Tag Archives: Central Bank of Norway

Have Norway's Central Bank Lost Touch With Reality?

According to the original plan from last year, the Norwegian key policy rate should now be 2,5%. But over the last months the Central Bank of Norway have been forced to freeze the rate amid growing uncertainties about the economic developments in both Norway and abroad. Some economist suggest that the central bank will have to lower the policy rate again, but at the moment that is out of the question as Norges Bank keeps holding on to its optimistic outlook.

“Recent developments in the Norwegian economy have been broadly in line with expectations. Activity is rising moderately. Inflation has slowed and is now below 2%.”

Svein Gjedrem

“Recent developments in the Norwegian economy have been broadly in line with expectations. Activity is rising moderately. Inflation has slowed and is now below 2 per cent,” Governor Svein Gjedrem at Central Bank of Norway says in a statement after the decision to keep the policy rate unchanged for a while longer.

According to the board of directors at Norges Bank, the global economic growth has been slightly stronger than expected, but the level of activity is still low in advanced economies.

Governor Svein Gjedrem. Central Bank of Norway.


“Turbulence related to public finances in several European countries has receded,” they say in the press release, adding;  “but the outlook for the US economy is somewhat more uncertain.”

“Considerations relating to both inflation and stable developments in output and employment imply that the interest rate should be kept low. The consideration of guarding against the risk of future financial imbalances that may disturb activity and inflation somewhat further ahead suggests that the interest rate should be gradually brought closer to a more normal level,” Governor Svein Gjedrem concludes.


Too Optimistic?

Several economists have pointed out that the central bank’s perception of the global economy is just plain wrong.

“There’s one thing I really disagree with; that the Central Bank emphasizes that the global economy is stronger than expected,” says macro economist Shakeb Syed at Handelsbanken to the website DN.no.

He points to statement were the bank writes:  “The growth in the global economy appears to have been somewhat stronger than expected, but the level of activity in industrial countries is still low.”

“You might find a few bright spots in Germany and Britain, but two birds do not make a summer,” Mr. Syed  underlines.

OUTDATED: For some reason, Central Bank of Norway are not taking the lastest downward revisions into account.

Here’s few more optimistic statements from the Norwegian central bankers:

* Growth in world trade and global manufacturing output has slowed somewhat, but overall activity has picked up somewhat faster than expected earlier this year, particularly in some European countries. Growth in emerging market economies is still strong.

* The IMF revised up its global growth forecasts for 2010 from 4.2 per cent in April to 4.6 per cent in July and maintained its growth forecast of 4.3 per cent for 2011.

* Underlying consumer price inflation is low in the euro area and the US. Inflation expectations are still stable in most advanced countries.

* The differential between German and Greek 10-year government bond yields is approximately unchanged at 7.6 percentage points. For Spain and Portugal the differential has narrowed by up to 0.6 percentage point to 1.5 and 2.5 percentage points, respectively. Greece, Spain, Italy and Portugal have conducted successful auctions of government bonds in the market.

* On 23 July, the results of the stress tests on European banks were published. Seven of 91 banks did not satisfy the capital requirements. The tests have reduced the uncertainty surrounding the financial position of the banks.

Here’s a copy of the full statement from the Central Bank of Norway.

(And some nice, good looking, charts to go with it).

Nothing Is Fixed

However Shakeb Syed says that the signs of growth seen in the euro zone lately is just temporary.

Chief economist Shakeb Syed. Handelsbanken ASA.

“I think that overall the picture is pretty dark. Remember that the focus in the euro zone is aimed at cutting budgets –  that is not growth inducing,” he explains.

He points out that there is the same focus in the US, and that you don’t find many good figures there, either.

“I believe in a catch-up in the longer perspective. Throughout the summer we’ve had some pretty okay numbers, but I don’t think were getting such good numbers going forward. I think we get figures showing that growth is very weak,” the Norwegian  macro economist says.

Many of the euro pessimists have been pointing out that the rise in the euro zone is just a flicker, and that none of the issues that dominated Europe in the spring has been resolved.

Shakeb Syed agree.

“There is nothing that is fixed,” he says.

“This only strengthens the belief that interest rates will be ultra low for some time, not only in the US but also in Norway,” he concludes.

