Svein Gjedrem: Prospects for the Norwegian economy
Speech by Mr Svein Gjedrem, Governor of Norges Bank (Central Bank of Norway), at
Sparebank 1 SR-Bank Stavanger, Stavanger, 26 March 2010.
The text below may differ slightly from the actual presentation. The speech is based on the assessments
presented at Norges Bank's press conference following the Executive Board's monetary policy meeting on
24 March and Monetary Policy Report 1/10.
* * *
The most acute phase of the global economic crisis appears to have passed. Output growth
has resumed in most parts of the world and the recovery has been strongest in emerging
market economies in Asia.
The crisis has given rise to new imbalances that will dampen the recovery.
Fiscal deficits are substantial in many countries and government debt is rising rapidly.
Deficits have increased markedly because of reduced tax revenues and stimulus measures
to underpin activity, but also due to government support measures for banks. The interest
rates at which governments borrow reflect to a large extent their financial position. Reducing
government debt in the US and many European countries will probably take several years.
Fiscal tightening is expected to commence among our main trading partners as from next
year, with the exception of Sweden. This will curb growth in overall demand for goods and
services.
Even with substantial tax cuts, strong growth in public spending and low interest rates,
unemployment has risen considerably in both the US and Europe. In many countries,
unemployment has grown by 3-4 percentage points. There is a risk that unemployment will
become entrenched, perhaps particularly in Europe.
It appears that the upturn in advanced economies will only be moderate. The economies of
many countries will continue to be marked by considerable spare output capacity. Spare
capacity and high unemployment will contribute to low inflation among trading partners in the
coming years.
Oil prices are just below USD 80 per barrel. Our projections are based on an oil price in line
futures prices. Futures prices indicate that oil prices will rise ahead. Emerging market
economies are making a growing contribution to global oil demand. These economies are
expected to continue to record solid growth. In addition, OPEC is steadily gaining market
power because growth in oil supply from non-OPEC countries is gradually stagnating. Oil
prices may nevertheless edge down if the recovery in the world economy loses momentum,
particularly since OECD oil stocks are still at elevated levels and OPEC spare production
capacity is relatively high. Gas prices are under pressure owing to increased availability of
shale gas in the US, a higher supply of LNG and low demand in Europe.
Futures prices indicate some rise in other commodity prices. Metal prices have risen as a
result of improved global growth prospects, but they are still somewhat lower than in summer
2008.
Key rates are close to zero in many countries. A number of central banks have signalled that
key rates will be kept low for an extended period, and key rate expectations abroad fell
through autumn and winter. Market participants do not anticipate a rise in key rates in the
US, the euro area and the UK until the end of 2010.
The interest rate differential between Norway and trading partners has increased. The krone
exchange rate has remained fairly stable through winter, although it is somewhat stronger
than projected in October. The krone is expected to remain at about the current level to the
end of the third quarter and then gradually depreciate somewhat thereafter.
Growth in the Norwegian economy came to a halt in autumn 2008, and Norway entered a
downturn in early 2009. The decline appears to have ended in the second quarter of 2009.
Capacity utilisation is lower than normal, but the downturn seems to be relatively mild.
Activity has been underpinned by substantial interest rate cuts combined with higher public
spending and high oil investment.
Fiscal policy was very expansionary in 2009. Petroleum revenue spending increased sharply,
and by close to 3 per cent of mainland GDP. Revenue spending will rise further this year.
Our projections are based on information from the final budget and the projections in the
National Budget for 2010. In line with this, the level of the structural, non-oil budget deficit is
maintained at this level to the end of the projection period.
According to the fiscal rule, the fiscal deficit should be reduced to about 4 per cent of the
capital in the Government Pension Fund Global (GPFG) when the economy resumes a
normal level of activity. If economic developments are broadly in line with projections, a fiscal
stance in line with the fiscal rule could result in a lower interest rate and a weaker krone than
projected.
The Government has estimated that the annual return on the fund will be around 4 per cent
over time. The average real return since the management of the fund began is now 2.7 per
cent, up from just 1 per cent a year ago. The figure reflects the recent recovery from the
sharpest deterioration in capital markets since World War II. With an unchanged risk profile,
the average return will most probably move back towards 4 per cent after a period.
The investment strategy of the fund is built on its long-term investment horizon and
substantial size. In 2009, we benefited from the long-term investment horizon. The return on
the fund was 25.6 per cent in 2009, which is the highest return ever recorded. The fund's
long-term investment horizon enabled it to buy equities and maintain its positions in
corporate bonds when other investors were forced to sell assets at low prices during the
financial crisis.
