svein gjedrem : terms of trade shocks and challenges for stabilisation policy speech by mr svein gjedrem, governor of norges bank ( central bank of norway ), at the symposium in honour of victor d norman, bergen, 7 june 2006. the speech does not contain new assessments of the economic situation or of current interest rate setting. please note that the text below may differ slightly from the actual presentation. the charts in pdf - format can be found on the norges bank ’ s website. * * * ladies and gentlemen, let me first say that i am glad of the opportunity to speak at this symposium. victor norman has made valuable contributions to our understanding of international economics, both as a researcher and teacher. most economists that have graduated in norway since the early 1980s are familiar with victor ’ s textbooks. victor has also been a powerful contributor to the public debate for more than a quarter of a century. while international trade and capital flows are key topics in his teaching and research, his involvement in the public debate also include issues like the competitive condition for business and industry, the effective utilization of resources – not least in the public sector – taxation and the tax system, pensions, health care, and many more. substantial improvements in norway ’ s terms - of - trade looking at economic developments globally and in norway over the last few years, it is reasonable to say that victor ’ s main fields of interest are more important than ever. trade liberalisation, political changes, technological advances, and a sharp reduction in transaction costs have fuelled a globalisation process that seems to have accelerated over the last 15 - 20 years. as a result, cross - border flows of goods, services and capital are growing at a markedly faster pace than world production. few countries are benefiting as much as norway – and losing as little – in the current environment of freer trade and increased cross - border labour mobility. prices for goods we import are falling in relation to prices for goods we export. norway ’ s terms - of - trade are improving. the norwegian economy has experienced a strong positive income shock. real national disposable income will increase by 25 - 30 per cent in the period from 2003 to 2006. the impact of the rise in oil and gas prices is particularly strong, but the terms - of - trade gains for the mainland economy have also been high. the situation in norway differs from that of our nordic neighbour countries. sales of swedish and finnish high - tech

they could also be less than $ 50 per barrel. furthermore, even estimating the probability that oil prices will be $ 100 per barrel, or $ 80 per barrel or $ 40 per barrel, is very difficult. this is the essence of uncertainty : it involves risks which cannot objectively be quantified. 2. uncertainty and investment important innovations to the theory of investment decisions were made by economists in the 1980s. researchers such as ben bernanke, robert pindyck, dani rodrik and ricardo caballero demonstrated that decisions by private sector investors to undertake irreversible investments – that is investments with sunk costs – are very sensitive to risk and uncertainty about future prices, costs and other variables which affect the financial viability of the investment. faced with uncertainty about such variables, investors have incentives to delay their irreversible investments in order to wait for more information which will reduce that uncertainty. this is known as the option value of waiting. the greater is the risk and uncertainty about the future path of variables which affect the viability of an investment, the higher is the option value of waiting and the larger are the incentives facing the investors to delay their investment. bis central bankers ’ speeches what does this mean for uganda? uncertainty has implications for investment in both the oil industry and the rest of the economy. let me start with the oil industry. most of the capital investments in the oil industry are irreversible, especially those involving large scale infrastructure such as pipelines, so the option value of waiting will be a factor influencing investment decisions in the industry. given the uncertainty about long term oil prices, the probability that future oil prices will be too low to enable investments in the oil industry in uganda to be commercially viable over the lifetime of the projects is not zero. you may reasonably take the view that the probability that oil prices will be too low to ensure the viability of investments is small, but it cannot be dismissed entirely. investors in the oil industry face a tangible risk that global oil prices over the long term will render their investments unviable. that risk is higher today than it was prior to the fall in global oil prices in mid 2014. as a consequence, investors in the oil industry face incentives to delay or slow down their investments as they wait to see how global oil prices might evolve. that does not mean that oil companies will not invest in uganda ’ s oil industry, but it does mean that they will be more cautious about committing resources to irrevers