ECONOMIC PERSPECTIVES
THURSDAY
Annual address by Governor Øystein
18 FEBRUARY
Olsen to the Supervisory Council of
2021
Norges Bank on Thursday,
18 February 2021
perspectives 2021
INTRODUCTION
One year ago, I stood here and delivered the annual address to 300 guests. This year is
different. This evening there are no guests physically present at the central bank. The
contrast with last year could hardly be greater.
The same also goes for the theme
running through this evening's
speech - the Covid-19 pandemic.
Not a trace of it can be found in last
year's speech. Yet contagion was
lurking right outside our borders.
Arne
We sensed that something was
Dag
brewing. Norges Bank was in the
process of revising down its
Ivarsøy,
/
economic forecasts. The employees
at our Shanghai office had been sent
Museum
home, yet we did not foresee how
far-reaching the outbreak in Wuhan
National
would be. Two weeks after
delivering last year's speech the first
Photo:
case was recorded in Norway - soon
thereafter, Norway went into
Kittelsen,
lockdown.
Theodor
Since then, we have done what
people do during serious epidemics -
Illustration: we engage in social distancing. We
can still meet - in a way.
Technological innovation has provided us with new possibilities.
During the Black Death, wealthy farmers from the western fjords of Norway isolated
themselves in Jostedal, a remote valley that reaches into the mountains. They had to
find new ways to communicate. The farmers maintained contact with the outside
world by sending and receiving letters placed under a stone at the entrance to the
valley.
This past year, the letter stone has been replaced by the internet.
A HISTORICALLY DEEP DECLINE
ECONOMIC
Eleven months after the first lockdown, daily life has yet to return to normal. Norway PERSPECTIVES
18 FEBRUARY 2021
has been quite successful in keeping down infection rates, although we have seen
regular flare-ups. The country's borders are now closed.
The measures to contain infection are necessary, but they do have side effects, both
economic and social.
People in risk groups have been isolating. Young people have been following courses
online - many alone in a bedsit. Socialising with friends has been put on hold
Chart 1 Historically deep decline
GDP for mainland Norway. Annual growth. Percent
0 0
1921 1931 1940 1944 1989 2009 2020
Sources: Statistics Norway and Norges Bank
For Norway, the economic downturn will stand as one of the deepest in history (Chart
1). Not since the Second World War has activity in the Norwegian economy shown
such a steep decline.
The crisis has had uneven effects.
Containment measures and fear of infection have resulted in a sharp decline in
spending on services. During the lockdown last year, unemployment increased
fourfold over a few weeks, reaching 400 000 persons, or close to 15 percent of the
labour force. In some business sectors, unemployment remains very high.
Other sectors have been shielded. Interest rate cuts have given households more
money to spend. At the same time, there were fewer opportunities for them to spend it.
So while some have faced a precarious job situation, others have used the occasion to
save. We see the same impact and uneven effects in a number of other advanced
economies.
Chart 2 Many countries have been harder hit than Norway
ECONOMIC
PERSPECTIVES
18 FEBRUARY 2021
GDP growth, percent Total COVID-19 deaths per 10 000
UK
Italy
US
Sweden
Japan
Norway
0 5 10 15 20
Souces: IMF, OECD, OurWorldInData.org, Statistics Norway and Norges Bank
Many countries have been hit harder than Norway - in terms of both economic and
health effects (Chart 2). The differences reflect in part how quickly countries locked
down and put a brake on the first wave of infection. The design of support measures,
organisation of the health sector and structure of the economy have also played a
decisive role.
In countries with a rudimentary welfare system and a large informal sector, the
pandemic has had serious consequences. Unfortunately, 2020 proved to be the year
when the global poverty rate showed a renewed rise.
THE WAY AHEAD
Pandemics are watershed events that leave behind long-lasting scars. They have
claimed a multitude of lives through history. The most devastating ones have laid
fertile land barren, reduced the supply of labour and entailed a loss of knowledge.
During the Spanish flu pandemic, more than 50 million lives were lost, many of
working age.
Once the Covid-19 pandemic is over, we will have been through a long period of
restrictions on how we spend money, how we get from place to place and how we
work. The Covid-19 pandemic will leave behind scars as well.
