svein gjedrem : is the financial system stable? speech by mr svein gjedrem, governor of norges bank, at the 2001 annual meeting of the norwegian savings banks association, haugesund, 18 october 2001. please note that the text may differ slightly from the actual presentation * * * introduction the role of the financial industry in the economy has become increasingly important over the last decades. deregulation and technological advances have increased the industry ’ s opportunities and scope to channel savings to various projects. strong competition has induced the industry to make use of these new opportunities. the range of saving and financial instruments is becoming ever wider. systems and financial instruments for managing and controlling risk are becoming more advanced. as a result, it has become easier for households and enterprises to decouple consumption and investment from current income. in the second half of the 1990s, in particular, international capital markets have become more integrated. it has been easier for growing economies to finance investments through a balance - of - payment deficit and foreign capital. at the same time, countries with high savings can increasingly diversify their investments. globalisation places increasing demands on the business sector ’ s ability to adapt. new products and technology squeeze out old solutions. this creative destruction, as schumpeter called it, may foster a more efficient distribution of resources and higher economic growth in the long run. a rapidly changing environment places considerable demands on the financial industry. the financial prospects for a project must be assessed in relation to risk. a diversified portfolio of loans and investments limits expected losses. losses on one project may be more than offset by gains on another. economic growth is cyclical. during an upswing most projects fare better than expected. a deep recession can lead to heavy losses, insolvency and financial crisis. banks may address this risk by building up sufficient buffers during upturns. often, this is not done in practice. instead, financial enterprises tend to place special emphasis on increasing market shares while times are good and allow their capital ratios to fall. it is during an upturn that the basis for the downturn is laid. financial crises are often characterised by a first phase when optimism predominates, risk assessments weaken and the willingness to borrow and asset prices increase. when negative news starts to spread, investments fall short of expectations and the mood shifts, asset prices fall and debt - servicing problems accumulate. a financial bubble can first be identified with certainty after it has burst. there are

sector negotiations can take into account that the higher pay increases are, the fewer people that can be paid over government budgets. the interaction here became clear when public sector employment fell after the expensive wage settlement in 2002. in the years following 1997, with strong growth in public expenditure, the fiscal rule pointed to a continued increase in the use of petroleum revenues. we had to expect that this increase would lead to a deterioration in the competitive position of norwegian manufacturing, either through higher wages or through an appreciation of the krone exchange rate, and with norway ’ s relatively higher wage growth, competitiveness has been weakened by approximately 15 per cent since the mid - 1990s. the krone exchange rate has been influenced by high oil and gas prices and prices for other norwegian export goods. monetary policy has also influenced the path for norway ’ s relative costs, but the nominal value of the krone is about the same as ten years ago. strong growth in public expenditure and expectations of moderately higher growth in the use of petroleum revenues now seem to have been factored into the cost level. even at the beginning of the oil age in norway in the early 1970s, the relationship between the use of petroleum revenues and changes in industry structure was raised as an issue. manufacturing industry was scaled back in waves in the course of this period. the last wave occurred around the turn of the millennium, but a substantial decline also occurred in the periods 1977 to 1984 and 1987 to 1992. prior to these periods, the manufacturing sector ’ s competitiveness deteriorated. today, about 55, 000 fewer persons are employed in manufacturing than was the case in 1998. the share of our imports that can be covered by current petroleum revenues and some of the petroleum fund will gradually diminish. competitiveness must therefore be improved. competitiveness may have to return to a level we have not experienced since petroleum production began. rough estimates indicate that the real exchange rate that safeguards the balance of trade when norway ’ s oil wealth no longer has the same weight in the economy will be more in line with the real exchange rate we had in the 1960s. thank you for your attention. 7 / 7