samchain/econo-pairs-v1 huggingface dataset:
Chart 7 Medium-term cycle in real GDP and credit (US)  Source: Bank calculations. The same broad patterns are evident in the data when moving from credit to asset (equity and house) prices in the UK and US (Charts 8–9). A clear financial cycle is evident in both these series, distinct from the typical business cycle in its amplitude as well as frequency. 12  BIS Review 168/2010  The peak to trough variation in asset prices is, if anything, greater than for credit: around 40 percentage points for equities and around 15 percentage points for house prices over medium-term horizons in the UK. Charts 10 and 11 demonstrate those differences, plotting medium-term frequency cycles in GDP and asset prices in the UK and US since 1945. Chart 8 Medium-term cyclical fluctuation in UK real equity and house prices  Source: Bank calculations. Chart 9 Medium-term cyclical fluctuation in US real equity and house prices  Source: Bank calculations. BIS Review 168/2010  13  Chart 10 Medium-term frequency cycles in GDP and asset prices in the UK  Source: Bank calculations. Chart 11 Medium-term frequency cycles in GDP and asset prices in the US  Source: Bank calculations. 14  BIS Review 168/2010  In Annex 2 we show results for the other 10 countries, applying the same techniques to real GDP and real credit. Although the cycles are sometimes not as regular, the same general cyclical patterns in output and credit are present using the wider panel of countries.

Another aspect that needs to be mentioned is being paranoid about the worst that could happen. This is sometimes referred to as productive paranoia. Central bankers need to excel as risk managers – knowing what could go wrong and prepare for the worst that is yet to come. In part it involves building the buffers to prepare for the unexpected events before they happen. When I am asked the question about how we are going to manage ‘the lift off’ – the normalisation of interest rate by the Federal Reserve in the United States – my response is that it is not what we will do now but what we have done before it happens that will see us through this period. It is not only the buffers that have been built but also the capability that has been developed that will better allow us to intermediate and thus absorb the shock. This will enable us to withstand the volatile financial flows that are already occurring in anticipation of this eventuality. Sometimes there are also Black Swan events. These are defined as those developments that have a low probability of happening and that is difficult to predict and anticipate. Being paranoid and building the resilience against such shocks will contain its damaging effects. Therefore continuous rigour needs to be applied all the time, during the good times and the challenging times. Vigilance, detecting developments that could signal danger, early recognition of risks are all important.
Measured in a common currency, prices are high, but they have over time remained fairly stable in relation to trading partners. The ratio of Norwegian to foreign prices today, converted to the same currency, is not substantially different from the average over the past 30 years. There is evidence to suggest that the exchange rate will contribute to cushioning changes in the price ratio.4 When inflation in Norway has been higher than among trading partners for a period, the krone has tended to depreciate. When there are expectations that inflation in Norway will develop approximately in line with other countries, the exchange rate will also normally return to its normal range in periods when the krone has been particularly strong or particularly weak. This relationship is the reason why stability in the exchange rate and in exchange rate expectations over time is dependent on stable inflation expectations, which in turn depend on low and stable inflation. Evidence indicates that an inflation target provides a sound anchor for exchange rate expectations. However, these expectations will also depend on fundamental conditions such as developments in government expenditure and revenues, productivity growth, oil prices and the terms of trade, excluding oil. Deterioration in competitiveness following several years of high wage growth High wage growth over several years has eroded the competitiveness of the Norwegian business sector. Last year, the effects of high wage growth were amplified by the changes in the krone exchange rate.