Chart 3 Economic growth has fallen
Mainland GDP per capita. Contribution to average annual growth ECONOMIC
PERSPECTIVES
4 4
18 FEBRUARY 2021
Productivity
Employment
GDP per capita
3 3
2 2
1 1
0 0
1970-79 1980-89 1990-99 2000-09 2010-19
Sources: Statistics Norway and Norges Bank
Growth in output per capita has been moving down over several years (Chart 3), and
labour input is now growing at a snail's pace. At the same time, the primary source of
growth - productivity - is making a steadily smaller contribution. This is a trend we
share with other advanced economies. An underlying driving force - cross-border
trade - is showing signs of flattening out. The pandemic could influence these trends.
Previously, sharp declines in economic activity have been followed by a persistent rise
in unemployment and a lower labour force participation rate. In Norway, we saw this
following the financial crisis and after the fall in oil prices in 2014. Five years after the
oil price fall, employment was still lower than before in those parts of the country that
were particularly hard hit.1
Chart 4 Rising number with low education levels among long-term unemployed
Long-term unemployed. Number of persons
20000 20000
February 2020
January 2021
15000 15000
10000 10000
5000 5000
0 0
Lower Upper Higher education, Higher education,
secondary school secondary school up to four years over four years
Source: Norwegian Labour and Welfare Administration (NAV)
1 Ellingsen and Galaasen (2021): Langvarige konsekvenser i arbeidsmarkedet [Lasting consequences in the labour
market], Staff memo 1/2021, Norges Bank (Norwegian only).
Long-term unemployment leads to a loss of skills.
The support schemes implemented by the authorities are meant to be a bridge to more
normal times. But the new normal will be shaped by adjustments in household and
business behaviour over the past year. Once the economic downturn is over, the labour
market may have changed. Certain jobs may not be coming back, making the path
back to work difficult for some. A number of long-term unemployed may drop out of
the labour market entirely.
The long-term decline in productivity growth has taken place alongside a digital
revolution. A number of explanations for this apparent paradox have been advanced.
For instance, it may be costly to introduce new technology that increases work
efficiency.2 Another hypothesis is that a shift in the structure of the economy towards a
larger services sector has depressed productivity growth.
During the pandemic, many businesses have been doing things in new ways, but have
put restructuring on hold. Over the past year, there have been fewer bankruptcies than
normal, and investment activity in the business sector has been low. The downturn
may have reduced the value of production capital and skills. New businesses will be
established, and workers will have to acquire new skills. This process takes time and,
while underway, may dampen productivity growth further.
But the pandemic may also unlock a larger share of the potential inherent in new
technologies, perhaps in certain service segments in particular. Over the past year, we
have been forced to use a wider array of digital tools, both at work and at home.
Online shopping has surged. Large-scale processes have been managed from kitchen
tables, children's bedrooms and home basement offices. International conferences are
livestreamed.
We will continue to use many of these solutions. The pandemic will also leave behind
a positive legacy.
Last winter we saw how short the path was from a local virus outbreak in Wuhan to a
global health crisis. Covid-19 followed the same routes as tourists, labour and goods.
The virus showed how closely interconnected and interdependent countries are.
Chart 5 Growth in global trade has stalled
Share of global GDP. Percent
ECONOMIC
PERSPECTIVES
30 30
18 FEBRUARY 2021
Trade in goods
Trade in services
25 25
20 20
15 15
10 10
5 5
0 0
1977 1983 1989 1995 2001 2007 2013 2019
Sources: Refinitiv Datastream, WTO and Norges Bank
A rising number of countries have been integrated into world trade over the past
decades (Chart 5). The gains have been substantial. Poverty has been reduced.
Crossborder cooperation has enabled technology to advance faster than it would have done
otherwise.
Since the financial crisis, growth in global trade has stalled. While service exports
have continued to rise, trade in goods as a share of global GDP has been more or less
flat in recent years because a number of sources of growth in goods trade are drying
up. Large countries such as China and India are now fully integrated into the global
economy. Robotisation has put the brakes on offshoring production from high-cost
countries.
So far there are few signs that the pandemic will lead to more permanent changes in
global trade. Despite some disruptions in global supply chains and goods transport,
trade in goods has held up well. Following a temporary decline, trade picked up
through 2020.
Travel and tourism are among the industries profoundly affected by the pandemic.
Much of the tourist traffic is likely to rebound once we can cross borders freely again,
but many have discovered this past year that online meetings are also an effective
alternative. This may result in less travel activity than before. Environmental
considerations suggest the same.
