturn proved to be milder in Norway than
elsewhere, but the banking sector seems also to have performed its craft fairly well.
Moreover, government and central bank liquidity provision measures were effective. The
liquidity crisis passed quickly and a solvency crisis did not occur in Norway's banking system.
The rapid rebound in oil prices and a weaker krone provided a boost to the economy. The
interest rate was lowered sharply to a historically low level and public spending increased
markedly. The downturn was milder than we had expected when the interest rate was
reduced - partly because oil prices proved to be higher than expected and partly because
the policy measures were more effective than we had dared to assume. Therefore, we now
expect to raise the policy rate at a gradual pace back to more normal levels.
The emerging economies were hardest hit by the global crisis in the late 1990s. This time
OECD countries were the most severely affected. But Norway largely escaped both crises.
Overall, output fell less in Norway than in other countries and is recovering more quickly.
Unemployment has remained low.
Norway is not unique
We cannot expect underlying forces to be as beneficial in the future. Real interest rates
cannot be expected to fall. Another sharp boost to export prices is not likely. In addition,
there are vulnerabilities in the Norwegian economy. Labour has never been as costly, and
businesses may be at a disadvantage in tenders and competitions given the current high
level of spare capacity in other countries. Moreover, it has never been more profitable to
relocate activities abroad.
During the upturn, Norwegian firms fared well in spite of high costs, thanks to efficiency
gains, high turnover volumes and price increases. Despite the high cost of Norwegian labour,
there has been virtually full employment. Markets will be more demanding ahead. Despite
the floating exchange rate, our cost level cannot be expected to fall to any great extent as
economic conditions are weaker in other European countries than here.
The industrial structure in Norway's relatively small economy is different from that of other
advanced economies. The emergence of new Asian market economies is beneficial for
Norway owing to its sizeable commodity exports and freight transport. This is also reflected in
Norway's equity market.
The value of Norwegian listed companies correlates closely with the value of companies in
emerging market economies. Norway is vulnerable to a slowdown in growth in Asia. In such
a scenario, commodity prices might fall and the terms of trade deteriorate. Norway's high
cost level could at the same time make it difficult for the business sector to shift to new
markets.
Petroleum revenue spending
Government petroleum revenue spending influences Norway's cost level and trade
conditions in international markets.
According to the fiscal policy guidelines, petroleum revenues should be phased gradually into
the economy, approximately in pace with the expected real return on the Government Pension
Fund Global, which is estimated at 4 per cent per annum. In periods of high or rapidly rising
unemployment, the use of petroleum revenue can be increased, and, inversely, fiscal
retrenchment is needed during periods of high economic activity and resource scarcity.2
It now appears that capacity utilisation in the Norwegian economy may return to a normal
level in one and a half to two years - and with a somewhat lower unemployment rate than
today. A different path can be met with an interest rate response. Our understanding of the
fiscal rule is that the government budget for 2012 or at the latest for 2013 should aim at
bringing down petroleum revenue spending to 4 per cent of the capital in the Pension Fund.
The scale of petroleum revenue spending - growth in public expenditure - is important for
developments in competitiveness, also referred to as the real krone exchange rate, in the
long term. But, in the short term, the krone exchange rate can vary widely, and it depreciated
in autumn 2008 when capital sought safe havens. This helped Norwegian manufacturing in
the first phase of the downturn. Since then, the krone has appreciated considerably.
In 2009 and 2010, government petroleum revenue spending shows a substantial increase
and foreign investment via the Pension Fund a decrease. This leads to higher commercial
demand for the Norwegian krone which directly contributes to its appreciation.
More fundamentally, the krone is influenced by the difference in activity at home and abroad
and how fast the interest rate has to be increased in Norway to keep inflation low and stable.
The economic geography of Norway will change over the next 10 to 15 years. The domestic
cost level and the real economy crisis abroad will put pressure on jobs and businesses in
manufacturing communities.
And as mentioned, the most important, perhaps the only, instrument available to the
authorities in addressing this challenge is to restrain petroleum revenue spending.
Petroleum revenue investment
Let me now turn to the Government Pension Fund Global.
It took a generation from the time the first oil field was discovered in the North Sea until the
government began to set aside economic rent. The Government Petroleum Fund was
established in 1990 and the first transfer to the wealth fund was made in 1996.
Each year since that time, as a savings plan, the government has set aside a portion of
current income from petroleum activities as deposits in the Fund. Today, the value of the
Fund is around NOK 2.6 trillion, or about 115 per cent of 2009 GDP in Norway.
New transfers will likely be made to the Fund for perhaps a little more than another decade.
The Fund will in that case continue to grow and may reach twice its current size. The actual
build-up of the Fund may span a short generation.
The Fund will thereafter enter a new phase. With lower revenues from oil and gas activities, it
will no longer receive capital transfers from the government. When oil and gas revenues
cease to provide the government with economic rent, only the annual real return on the Fund
can be used on a permanent basis.
In the mid-1990s, oil prices were around USD 20 per barrel and revenues were set aside.
This year the oil price must be over USD 50 per barrel to generate sufficient oil revenues to
make transfers to the Fund. We must be prepared for wide variations in oil prices, and the
first year without transfers of oil revenues - but rather withdrawals - may be approaching.
Increase in equity share
Under the Fund's investment strategy, more equities are purchased when equity prices fall and
fewer when prices rise. Thus, the Fund purchased a large volume of equities in the period from
2001 to 2003 and during 2008 and 2009. As a result the Fund currently holds a little more than
