Jarle Bergo: The Norwegian economy - possibilities and challenges
Address by Mr Jarle Bergo, Deputy Governor of Norges Bank (Central Bank of Norway), at a seminar
hosted by Agder Research Foundation, Arendal, 12 May 2005.
Please note that the text below may differ slightly from the actual presentation. The address is based on the assessments
presented at Norges Bank's press conference following the Executive Board's monetary policy meeting on 20 April, Inflation
Report 1/05 and on previous speeches.
The can also be found on the website of the Norges Bank.
Charts in pdf-format
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The Norwegian economy is growing at a solid pace and there are prospects that growth will remain
high. The recession was mild after the previous expansion culminated in 2002. The period of relatively
high cost inflation in Norway came to an end without production being impacted to the same extent as
during the recessions in the early 1980s and around 1990. One of the main reasons for this is
probably that low inflation in the 1990s and current monetary policy have anchored expectations of low
and stable inflation among economic agents.
Together with private consumption and fixed investment in the petroleum sector, traditional exports
were an important factor underlying growth in the early stages of the recovery that started in the first
half of 2003. Prices for many of our main export goods have risen as a result of strong growth in new
markets. However, growth in Norway's total exports excluding oil and gas is lower than import growth
among our trading partners.
Mainland fixed investment has gradually become an important driving force in the upturn. Investment
has picked up in most industries and growth was stronger than expected towards the end of 2004.
Norges Bank's regional network has registered rising investment in all industries. Petroleum
investment in particular appears to be growing at a rapid pace. This may continue to boost mainland
output.
Even with a strong upturn in the mainland economy, the increase in the number employed has been
relatively modest. Productivity rose fairly sharply in the first few quarters after economic growth picked
up. Normally, when productivity growth is strong, enterprises again begin to hire new staff. The current
upturn has lasted about two years. The fairly low level of growth in employment, as measured by the
number of employed, must be seen in the light of the sharp decline in sickness absence through 2004
after rising for several years. The decrease in sickness absence has increased the supply of labour to
companies and reduced the need for new employees. Measured in person-hours worked, employment
growth was solid last year. Person-hours worked increased by 2.2% from 2003 to 2004. A corollary to
the increase in the number of person-hours worked is partly reduced sickness absence and partly
three more working days in 2004 compared with 2003.
Inflation has been low in recent years. Initially, the fall in prices for imported consumer goods pushed
down underlying inflation. After a period, the rise in prices for domestically produced goods and
services also slowed. Inflation measured by the CPI-ATE reached its lowest level in the first months of
2004. Inflation remained at less than 1⁄2% until after the summer before picking up in the autumn.
Inflation moved up primarily as a result of a slower decline in prices for imported consumer goods. The
depreciation of the krone since the beginning of 2003 has contributed to these developments. In
addition, the rise in prices for domestically produced goods and services stabilised, and towards the
end of 2004 there was a tendency towards a higher rise in prices for these goods and services.
Prices for imported consumer goods fell more than expected at the beginning of 2005, while the
tendency towards a more rapid rise in prices for domestically produced goods and services has
persisted. So far in 2005, inflation measured by the CPI-ATE has been around 3⁄4 per cent.
The other Nordic countries have also experienced falling inflation. Inflation has declined, and is now
relatively low in Sweden, Denmark, Finland and Norway. The year-on-year rate of underlying inflation
in these countries was around 1 per cent in March.
A common feature of the low level of inflation in the Nordic countries seems to be the sluggish trend in
prices for imported consumer goods, even though developments have not been entirely the same in all
the Nordic countries.
Reliable information about the economic situation is important when setting the interest rate.
Information from the regional network is a useful supplement when assessing the current economic
situation.
Region South reports high growth in activity in all industries. The market outlook is positive and more
broadly based than previously. Growth in the export industry and the construction sector is expected to
remain solid, although somewhat weaker than earlier. On the other hand, there is now more optimism
in the retail trade and service sectors.
Capacity utilisation varies across industries. There is little excess capacity in the construction sector.
Skilled labour in particular is in short supply. There is some excess manufacturing capacity, while
considerable excess capacity is reported in retail trade and services.
The export industry is expecting a slower rise in prices for export products next year, while in general a
stable rise in prices is expected in other industries.
Profitability is increasing, particularly in manufacturing for the domestic market, the construction sector
and service industries.
Developments in employment show a mixed picture. Manufacturing employment is rising at a solid
pace, while the level of employment is stable in the other sectors.
Growth in the global economy will have an impact on developments in the Norwegian economy in the
period ahead. Global growth is expected to moderate somewhat this year and stabilise in the years
ahead. In the US, growth seems to have remained solid in the first quarter. Heightened uncertainty
with regard to developments in the US economy and weaker results for some large companies have
resulted in falling prices on world stock exchanges. Developments are weaker in the euro area -
unemployment remains high and consumer confidence has fallen. In Japan, it appears that growth will
be positive from the fourth quarter of 2004 to the first quarter of 2005.