During the pandemic, national governments have had to focus primarily on giving
their own population the best possible protection against serious health consequences.
At the same time, this past year has clearly demonstrated the importance of
crosscultural and cross-border cooperation. Thanks to an extensive international research
effort, effective vaccines could be quickly rolled out.
Let's hope that it is this experience that we carry forward. In the long run, all countries
benefit from open borders, common standards and international cooperation.
A MORE ACTIVE FISCAL POLICY ABROAD
ECONOMIC
During the pandemic, economic support measures have been massive. While both PERSPECTIVES
18 FEBRUARY 2021
monetary policy and fiscal policy action was quickly taken, fiscal policy took the lead
(Chart 6). This was the case everywhere the pandemic has raged, not only in Norway.
Chart 6 Forceful fiscal policy response
Increased spending and reduced taxes. As a percentage of GDP
20 20
15 15
10 10
5 5
0
0
US UK
Italy
India
Brazil
Japan China
France
Norway
Germany
Sources: IMF and Norges Bank
The lockdown this past spring was sudden and brutal and its impact on businesses
varied widely. Fiscal policy measures have targeted the industries hardest hit by
containment measures. The objective has been the same: Persons who were out of a
job had to be secured financially. Unnecessary job losses had to be avoided.
Monetary policy has underpinned fiscal policy measures. Policy rates were reduced
where possible. Moreover, unconventional monetary policy, such as asset purchases,
was stretched even further.
Central banks have also effectively performed the tasks assigned to them for ensuring
well-functioning capital markets. Extensive central bank measures prevented problems
in the financial system from amplifying the global downturn.
Chart 7 Very low interest rates
ECONOMIC
Three-month money market rates. Trading partners1). Percent
PERSPECTIVES
6 6
18 FEBRUARY 2021
5 5
4 4
3 3
2 2
1 1
0 0
2005 2010 2015 2020
1) Weighted average of money market interest rates for seven trading partners.
Source: Refinitiv Datastream
A prevailing view over the past decades has been that fiscal policy should follow
simple, robust rules and should to a limited extent be used actively to stabilise the
economy.
Globally, there are now signs that this view is changing. The pandemic may mark a
turning point. In the period ahead, we are likely to see a more active fiscal policy
among many of Norway's trading partners. There are several reasons for this.
For one thing, there is a recognition that the room for manoeuvre in monetary policy is
limited. After the financial crisis, a number of central banks have assumed
considerable responsibility for sustaining activity and smoothing economic
fluctuations. At the beginning of last year, policy rates were therefore already at very
low levels (Chart 7).
At the same time, low policy rates reflect long-term trends, such as an ageing
population, a high willingness to save, greater inequality and declining productivity
growth. The result is that the level of what we refer to as the neutral interest rate is
lower than before, even when economic conditions are in balance. The room for policy
rate reductions in downturns is therefore smaller.
The change in the view of fiscal policy's role also reflects the growing focus on
structural challenges: economic inequality, a shift towards a greener economy and the
need for investment in digital infrastructure. In the new US administration, we find
this policy expressed by the motto "Build back better". In the euro area, the policy has
been labelled the "European Green Deal".
Chart 8 Debt grows in response to each crisis
ECONOMIC
Advanced economy public debt as a share of GDP.1) Percent
PERSPECTIVES
140 140
18 FEBRUARY 2021
120 120
100 100
80 80
Pandemic
60 60
40 40
Dotcom bubble
Financial crisis
International
20 20
and euro crisis
currency crisis
0 0
1970 1980 1990 2000 2010 2020
1) Projections for 2020 and 2021.
Source: IMF
If government spending increases, there is one concern that arises. An amount
borrowed today becomes a debt that must be repaid tomorrow. Experience from the
past 40 years shows that while public debt grows during crises, it does not shrink
when economic conditions normalise (Chart 8). During the financial crisis,
governments in many advanced economies borrowed on a large scale. Much of this
debt was still outstanding at the beginning of 2020. During the pandemic, borrowing
needs have again been substantial. Public debt has ballooned to new heights.
Persistently low interest rates mean that government borrowing appears to be on
favourable terms. But at some point further ahead, interest rates will rise again.
Central banks will have to consolidate their balance sheets. Some countries will then
find themselves in vulnerable position.