13⁄4 per cent of listed European equities and roughly 1 per cent of all listed equities.
The Fund's stock holdings are spread across different countries, sectors and regions. In the
early days of the Fund, the benchmark portfolio was restricted to investments in Western
Europe, North America, Japan, Brazil and a limited number of countries from all over the
world. Today the benchmark portfolio is more diversified and includes a large number of
countries globally.
In 2008 it was decided to increase the share of emerging market assets in the Fund's
benchmark portfolio. Thus, investments in these markets have grown.
The government has stated that the expected annual return on the Fund will be close to 4
per cent over time. Since its establishment, the average return has been 2.7 per cent. It was
only a little more than a year ago that we witnessed the steepest fall in global capital markets
in our time. By maintaining the Fund's risk profile it is fairly probable that the average return
will gradually approach 4 per cent again.
Last year was the best in the Fund's history. Gains in international equity and fixed income
markets led to a record annual return of 25.6 per cent in 2009.3 However, developments in
2009 must to a large extent be viewed in light of the financial crisis and are mainly due to a
reversal of the negative results in 2007 and 2008.
Multilateral approach to global challenges
Finally, let me turn to the international economic order and developments in multilateral
institutions over the past few years.
The international order and Norway
In recent years, increasingly assertive non-statutory bodies have emerged in the area of
international economic and financial collaboration, most notably the G20.When the global
financial crisis unfolded, the G204 rose to the task. Nevertheless, I believe that the role of
non-statutory bodies and the statutory institutions, such as the International Monetary Fund
(IMF)5, must be reconsidered to promote the necessary multilateral approach to global
governance.
Norway has a long-held tradition of participating actively in multilateral cooperation and
institutions has actively backed the multilateral responses to the financial crisis. As a global
investor with an open market economy, Norway has a strong and vested interest in the
wellbeing of global financial markets. This interest is shared with most market participants, large
and small. We have a common interest in a market-based international order, supporting a
level playing field and sound economic governance.
Lessons from the crisis
A key lesson from the global crisis is the need for multilateral cooperation and collective
action. It relates to the framework for polices on prevention, resolution, reform and
implementation. It also relates to the institutional set-up. The IMF has played a pivotal role in
presenting the initial lessons from the crisis, in providing finance to countries with temporary
balance of payments needs, and in preparing the overall framework for the international
policy response. When the good times return, we must avoid memory failure and remind
ourselves of these facts of life.
Shaping the global governance structure
At their summit in Pittsburgh last September, the G20 leaders "...designate[d] the G20 to be
the premier forum for our international economic cooperation".
As an effective and powerful group, the G20 featured prominently in the broad international
efforts to stabilise the global economy in late 2008 and early 2009. Without its prompt and
comprehensive action, the consequences of the crisis would have been much worse. Among
the G20 measures of 2009 were the efforts to strengthen confidence in international financial
institutions, the IMF in particular, to permit it to play an effective role in tackling the crisis.
Indeed, the G20 increasingly uses the IMF as an instrument of its policy implementation.
Nevertheless international policy cooperation has moved out of statutory bodies and into
groups of a select few, bypassing established channels and fora. Other countries are called
upon to contribute to efforts agreed by the G20.
Policy action and global imbalances
The large global imbalances that contributed to the current crisis are likely to widen anew, if
they are not addressed effectively. This would again put at risk the stability of the global
economy. Global and prompt policy action is therefore warranted yet again. To this end, the
G20 has embarked upon an unprecedented exercise in policy collaboration with the IMF.
Still, the G20 lacks the legitimacy that historically has been associated with a truly multilateral
framework. Its ambitious economic cooperation should be anchored in a multilateral
institution. The IMF is the logical choice. With G20 merging its activities with those of the
IMF, both will attain wider acceptance and legitimacy.
Success in the ambitious tasks of the G20 can only be welcomed by the rest of us. However,
it is a weakness that the members of the G20 represent only themselves. Virtually entire
groups of countries and regions are left out. They have no voice and no representation in the
work of the G20 or in the institutions which it chooses to set up to further its agenda. This is
at variance with the principles of multilateralism and international cooperation that have
prevailed since the end of the Second World War. Over time, this could easily weaken not
only the G20 process, but also the IMF as it will be perceived as increasingly guided and
controlled by the G20.
A strong institution like the IMF must be at the centre of multilateral economic and financial
cooperation. Virtually all the countries of the world participate and are represented in the
IMF. To be able to continue to play an effective role, the IMF needs to enjoy confidence and
trust, and to be seen as having a legitimate structure of governance. Last but not least, the
IMF needs to be financially strong, to have at its disposal financial resources commensurate
with its tasks, including the ability to provide prompt and significant financial support when
needed.
In closing, I would emphasise certain key principles:

First, systemically important countries need to collaborate effectively on
consistent economic policies. Their success is vital not only for their own good,
but also for that of others, including small open economies.

Second, this collaboration should be anchored in a multilateral and
statutorybased system of representation, for example through constituencies, where
smaller countries would participate, even if indirectly.

Third, the constituencies should have rotating representation, where small
countries, at least periodically, could participate directly.
Thank you for your attention.