Growth in Asia, except Japan, and in Central and Eastern Europe is expected to moderate but to
remain strong.
The outlook for growth in different regions indicates that the imbalances in the global economy, with
large deficits in the US and large surpluses in some other countries, will persist. Low growth in the
euro area and Japan is weakening the prospect of a gradual correction. This increases the risk
associated with these imbalances. Increased imbalances in addition to high oil prices and volatile oil
markets are contributing to the uncertainty surrounding developments in the global economy.
There are particularly large imbalances in the US balance of trade and current account. This partly
reflects the US federal budget deficit. Moreover, US households have a high level of consumption and
a low level of saving. Strong demand in the US has sustained growth in the world economy. The deficit
in the US is matched by surpluses in Europe and Asia.
A persistent deficit has pushed up US foreign debt to a high level.
The US population is growing faster than that of other OECD countries. This may suggest that saving
in the US is somewhat lower and investment somewhat higher than in other countries, but the impact
is now considerably greater than implied by demographic factors alone.
The imbalances may continue for a period. International capital markets are deep and liquid with an
ample supply of credit for US borrowers. If creditors begin to fear a fall in asset prices and withdraw,
this may still trigger substantial corrections. This may lead to higher interest rates and perhaps also a
fall in US equity markets that spills over to other countries' financial markets. In that case the dollar will
also depreciate. The household debt burden in the US may be another source of instability if
households abruptly reduce both housing demand and consumption.
The US is not the only source of trade imbalances. They also reflect very low growth in continental
Europe and the largely export-based growth in Asian countries. Countries other than the US must
therefore also contribute in order to prevent growth in the global economy from faltering.
With limited domestic growth capacity and high unemployment, many industrial countries are poorly
equipped to cope with a weaker dollar and lower US demand. The challenges are perhaps particularly
demanding in Japan and some large European countries.
There is also a risk that large imbalances in world trade and low employment in Europe will trigger
protectionism, which could reduce growth capacity even further.
Partly due to very high growth in demand for oil, the average price for Brent Blend rose to almost USD
40 per barrel in 2004. Strong economic growth, particularly in the US and China, has resulted in high
energy consumption. So far this year, the price of Brent Blend oil has largely moved between USD 45
and 55 per barrel. In the past few weeks, it has hovered around USD 50 per barrel.
Oil futures have also increased.
Little excess production capacity in OPEC countries, combined with the prospect of lower production
in non-OPEC countries, has probably influenced oil prices. At the same time, there are prospects of
continued strong demand growth in important oil-importing countries, such as China and some other
emerging economies.
The IMF has analysed supply and demand in the oil market for the period ahead in the latest issue
of "World Economic Outlook":
With price expectations at around the current level and global GDP growth at approximately 3 per
cent, demand for oil is expected to increase by around 2 per cent per year over the coming decades
up to 2030.
The rise primarily reflects higher demand for fuel for motor vehicles, particularly in non-OECD
countries. An increase in per capita income in China will in particular lead to a sharp increase in car
use.
Output in non-OPEC countries will peak soon - in 5 years, according to IMF estimates. Higher
demand will thus require higher output in OPEC countries. These countries have substantial oil
resources, but are currently producing close to capacity. Production capacity must therefore be
increased.
Higher demand can thereby be met by non-OPEC oil producers operating at full capacity while OPEC
passively accommodates any remaining demand by increasing its production capacity. Alternatively,
OPEC can take a more active position and push up prices even further by capping production.
Only a few years ago, a long-term price of around USD 20-25 (in real value) per barrel was the normal
estimate. Analyses such as that presented by the IMF suggest that the long-term oil price level may be
considerably higher than this.
Let us return to the Norwegian economy, and the possibilities and challenges facing Norway.
The projections in Inflation Report 1/05, published on 16 March, are based on a gradual increase in
the interest rate. This is in line with financial and foreign exchange market expectations. It is assumed
that the exchange rate will shadow movements in the forward exchange rate. This implies that the
krone will remain fairly stable around the current level in the years ahead.
Mainly as a result of persistently high oil prices and expectations that oil prices will remain high,
investment in the petroleum sector may reach record levels this year. The investment intentions
survey for the petroleum sector points to very high growth. The level is expected to remain high
throughout the projection period. Activity in the petroleum sector will have spillover effects on the
mainland economy, initially on the engineering industry and the construction sector.
The scale of petroleum investment and its spillover effects are highly uncertain. The last time
petroleum investment showed a sharp increase, in 1997/1998, growth was substantially stronger than
had been assumed. An upturn occurred in the Norwegian economy as a whole at the same time. The
unexpected increase in petroleum investment contributed to an economic upturn that was substantially
stronger than projected. If oil prices rise further or remain at the current high level for a long period,
petroleum investment may again amplify the cyclical upturn to a greater extent than projected.