In June 2007, the Ministry of Finance decided to increase the allocation to equities from 40 to
60 per cent. This was achieved over the two following years when equities for more than
NOK 1 trillion were purchased. The long period of phasing in purchases was profitable as the
fund was able to exploit falling equity prices during the financial crisis. The fund's global
equity holdings doubled in the same period.
Petroleum investment has increased substantially in recent years. Investment increased
between 2008 and 2009 in spite of postponements and cancellations of a number of projects
after the financial crisis unfolded in autumn 2008. This reflects that investment projects in
2009 were to a large extent determined by contracts that were concluded prior to the
financial crisis. Petroleum investment still showed a substantial decline through 2009.
The volume of petroleum investment is expected to drop further this year and next, followed
by a pick-up in 2012 and 2013. The investment decline this year and next reflects
postponements of projects and the near completion of large investment projects.
Exports have picked up after world trade showed a faster and somewhat stronger increase
than expected. Export companies in our regional network report that new orders have
increased and that production is expected to rise over the next six months. A further increase
in world trade will contribute to underpinning growth in exports.
Measured by relative labour costs, Norwegian labour has never been as costly as it is now.
As a result, the Norwegian export industry may lose market shares ahead. There are no
prospects of another rise in export prices as sharp as in the 2000s, when Norway's terms of
trade improved considerably.
Norges Bank raised the key policy rate on two occasions by a total of 0.50 percentage point
in the fourth quarter of 2009. The feed-through to bank lending rates has so far been
somewhat smaller. The average private lending rate increased by 0.09 percentage point from
the third to the fourth quarter, but the December interest rate increase will probably only feed
through in 2010. Weighted mortgage lending rates have increased by a quarter percentage
point since the key rate was raised for the first time in October.
The fall in business investment seems to be nearing an end. Information from the regional
network indicates that investment in private services will pick up this year. Manufacturing
enterprises in the regional network report that investment will fall between 2009 and 2010.
Corporate credit growth is still on the decline, but Norges Bank's fourth-quarter survey of
bank lending showed that banks have eased credit standards for the corporate sector.
Commercial building starts have picked up slightly since summer.
Housing investment fell sharply between 2007 and 2009. Turnover of new homes has
increased and house prices have risen markedly. Housing starts are expected to increase
ahead. Household credit growth has been stable in recent months.
Growth in private consumption increased through 2009 and growth is expected to continue.
In spite of a lower interest rate level, the household saving ratio increased to a record-high
level in 2009. This probably reflected high household debt levels with a need for some
households to consolidate, and a large degree of uncertainty owing to prospects of higher
unemployment and a fall in the value of housing wealth. At the same time, household real
disposable income increased. Almost half the increase is attributable to a lower interest rate
level.
Debt burdens are still high, but the stabilisation of employment at a relatively low level has
contributed to reducing uncertainty. The interest rate level remains low. In addition, house
prices have increased. The saving ratio is therefore expected to fall, and growth in private
consumption is projected at 5 per cent in 2010.
Reports from Norges Bank's regional network in February suggested that output growth will
remain relatively weak in the coming quarters, but with wide variations across industries.
Suppliers to the offshore sector expect activity to continue to shrink. The building and
construction industry also expects a further fall in output, while reports from household
suppliers and exporters suggest and increase in output ahead.
There are still few regional network enterprises reporting that capacity constraints will make it
difficult to accommodate higher demand. Since autumn 2009, it seems that capacity
utilisation has increase somewhat in coastal regions from the southwest to the north. Many of
the industries that are faring well are located in these regions, such as fish farming, fisheries,
parts of the metal industry and suppliers of operating services to the oil sector.
Employment stopped falling in the fourth quarter of 2009. Total mainland employment had
then declined by about 30 000 since autumn 2008. The fall in employment has been smaller
than the decline in output might imply. Productivity has fallen markedly. During the downturn,
the number of hours worked has decreased somewhat more than the number employed.
According to the Bank's regional network, reduced use of overtime hours, partial lay-offs and
reduced working hours among part-timers have resulted in lower average working hours.
Moreover, increased sickness absence has made a contribution. Output growth is expected
to increase gradually through 2010, while growth in the number of hours worked shows a
relatively small increase. As a result, employment will gradually become more consistent with
the level of output, and productivity will rise further through 2010. Compared with previous
downturns, productivity growth remains weak.
Owing to a fall in labour force participation, labour force figures were lower at the end of 2009
than at the beginning of the year in spite of underlying growth in the working-age population.
Some people exit the labour force or choose not to enter the labour force when labour
demand falls. Unemployment continued to rise in the latter half of 2009, but at a far slower
pace than earlier in the downturn. Registered unemployment is projected to remain at about
today's level to the end of the year. The Technical Reporting Committee on Income
Settlements estimates annual wage growth at 4.1 per cent in 2009. We expect wage growth
to show a further decline in 2010.