The Ghost of Ricardo

In the latest forecast by Norges Bank they estimate a 50% chance of a rate hike in December, and a 50% chance that the increase will come in January next year.

The reason for this uncertainty is (of course) those damn consumers who just won’t behave as expected according to the traditional Keynesian economic theories.

Economist David Ricardo


Instead they seem to have started saving the extra money they get through low interest rates and various stimulus measures.

Almost like described in the 200 years old economic theories of David Ricardo. A theory usually dismissed because of its lack of empirical studies, and the fact that it presupposes a rational behavior amongst people.

But the fact is that the Norwegian consumption has virtually stagnated in recent months, and at times have been far below the projections of Central Bank of Norway.

During last monetary policy report in June,  the central bank had to take down the consumption estimates sharply.


Meanwhile – I’m waiting for the revelation….



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Norway's Foggy Outlook

The Central Bank of Norway decided Wednesday to keep its key policy rate at 2%, as expected by most analysts. The Central Bank have also suspended its earlier projections for future rate hikes due to renewed uncertainty about the global – and in particular the European – economy. Yesterday’s labor market report showed a much sharper increase in unemployment than expected. Actually, no one seems to have a clue about what’s going on in our  economy right now.

“New information may reveal aspects of economic developments that suggest the Norwegian economy is following a different path than projected.”

Norges Bank

“The moderate recovery in the Norwegian economy is continuing, and inflation has moved broadly in line with projections. However, the turmoil in global financial markets is creating uncertainty with regard to economic developments. This suggests that the interest rate should be kept unchanged for a period and that the further increase will occur later than previously envisaged”, Deputy Governor Jan F. Qvigstad at Norges Bank says.

“The outlook for Europe is uncertain. Many countries are compelled to implement substantial fiscal tightening. This will dampen economic activity and may have an impact on other countries, both within and outside Europe. The projections in Monetary Policy Report 2/10, presented today, are based on the assumption that the turmoil in financial markets will gradually pass. Interest rates abroad are nonetheless expected to remain low for a fairly long period”, Qvigstad adds.

The Executive Board’s strategy is that the key policy rate should be in the interval 1½–2½ per cent in the period to the publication of the next Monetary Policy Report on 27 October unless the Norwegian economy is exposed to new major shocks, the Norwegian Central Bank writes in its statement.

A Major Mistake?

The Central Bank of Norway was the first in Europe (and the second in the world) to rise interest rates again after the 2008 financial turbulence.

Since October 2009, Norges Bank has raised the key policy rate by a total of 0,75 percentage point to 2%, against some screaming economists advice.

And there are now in fact some signs that might suggest the central bank have been relatively overoptimistic in its earlier projections of the development and recovery of the Norwegian economy.

Here’s what the central bank writes in their Monetary Policy Report 2/10, released today:

“The recovery in the Norwegian economy is continuing, albeit at a somewhat slower pace than envisaged in March. Underlying inflation is now around 2% and is expected to slow further towards the turn of the year. Lower interest rates abroad and a weaker outlook for Europe, higher money market premiums in Norway, somewhat lower growth in the Norwegian economy ahead and slightly lower wage growth suggest that the key policy rate should be raised somewhat later than projected in the March Monetary Policy Report.”

Well, it’s better than saying; “we screwed up.”

The Rate Must Go Up (At Some Point… )

“The risk of a prolonged period of turbulence in financial markets, resulting in a weakened outlook for inflation, output and employment in the Norwegian economy, suggests that the increase in the key policy rate should be postponed. On the other hand, interest rates in Norway  are low. The consideration of guarding against the risk of future financial imbalances that may disturb activity and inflation somewhat further ahead suggests that the interest rate should be brought closer to a more normal level,” the central bankers writes.

Translation: “We think it’s best to keep the interest rate low for a while. We have no idea for how long, and it might just make things worse.”

Major Uncertainty

However, The Central Bank of Norway admit to the unusual uncertainty related to the global economy:

“The projections are uncertain. New information may reveal aspects of economic developments that suggest the Norwegian economy is following a different path than projected. If the financial market turbulence should rapidly abate, economic activity, in Norway and abroad, may increase more sharply than projected in this Report and result in higher inflation. Higher capacity utilization or lower productivity growth may also push up inflation more rapidly than currently projected. On the other hand, inflation may be lower if global developments prove to be substantially weaker than projected or the krone appreciates markedly.”