The interest rate reductions and the fall in the krone exchange rate imply that inflation will gradually increase and will be considerably higher than the current level as early as next spring. After such a period of very low inflation as we have now witnessed, it is appropriate to be particularly vigilant in monetary policy in the event that inflation does not increase as projected. 2  These estimates are uncertain and must therefore be interpreted with caution. The analysis of developments in the exchange rate from May 2000 to January 2003 is discussed in more detail in Bjørn Naug (2003): “Faktorer bak utviklingen i kronekursen – en empirisk analyse” (Factors underlying developments in the krone exchange rate – an empirical analysis), in Norges Bank’s Occasional Papers, no. 31 (Norwegian only). 3  These projections are discussed in more detail in Norges Bank’s Inflation Report 3/2003. The analyses are based on the technical assumption that the interest rate will move in line with expectations in financial and foreign exchange markets, implying that the interest rate will remain at the current level well into 2004. Thereafter, the interest rate in Norway is assumed to rise gradually in pace with interest rates in other countries. The forward exchange rate implies a moderate depreciation of the krone through the projection period. 4  BIS Review 53/2003  Share of employment back at trend As mentioned earlier, developments in the output gap are a measure of output stability.
In London, an additional source of demand has come from foreign investors looking for alternative sources of return amid a global environment of low interest rates. The government’s help to buy scheme may have also played a role though it is early days. Transactions are still quite low. How much pent up demand exists and how quickly it will come through, is of course unknowable. But it is not at all implausible that it could add significantly to pressure on the market for the next few years. Use of the government’s help-to-buy scheme continues to expand. All of this paints a picture of further pressure on transactions that could take us quickly to pre-crisis rates. Despite the dip in March, housing transactions are still up 30% on their level a year earlier. Were transactions to grow at that pace from here on, we would go past the 97–2007 average level of around 120,000 per month before the end of this year; and be back at 2007 levels by the first half of next year. Nor can we look to increased supply to help to quickly relieve some of this pressure. Housing starts, insufficient to meet demand before the crisis, dropped from around 230,000 to an average of a little over 120,000 between 2008–12. They have begun to recover – indeed, dwellings investment has been a major part of the recovery in economic growth over the past 12 months. But the increase in housing starts seen over the past few years has lagged behind growth in transactions.

The history of our housing market for the last 25 years is one in which the supply of housing in the place and of the type that people want has not kept up with demand. In 2004, Kate Barker – a former MPC member – concluded in her extensive report on the housing market that, if we wanted to reduce the trend in annual real house price growth to 1%, we needed to build an additional 120,000 private sector homes annually in England, an increase of almost 100% relative to the 2002–3 level. In the end, and despite a credit boom, the increase in annual housing completions up to the crisis was only 25%. 2  BIS central bankers’ speeches  There are many reasons for the failure of the supply of housing to keep up with demand in the UK which go well beyond the remit of a central bank. But the effect is that when demand grows strongly house prices can keep rising quickly for a long time. This is a movie that has been seen more than once in the UK. So it is not surprising, given the history of our housing market that the recent sharp increase in house prices and transactions appear to have fuelled growing expectations of an ever accelerating market. Contrary to the received wisdom in the rest of the world, the strength of housing market rather than the weather may be the dominant topic of conversation in the UK.
However, the six-monthly control stations that are an integral part of the Swedish consolidation programme have made - and continue to make - it possible for observers to monitor the political system’s determination in this respect to achieve the goal of balance in 1998. The current situation At the beginning of 1996, favourable prospects for inflation prompted a monetary policy realignment. Continuously falling inflation expectations, accompanied by subdued demand, improved the outlook for inflation in 1996 and 1997. At the end of 1996 underlying rate of inflation was about 1.5 per cent. The twelve-month rate of headline inflation, which was actually negative for some months in the latter part of 1996, was affected by temporary factors, above all as a result of the Riksbank’s interest rate cuts. The better prospects for inflation paved the way for a notable reduction of the repo rate during 1996, from 8.91 to 4.10 per cent, the latter being the lowest instrumental rate in Sweden for at least thirty years. Together with the impact of the exchange rate, the overall monetary conditions are accordingly contributing to a continued recovery in the real economy. A shift in the composition of demand began in the course of 1996. But although the contribution to GDP growth from net exports decreased, the effect of foreign trade remains positive. Private consumption is continuing to rise at a subdued but stable rate and its composition seems to be shifting in favour of durable goods, cars in particular.