NORWAY WAS WELL POSITIONED
Norway clearly stands out in this regard. We were well positioned to face the
economic crisis triggered by the pandemic. Unlike many other countries, we have
been able to pursue a very active fiscal policy without having to borrow. We also had
room for manoeuvre in monetary policy.
In a little over a month, it will be 20 years since the current framework for the division
of responsibility in economic policy was established. Fiscal policy would be guided by
the fiscal rule, while monetary policy would target inflation. Up until 2001, fiscal
policy was responsible for stabilising employment and output. After the switch to
inflation targeting, monetary policy has functioned as the first line of defence in
stabilisation policy.
The primary task of monetary policy is to ensure monetary stability. It must not pursue
its primary objective to the exclusion of other relevant considerations. Monetary
policy must also take into account the real economy. A monetary policy regime that
ends up amplifying fluctuations in the real economy will fail the test of time. As long
as confidence in low and stable inflation is well anchored, monetary policy can
contribute to high and stable output and employment.
exchange rate has functioned as an important shock absorber. When Norway s terms
of trade weakened owing to the oil price fall, a weaker krone helped to support
business sector competitiveness.
Chart 9 Historically low policy rate
Percent
12 12
10 10
8 8
6 6
4 4
2 2
0 0
1991 1996 2001 2006 2011 2016 2021
Source: Norges Bank
With a policy rate of 1.5 percent, monetary policy could again make a contribution
when Norway and much of the global economy locked down nearly a year ago. In the
space of a short time, the policy rate was lowered to zero (Chart 9).
The policy rate cuts had a broad impact and freed up funds for indebted businesses and
households. As containment measures are scaled back, continued low interest rates
will underpin consumption and investment, paving the way for a resumption of
business activity.
The room for manoeuvre in monetary policy is nearly exhausted. We do not envisage
making further policy rate cuts from today's level.
Yet as long as the crisis is ongoing, an expansionary monetary policy will be needed to
stimulate the economy. This reduces the risk that unemployment becomes entrenched
at a high level. At the same time, persistently low interest rates entail a risk of a
build-up of financial imbalances. In Norway, rapidly rising house prices and further
household debt accumulation pose a particular risk. Once there are clear signs that
economic conditions are normalising, we will again seek to normalise the use of
instruments - as we did after the financial crisis in 2008 and after the oil price fall in
2014.
SUBSTANTIAL TRANSFERS FROM THE GOVERNMENT
ECONOMIC
PENSION FUND GLOBAL
PERSPECTIVES
18 FEBRUARY 2021
The monetary policy stance in the period ahead will be influenced by the timing and
means of fiscal policy normalisation. Here the authorities face a difficult balancing act.
On the one hand, the crisis is not yet over, and there is uncertainty regarding infection
rates and the progress of vaccination. Against this background, the Storting
(Norwegian parliament) has decided to extend the extraordinary support measures
aimed at both individuals and businesses until September.
At the same time, it is important that the support measures are scaled back as the
situation becomes more normal. If these measures are extended too far into the future,
we risk impeding necessary business restructuring. Workers may miss out on
opportunities to seek new jobs, and unemployment may become entrenched at a higher
level than prior to the crisis.
In the light of long-term considerations, it is also important to reverse the sharp rise in
government spending during the crisis.
In 2020, NOK 300 billion was transferred from the Government Pension Fund Global
(GPFG) to cover the central government budget deficit. The decision to tap the GPFG
has been the right one. An economic shock of the scale that we have witnessed
requires potent medicine. The GPFG is intended to act as a buffer when the economy
is exposed to shocks. At the same time, it is an intergenerational investment fund to be
distributed across current and future generations.
The pandemic is the third large economic shock to hit the Norwegian economy in the
space of a few years. Each time, transfers from the GPFG to the central government
budget have increased, but without being substantially reduced afterward.
Chart 10 Before the crisis: One krone in six transferred from the GPFG
Transfers from the GPFG as a share of public spending. Percent
30 30
25 25
20 20
15 15
10 10
5 5
0 0
2001 2006 2011 2016 2020
Sources: Ministry of Finance, Statistics Norway and Norges Bank
(Chart 10). Because of the fund s substantial size, this has been possible without
breaching the fiscal rule.
