øystein olsen : managing wealth – some thoughts on economic policy and the allocation of national savings speech by mr øystein olsen, governor of norges bank ( central bank of norway ), at a meeting hosted by the norwegian embassy, rome, 29 november 2012. * * * introduction european economies are currently going through hard times, with repercussions of the crisis still being felt throughout the world economy. for all of us, it is a humbling experience to observe how closely interconnected markets and economies have become across national borders. my intention here this evening is not to point at solutions to the challenges currently facing the euro area. what i can offer, however, is the perspective of a friendly neighbour and a substantial investor. in this modest capacity, i hope to sound a note of optimism from a region of europe that in its recent past went through a grave crisis, which was followed by a series of reforms and, eventually, the return of prosperity. the nordic experience with the cycle of crisis, reform and recovery might provide some perspective for those european countries now facing similar challenges. i will also make some remarks on the current situation in financial markets in general, and government bond markets in particular, from the viewpoint of a global investor. easy money is bad for you slide 1 : landes quote in his book the wealth and poverty of nations the historian david landes describes how the spanish empire went into a long period of decline when the flow of latin - american gold dried up in the mid - 17th century. according to landes, the moral of this story is that “ easy money is bad for you. it represents short - run gain that will be paid for in immediate distortions and later regrets. ” 1 as a country rich in natural resources, norway has shared and tried to learn from this experience. perhaps the quotation from landes also rings true for all those who borrowed cheaply during the boom before 2008, and who now have to face the consequences. windfall gains, like large and unsustainable capital flows from abroad, are double - edged. they provide short - term relief from hard choices, but may carry with them hardship in the longer term. slide 2 : output gap : a boom - bust economy after the discovery of oil in the north sea in 1969, government spending and social programs expanded rapidly in anticipation of future petroleum revenues. we sought to build a bridge across the post oil - shock recession in europe. but it was a bridge to nowhere.

, and will not entail a large sell - off on our part. instead, the effect will be merely a temporary drop in our purchases of european assets. under the new principle, the fund will still be overweight in european assets, compared to a market neutral position. lessons from the crisis the high equity share, the capacity to increase the risk level in certain periods and the need for diversification are derived from the fund ’ s characteristics. let me now review some of the lessons from the financial crisis that have also shaped the development of the fund ’ s strategy. these changes are closer to the centre of the european debt crisis. the risk tolerance of the fund is to a large degree defined by the strategic equity share, which, as i mentioned, is 60 per cent. since the fund is heavily exposed to risk by virtue of its relatively high equity share, the function of government bonds is in essence to reduce the overall volatility of the portfolio. from this perspective, the most important role for government bonds is to hedge the equity portfolio. the hedge is best achieved by holding liquid government bonds with high credit quality. typically, this entails an overweight of the safest, low - yield government bonds. conversely, high - yield government bonds are more volatile, and thus they do not serve the overall purpose as a hedge in a global portfolio. bis central bankers ’ speeches slide 14 : fixed income : new benchmark the fund ’ s benchmark index for bonds is divided into 70 percent public and 30 percent corporate debt. previously, the allocation in the bond portfolio was based on market weights, and thus the portfolio was allocated in proportion to volume of the sovereign debt issued by each country. this resulted in rising allocation to the bonds of countries with increasing debt. the risk linked to this strategy became clear in the wake of the financial crisis. a reallocation of government debt on the basis of gdp weights will reduce this risk. moreover, we have started investing in government debt issued by emerging countries. the consequence of this is a reduction in the fund ’ s european holdings. increased demand for the safest government bonds may be regarded as an adjustment to the climate of high spreads and volatility that we have witnessed in recent years. in a market environment characterised by general uncertainty, market expectations might cause a slight increase in risk premiums to mount rapidly, unless the underlying cause of the increased risk premiums is dealt with by the relevant authorities. to sum up : a downweighting of