The uncertainty facing exposed industries is still considerable and wage growth among
trading partners is low. A reserve of foreign labour and persons who have temporarily exited
the labour force, and who may rapidly return, is probably pulling down wage growth. Wage
earners' share of income in the mainland economy is at a high level, after rising from 62 per
cent in 2005 to 65 per cent in 2009. On the other hand, unemployment will probably level off
at a lower level than in previous downturns, and in some sectors of the economy
unemployment is still low. Wage growth is expected to move up towards the end of the
projection period.
The operational target of monetary policy is low and stable inflation with annual consumer
price inflation of close to 2.5 per cent over time. Over the past 10 years, inflation has on
average been somewhat below, but close to 2.5 per cent. From 2003 consumer price
inflation was consistently somewhat lower than the target and monetary policy was then
oriented towards bringing up inflation. In 2007 and 2008, inflation edged up and exceeded
the target somewhat. The key policy rate was gradually raised to a more normal level. When
the outlook for the Norwegian economy abruptly changed in autumn 2008, inflation was close
to target and inflation expectations were firmly anchored. The key policy rate was reduced
from autumn 2008 to summer 2009 to prevent inflation from falling too far below target and to
mitigate the effects of the global downturn on the Norwegian economy. The interest reduction
brought the real interest rate down to a level far below normal. At the same time, households
and firms could remain confident that the expansionary monetary stance would not contribute
to price and wage spirals in the longer term.
In Norway, various measures of underlying inflation have been close to 2.5 per cent in recent
months. Lower wage growth, reduced capacity utilisation and low global inflation have
counterbalanced the effects of higher energy prices and the krone depreciation in autumn
2008. Consumer price inflation is expected to fall to somewhat below 2 per cent in 2010
following the krone appreciation over the past year.
The interest rate is set with a view to stabilising inflation close to 2.5 per cent over time and
bringing capacity utilisation gradually back to a normal level. Growth in the Norwegian
economy is expected to gradually pick up through the remainder of this year and next.
Capacity utilisation is expected to be close to a normal level in 2011 and to reach this level in
the course of 2012. In our projections, inflation gradually moves up towards 2.5 per cent
around the end of the projection period as capacity utilisation reaches a normal level and the
effects of the krone appreciation unwind. Wage growth shows a gradual increase. The
projections are based on a gradual rise in productivity. Improved productivity will ease cost
pressures for firms. The projections are also based on increased scope for firms to
strengthen profitability by raising prices.
Activity in the Norwegian economy picked up towards the end of 2009. The interest rate was
raised by 0.50 percentage point towards the end of the year with a view to maintaining
inflation at 2.5 per cent over time. New information suggests that the recovery in the
Norwegian economy is continuing, but that capacity utilisation is probably somewhat lower
than anticipated in autumn 2009. Combined with lower interest rates abroad, a stronger
krone and lower wage growth suggest that the interest rate forecast should be revised down
somewhat in relation to the October Report.
Interest rates in Norway are low. The effect on private consumption of the substantial interest
rate cuts in 2008 and 2009 has probably not been exhausted and high consumption growth
is expected to continue in 2010. House prices have risen. The new guidelines for prudent
residential mortgage lending issued by Finanstilsynet (the Financial Supervisory Authority of
Norway) may curb household debt accumulation. Over time, household borrowing may
nevertheless increase considerably and saving may fall. The aim of guarding against the risk
of future imbalances, which may disturb activity and inflation somewhat further ahead,
suggests that the interest rate should be gradually brought closer to a more normal level.
On the other hand, a marked interest rate increase in Norway and a wider interest rate
differential between Norway and other countries may entail a risk of a considerably
strongerthan-projected krone, resulting in inflation that is too low. This will make it difficult to bring
inflation up to target within a reasonable time horizon. A strong krone may also lead to lower
activity in exposed industries and thereby lower capacity utilisation in the Norwegian
economy. This suggests that the interest rate should not be raised too rapidly.
Monetary policy cannot fine-tune developments in the economy, but it can mitigate the most
severe effects when the economy is exposed to shocks. Overall, the outlook and the balance
of risks suggest that the key rate should be gradually increased ahead, although somewhat
later than we envisaged in October 2009.
On 24 March, the Executive Board decided that the key policy rate should be in the interval
11⁄2-21⁄2 per cent in the period to the publication of the next Report on 23 June 2010 unless
the Norwegian economy is exposed to new major shocks. The interest rate was kept
unchanged at this meeting. This is based on the assessment that inflation and capacity
utilisation may for a period be slightly lower than previously projected and that the interest
rate should be increased somewhat later than expected in autumn 2009.
Thank you for your attention
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