The upturn in mainland fixed investment is broadly based. Improved profitability, higher capacity
utilisation and solid export growth will contribute to continued investment growth in goods-producing
industries. Demand for services is expected to continue to expand for a period ahead with an
attendant increase in investment in service sectors. When growth in the economy gradually slows,
investment growth will probably slacken.
Mainland exports of goods and services will continue to benefit from solid global growth this year.
Later in the period, a continued loss of market shares as a result of high cost levels will dampen export
growth.
Growth in private consumption is expected to remain high this year and next. Low real interest rates,
solid growth in real disposable income and a continued rise in house prices will contribute.
Unemployment is projected to decline this year and next. In subsequent years, growth in demand and
output is expected to ease and unemployment may edge up again when capacity utilisation
approaches a more normal level.
With a somewhat tighter labour market and rising inflation in the years ahead, wage growth may pick
up. Over the past year, low consumer price inflation has probably contributed to keeping nominal wage
increases lower than implied by labour market tightness in isolation. Low inflation has resulted in high
growth in household purchasing power even with moderate pay increases.
The results from this year's wage settlement indicate that wage growth this year may be lower than the
projection in the March Inflation Report.
Inflation among our trading partners is expected to be low in the next few years. It is likely that high
prices for oil and other commodities will continue to push up prices for goods where wages account for
a small portion of total costs. On the other hand, growth among most of our main trading partners will
probably be too low for idle resources to be utilised in the next few years. Particularly in the euro area,
wage growth is likely to be low as a result of moderate economic growth and high unemployment.
Overall, it would appear that external price impulses via consumer goods to the Norwegian economy
will remain negative this year and next. There is no indication that growth in imports from low-cost
countries is declining. The decline in prices for clothing and footwear will probably continue in the
coming years. Prices for audiovisual equipment are still falling as a result of strong international
competition and high productivity growth. We assume that the effects of structural changes in these
markets will gradually be exhausted towards the end of the projection period. External price impulses
via consumer goods are then expected to increase in pace with unit labour costs among our trading
partners.
With a path for the interest rate and the krone exchange rate in line with the baseline scenario in
Inflation Report
1/05, inflation may increase gradually from less than 1 per cent today to close to 2 per
cent in mid-2006. Under these assumptions, inflation may stabilise at around 21⁄2 per cent at the
threeyear horizon. Developments in line with these projections imply that the output gap will increase to
about 11⁄4 per cent in 2006. As the interest rate is gradually increased to a more normal level, growth in
private demand will probably ease, and capacity utilisation may be brought down and stabilise.
Developments since the March Inflation Report was presented do not provide grounds for changing
this perception of the state of the real economy. The results of the wage settlement so far suggest that
wage growth this year will be somewhat lower than projected by Norges Bank. Inflation, on the other
hand, has been broadly in line with expectations, and there has been virtually no change in the krone
exchange rate. The inflation outlook has not changed substantially since the March Inflation Report
was published.
At its meeting on 20 April, the Executive Board stated the following:
"The Norwegian economy is growing at a solid pace, and capacity utilisation is rising. An interest rate
that is kept at the current level for a long period might lead to a situation where capacity utilisation
becomes too high further ahead. Bottlenecks may arise in some sectors of the economy, and the
sharp rise in property prices and borrowing may persist for a longer period. This could be a source of
instability in demand, output and inflation in the somewhat longer run. This implies, in isolation, a
higher interest rate. At the same time, the current rate of inflation is low, and there are prospects of low
inflation for a period ahead. The objective of bringing inflation back to the target of 21⁄2 per cent and
anchoring inflation expectations imply a continued expansionary monetary policy.
The monetary policy assessments presented by Norges Bank in March indicated that the interest rate
will rise after a period and at a gradual pace. Economic developments since then have been broadly in
line with expectations. International key rates are rising, albeit slowly and from a low level. Although a
gradual rise in the interest rate seems to provide a good balance between the different objectives, the
Executive Board concluded that it is too early to increase the interest rate at this monetary policy
meeting."
Low interest rates over a long period have contributed to strong growth in household borrowing. Both
housing investment and house prices have risen sharply. House price inflation has slowed somewhat,
but remains high. In 2004, housing starts were the highest in several years. Home refurbishment is
probably also rising sharply.
The high level of borrowing has resulted in a substantial increase in the household debt burden. Loan
debt relative to disposable income is now as high as at the end of the 1980s.
Interest expenses relative to income are nonetheless considerably lower now, whether based on
current interest rates or expected rates in the next few years. Households will however be vulnerable if
unexpected disturbances result in higher than expected interest rates.