In the course of a decade, public budgets have come to rely heavily on the return on
the GPFG, which was originally established to shield the Norwegian economy from
oil price volatility. Today, a large portion of the resources under the shelf has been
tapped and converted into investments in global equities and bonds. The GPFG has
grown to become immense. This has provided fiscal space, but it has also increased
our exposure to fluctuations in global securities markets. One vulnerability has been
replaced with another.
Chart 11 Considerable movements through 2020
GPFG. In billions of NOK
1500 1500
1000 1000
500 500
0 0
Return
Krone exchange rate
Transfers
Q1 Q2 Q3 Q4
Source: Norges Bank
The year 2020 clearly illustrated how quickly equity markets can change course - in
both directions. The decline was more brutal and the rebound faster than we have
previously seen. Over 22 days, the global composite equity index fell by 20 percent,
but the markets quickly reversed direction. Already in the second quarter, the GPFG's
worst quarterly result turned around to one of its best (Chart 11).
The GPFG has enjoyed several years of solid returns - above the returns expected.
This does not mean that we should revise up expected future returns - perhaps the
opposite.
Chart 12 Low long-term interest rates
ECONOMIC
Ten-year US Treasury yield. Percent
PERSPECTIVES
16 16
18 FEBRUARY 2021
14 14
12 12
10 10
8 8
6 6
4 4
2 2
0 0
1960 1970 1980 1990 2000 2010 2020
Source: Bloomberg
The expected annual real return is estimated at 3 percent. The estimate was most
recently updated in connection with the decision to increase the allocation to equities.
Two key variables were used in the calculation. One was the expected return on the
fixed income portfolio, and the other the size of the equity risk premium, which is the
extra compensation we expect when taking risk in the equity market.
The bulk of the fixed income portfolio is invested in long-dated sovereign bonds.
When interest rates fall, bond prices rise. The return on the fixed income portfolio
therefore held steady through the period of falling interest rates. But this is a one-off
gain (Chart 12). Interest rates have now fallen to historic lows, and the expected return
on the fixed income portfolio going forward has fallen.
Equity prices have risen sharply in recent years. Taking risk in the equity market has
paid handsomely. But we cannot assume that the gains will be as high in the future.
If we were to repeat our calculations from 2016, the changes in interest rates alone
would have reduced the estimated expected real return from around 3 percent to about
2 percent annually.3
Such estimates are fundamentally uncertain. The actual return may be substantially
lower or higher than this estimate, as the history of the GPFG has shown. Even so, this
uncertainty is something that we should bear in mind when drafting future central
government budgets.
CONCLUSION
ECONOMIC
Eleven months ago, Norway had to lock down. At that time, we had no vaccine or PERSPECTIVES
18 FEBRUARY 2021
medicines that could prevent the illness from spreading. We had to resort to
wellknown remedies: Hand disinfectant, soap, hot water and not least - social distancing.
Here at Norges Bank, it has not been any different.
But times have changed. During the Spanish flu pandemic, Norges Bank decided to
dispense a daily dose of cognac to employees who were ill or not feeling very well.
And as Chief Cashier Cederstrøm could report: "...Its effect was instantaneous - no
one got sicker, and everyone got better - the Spanish flu was no longer raging at
Norges Bank."
Nowadays, most of us would have politely declined the offer of cognac during
working hours. The vaccine is a safer bet. There are brighter and better days ahead.
The pandemic will soon be on its way out.
For those who have become unemployed or
furloughed or had their lives put on hold,
n
se
this is heartening news. This also gives
el
t
it
hope to business owners who have
K
or
d struggled to keep going. Yet for many,
o
e
h
operating conditions have changed.
T
:
n
The pandemic is leaving its mark.
o
i
at
sr Businesses have closed, study plans
lu
Il
have changed and demand in the labour
market has likely shifted towards new skills.
In the meantime, we must hold firm to the characteristics of our society that have
proved to be strengths in the face of crisis.
Throughout the pandemic, the health sector has been able to provide care for all
severely affected Covid-19 patients.
We have leaned on a well-developed welfare system. Covid-19 patients and
symptomatic persons have been able to stay at home. The unemployed have not been
left without income.
In economic policy, there has been room for forceful action.
But perhaps most important of all, the crisis has shown the importance of trust and
solid institutions. We have placed our trust in the measures taken by our government
and in each other. This is what we do when our country is faced with a crisis. Come
what may.