The assessment I am sharing was made by the Monetary Policy Committee in its meeting in October and is now available in our latest Inflation Report that has just been published. The key point is that, with the ongoing recovery, the Thai economy is set to return to positive growth next year, supported by improvements in the global economy and continued policy stimulus to support private sector demand. A key part of the policy stimulus is the expansionary fiscal policy of which a fiscal deficit equivalent to 3.9 percent of GDP is set for the 2010/2011 fiscal year. Stronger momentum in exports, continued policy stimulus, and a recovery in private sector demand are expected to lift real GDP growth to a range of 3.3 to 5.3 percent in 2010. As the economy returns to growth, a return of domestic inflation is also expected next year on the back of a rebound in economic activities and the rise in oil prices. Inflation next year,  while rising, is forecasted to be within our policy target of 0.5-3.0 percent for core inflation. Again, developments on the inflation front is not without uncertainty. With growth, pressure on prices could return quickly, not to mention the added pressure to inflation that could be coming from the oil price and from the spillovers of the possible rises in asset price linked to persistent capital inflows. Hence, the challenge for monetary policy next year will be to help foster a sustained economic recovery while maintaining price and financial stability.
With oil split on a per capita basis Scotland and the rest of the UK look about as similar as the core and periphery of the euro area; but with oil split on a geographic basis they look about as diverse as the United States (table 1). Despite any differences, the close integration of the Scottish and rest of UK economies has helped ensure that their economic performance has been very similar over a long period – output growth is highly correlated (chart 1).9 So theory notwithstanding, being similar doesn’t necessarily help and being different doesn’t necessarily hinder. This suggests we should look elsewhere for the ingredients of a successful union: to the mobility of labour, capital and goods; to institutional structures promoting financial stability; and to institutions that mutualise risks and pool fiscal resources. An economic union with free movement of labour, capital and goods The “five tests” formulated by the UK Government to analyse the merits of joining the euro in 2003 were crafted in large part around the degree of integration of the UK and the euro area.10 That is because greater openness and integration within a currency union not only enhances  6  These dynamics were in operation in the recent euro area crisis, until the announcement of the ECB’s Outright Monetary Transactions. 7  Members are similar when they experience similar shocks and respond to the same shock in similar ways.

This helps to align economic cycles and makes a common monetary policy more appropriate. 16, 17  11  The classic early contribution on this point was made by McKinnon (1963), who argued that the more open the economy, the more flexible would be domestic prices and wages so that movements in the exchange rate would have little impact on competitiveness, and would be less effective as a stabiliser. In that case moving to a fixed exchange rate would be less costly. 12  Mundell (1961). 13  Some, including Bean (1992), have expressed scepticism that factors of production could in fact move over a shorter timescale than that over which prices and wages adjust. 14  This is consistent with evidence that labour moves less in Europe in response to regional shocks than is the case in the US – see Blanchard and Katz (1992) for the US, and Decressin and Fatas (1995) who apply the same methodology to Europe. The latter find that participation reacts by more to a labour demand shock, and migration by less in Europe than the US. 15  Office for National Statistics, 2011 Census. 16  Frankel and Rose (1998) found that countries with closer trade links tend to have more tightly correlated business cycles. Since joining a currency area promotes trade integration, it also is also likely to help align international business cycles. That means one of the key optimum currency area criteria is endogenous to the decision to join.
But the economy also became badly unbalanced – overly dependent on domestic demand and with a trade deficit that was steadily expanding relative to domestic output. The real exchange rate change brought about by the depreciation of sterling (and indeed the increase in VAT) reflected a need to rebalance the economy away from domestic expenditure and towards net exports. That real exchange rate shock will cause a change in relative prices, with import prices rising relative to domestic wages and prices. It may take several years for that price level effect to work through fully, generating higher inflation rates for the duration. It is possible, but by no means certain, that this effect has now worked through. A key and recurring theme in setting monetary policy is that one has to look at the source of the shocks to understand their inflationary consequences and judge the appropriate policy prescriptions. The first question I want to address today is, given our inflation target, what is the right monetary policy response to these shocks? I then want to talk a little about how we make such decisions and, in particular, the role played by models and forecasts. How should monetary policy have responded to the recent shocks to inflation? The economics profession has long accepted that different shocks warrant different policy responses. Assume for a moment that one can perfectly identify the source and nature of a shock to the economy (which of course, one never can).