Oil gives us an economic base that is not available to many other countries. But it also presents us
with considerable challenges:
First, we must remember that our petroleum resources are part of our national wealth. When oil is
extracted and sold, natural assets are transformed into financial wealth. Norway's national wealth
belongs not only to our generation, but also to future generations. This means that our petroleum
wealth must be equitably distributed between generations. The authorities must therefore exercise
fiscal discipline, taking into account long-term considerations.
Moreover, the size of the cash flow from petroleum activities varies considerably. If petroleum
revenues were to be used as they accrue, this would lead to considerable fluctuations in demand in
the Norwegian economy, amplifying cyclical fluctuations as a result.
Third, the use of petroleum revenues would have an impact on competitiveness in Norwegian
business and industry. A high level and substantial fluctuations in the use of petroleum revenues
would have a negative impact on the operating parameters for internationally exposed industries. It is
important that we succeed in maintaining an industry structure that promotes learning, innovation and
development.
The Government Petroleum Fund was established in 1990 with a view to safeguarding long-term
considerations in the use of petroleum revenues. In March 2001, the fiscal rule and new guidelines for
monetary policy were introduced. The fiscal rule implies that the central government budget deficit
shall be equivalent over time to the expected real return on the Government Petroleum Fund. The new
guidelines for economic policy received broad support in the Storting.
The rule specifying that only the real return on the Petroleum Fund is to be used means that the
capital in the Fund is not depleted. The capital in the Petroleum Fund will increase as long as there is
a positive cash flow (to the central government) from petroleum activities. When the conversion from
petroleum revenues to financial wealth has been completed, the objective will still be to restrict
withdrawals so that the real value of the Fund's capital is maintained - in principle, indefinitely.
The fiscal rule thereby provides a long-term anchor for fiscal policy. It provides a stable framework that
contributes to curbing fluctuations in the Norwegian economy that are caused by converting petroleum
revenues into investment at home and abroad.
The new guidelines have changed the interaction between the different components of economic
policy. Monetary policy has been given a clearer role in stabilising economic developments. A clear
monetary policy objective is a necessary complement to the fiscal rule for ensuring reasonable
macroeconomic stability. The operational target of monetary policy as defined by the Government is
inflation of close to 2.5 per cent over time. The inflation target provides an anchor for economic agents'
choices concerning saving, investment, budgets and wages. Households, businesses, public entities,
employees and employers can base decisions on the assumption that inflation in Norway will be
2.5 per cent over time.
High oil prices have a different impact in Norway than in oil-importing countries. When oil prices
increase, the value of Norway's national wealth rises. The idea behind the Petroleum Fund is that the
cash flow from an increase in oil prices should accrue to the Fund and be invested abroad and should
not be included directly in the government budget. As a result, the increase in the cash flow will not
affect the domestic economy. Likewise, a fall in oil prices will not have an immediate impact on the
domestic economy, but result in a lower accumulation of foreign assets.
Even though the Petroleum Fund and the fiscal rule shield the Norwegian economy to a certain extent
from fluctuations in the oil market, the Norwegian economy will still be affected by developments in oil
prices. If changes in oil prices influence growth in the global economy, this will in turn impact
Norwegian exports of traditional goods and services. Petroleum investment on the Norwegian
continental shelf is another important channel. Fluctuating oil prices contribute to substantial variations
in petroleum investment. This has spillover effects on the mainland economy.
The value of the Petroleum Fund, measured as a percentage of GDP, will rise in the years ahead. On
the other hand, Norway, like many other countries, is facing substantial fiscal challenges. The
expected dependency ratio, i.e. the ratio of persons over the age of 67 to persons aged 20 to 66, will
rise sharply in the years ahead. The National Insurance Scheme's spending on old age and disability
pensions, based on the current social security rules, is increasing.
The return on the Petroleum Fund can only cover a small portion of this increase. According to
Ministry of Finance calculations, a funding requirement equivalent to 6 per cent of GDP will still be
uncovered in 2060 given an oil price of NOK 230 (2005-kroner), or around USD 35 per barrel. Oil
futures 6-7 years ahead are now higher than this. If oil prices remain as high for the foreseeable
future, the funding requirement will be somewhat lower. To base decisions on this, however, would be
a very risky strategy.
Even though Norway's petroleum wealth is substantial, it is our human resources that account for most
of our national wealth. Even a small increase in the "return" on human capital might generate
considerable gains. The return on this capital partly depends on our pension schemes and the
application of social security rules. These should be designed in such a way that they provide
incentives and opportunities to work. Labour market legislation must also promote production and
employment.
The Storting (Norwegian parliament) is currently in the process of completing its deliberations on the
Pension Commission's proposals for reforming the national insurance system. If we succeed in
reducing the dependency ratio through a modernised national insurance system and other reforms,
this will be an important contribution to addressing the fiscal challenges we are facing.