The actual return on the Fund in 2001 will not be included in the calculations until the budget for 2003. Moreover, attempts shall be made to curb the impetus from particularly large fluctuations in the phasing-in rate implied by the main rule: “In the event of extraordinary, substantial changes in the Fund’s capital or in the structural, non-oil deficit from one year to the next, the change in the use of petroleum revenues must be distributed over several years based on an estimate of the size of the real return on the Fund a few years ahead” (Report no. 29 to the Storting 2000-2001, p. 7). This means that fiscal policy can still be used to stabilise economic developments. This is a sound Norwegian tradition, but may be demanding. At last year’s seminar, the Central Bank Governor stated: “In Norway it is important that the annual budgets are anchored in a long-term strategy which takes into account that oil revenues may fluctuate from one year to the next”. The guidelines satisfy the requirements of this long-term strategy. Consensus concerning the guidelines and adherence to them will create confidence in the long-term formulation of fiscal policy. This also provides a stable framework for monetary policy. Under such conditions, the effect of monetary policy instruments will be more predictable. The uncertainty facing economic agents is reduced through the establishment of credible fiscal policy guidelines. A stable operating environment is an important precondition when decisions that have long-term consequences shall be taken.
The implication is that you see a trade-off between inflation and the rate of economic growth, so that if only we’d let up a bit on controlling inflation then this country could enjoy higher activity and lower unemployment, which are the really good things in life - or at least we could avoid some of the worst damage that is currently being inflicted upon the whole of the agriculture, large parts of manufacturing industry and even some services sectors. And that might even be true for a time. The trouble is that, in anything other than the short term, it would be likely to mean more rather than less economic damage, and lower rather than higher growth and employment. Often in the past in this country we behaved as if we thought that promoting higher growth and employment - which of course is what we all want to see - was largely a matter of pumping up demand. We paid too little attention to the structural, supply-side, constraints. All too often we tried to buy faster growth and higher employment even at the expense of a bit more inflation. In effect we tried to squeeze a quart out of a pint pot. And you all know the result - rising inflation and a worsening balance of payments, which eventually could only be brought back under control by pushing up interest rates dramatically and forcing the economy into recession.

And that, of course, is exactly what we do in fact do - using the vast array of official economic statistics and financial market data, all the publicly available and some private surveys and commentaries, as well as a wealth of anecdotal and structured survey evidence that we collect BIS Review 71/1998  -3-  ourselves, through our 16 non-executive directors, through the frequent visits which MPC members make around the country, and through meetings in London, and through our network of 12 regional, information-gathering and disseminating, agencies with their 7000 industrial contacts throughout the United Kingdom. And we openly display the facts as they are available to us, as well as our analysis and our conclusions, regularly through the publication of the minutes of our monthly meeting and in the quarterly Inflation Report. So when people say to me that the economy is headed for recession, I’m interested in comparing the evidence on which they base their views with our own evidence, and I want to know whether or not they are also saying that they expect us to undershoot the Government’s inflation target. Let’s just for a moment turn down the noise and look at some of the relevant facts as they relate to the economy as a whole. Since the economy started to recover from recession in the spring of 1992 - some 6½ years ago - overall output has grown at an average rate of about 3%.
ERM-II is a useful prelude to full euro area membership and, other things being equal, will reduce exchange rate volatility. But ERM-II membership is not a magic solution, and the accession process can prove risky. As a result, it is important that economic policy and the regulatory framework be designed to maintain economic stability and keep financial risk within acceptable limits. Most of the changes that will improve economic policy under a flexible exchange rate will also be helpful in the run-up to euro area membership. These changes are discussed in greater detail later in this chapter. Chapter 24 focuses on what euro area membership and full participation in European Central Bank (ECB) operations entails. A number of amendments must be made to the Act on the Central Bank of Iceland in order for the Bank to fulfil the requirements made of national central banks in the euro area, as regards independence and the ability to carry out the tasks entailed in euro area membership. In addition, increased requirements are made concerning central banks’ participation in the formulation and implementation of financial stability policy (see Chapter 25). Money serves as a medium of exchange, a unit of account, and a store of value. The better it retains its value against goods and services and other currencies, the better a store of value and the more reliable unit of account it is. The more it used in trade and the more generally it is recognised in settlement, the better a medium of exchange it is.

One form of exchange rate target familiar to Icelanders is a declared target of an exchange rate index with a defined fluctuation band. Such an arrangement prevailed in Iceland before the inflation target and floating exchange rate were adopted in March 2001 (see Chapter 12). The original fluctuation band was rather narrow, at ±2½%. It was then widened to ±6%, and again to ±9%, after it proved more difficult, and in some ways riskier, to hold the exchange rate within a narrow band once restrictions on capital movements were lifted. But it was also  6  BIS central bankers’ speeches  growing imbalances in the domestic economy that contributed to the demise of the exchange rate target. Those imbalances were due in part to excessively accommodative demand management, which provided insufficient support for the exchange rate policy. An exchange rate peg of this type has an advantage in that, in the long run, inflation will tend to converge on inflation in the anchor currency area and exchange rate volatility will be reduced. However, Iceland’s experience in this area – and that of many other countries – shows that it is difficult to maintain such a unilateral exchange rate peg when movement of capital is unrestricted and the exchange rate policy receives inadequate support from fiscal policy and other aspects of demand management (see Chapter 18). Thus it is not a given that this would be a viable option for Icelanders, as such a policy might lack credibility because of previous experience.