Monetary policy cannot fine-tune developments in the economy, but it can mitigate the most severe effects when the economy is exposed to shocks. On balance, the outlook  and the balance of risks suggest that the key policy rate should be held at the current level for a period and then be raised gradually towards a more normal level.”

A more “normal level” is, according to the Norwegian central bank about 4 – 5 percent.

The interesting question here is; what happens if the central bank discover that the old definition of “normal” have been replaced with a new “normal.”

This is the new projections for the Norwegian key policy rate:

Here’s a copy of the full Monetary Report 2/10 from Norges Bank.

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Norway At The End Of An Era

Norway’s glorious days as one of the worlds major oil producers are numbered. It will probably be over in about 10 years or so, governor Svein Gjedrem at Central Bank of Norway pointed out in a speech at a conference in the city of Stavanger, Tuesday. He warns about a painful process ahead, with substantial cost reductions and severe job losses.

“Norway’s cost level and low growth in Europe will bring pressure on jobs and businesses in the manufacturing communities. Entire manufacturing sectors may be lost.”

Svein Gjedrem

“Look what I found! shouted Askeladden in the Norwegian folktale “The Princess Who Always Had to Have the Last Word”. He found a dead magpie, a willow hank, a bit of broken saucer, two ram’s horns, a wedge and a worn-out shoe sole, which he managed to transform into a princess and half a kingdom.”

Governor Svein Gjedrem at Central Bank of Norway has made his “trademark” by using quotes from Norwegian literature in his speeches.

Today’s performance at the oil seminar in the city of Stavanger on the Norwegian west coast was no exception.

Here’s the rest of the fairy tail:

Askeladden (the Ash Lad) is often perceived as the embodiment of sound Norwegian values such as a sense of adventure, courage and helpfulness. Askeladden is nevertheless someone who succeeds by pure chance.

Like Askeladden, we also found wealth, but under the sea floor. We were lucky.

An abundance of natural resources is in principle of benefit to a country’s economy. The production of petroleum and other natural resources generate gains that exceed the normal return on invested capital, economic rent. But oil is also associated with challenges. As early as in 1974, the Storting deliberated the economic challenges relating to oil production.

We were able to learn from the experience of other countries. The concept Dutch disease stems from the negative effects on the Dutch economy of the spending of revenues from the substantial gas resources of the Groningen field. From the end of the 1960s, these revenues financed strong growth in public expenditure, which led to higher costs and a decline in manufacturing. The situation went too far, resulting in large balance of trade and government deficits which required tightening measures. This in turn led to a sharp rise in unemployment in the first half of the 1980’s.

But the Netherlands is not the first example of a nation that failed in this respect, and far from it. A very clear example is provided by Spain as early as in the 17th century when the colonization of South and Central America provided the country with access to vast natural resources and gold. The historian David Landes describes the effects on Spanish society in his book “The Wealth and Poverty of Nations” where he cites a happy Spaniard who proclaimed the following in 1675:

“Let London manufacture those fabrics of hers to her heart’s content; Holland her chambrays; Florence her cloth; the Indies their beaver and vicuna; Milan her brocades: Italy and Flanders their linen, so long as our capital can enjoy them. The only thing it proves is that all nations train journeymen for Madrid and that Madrid is the queen of Parliaments, for the world serves her and she serves nobody.”

From time to time, I meet representatives of the diplomatic corps in Norway. They seldom fail to mention the high cost level in Norway and their bewilderment over aspects of our way of life. A 17th century Moroccan ambassador was even more critical in his account of the wealthiest nation at that time:

“…the Spanish nation today possesses the greatest wealth and the largest income of all Christians. But the love of luxury and the comforts of civilization have overcome them, and you will rarely find one of this nation who engages in trade or travels abroad for commerce as do the other Christian nations […]. Similarly, the handicrafts practiced by the lower classes and common people are despised by this nation, which regards itself as superior to other Christian nations. Most of those who practice these crafts in Spain are Frenchmen [who] flock to Spain to look for work … [and] in a short time make great fortunes.”

The oil age in Norway has now spanned about 40 years and there are prospects that it will continue for some time ahead. We will most likely still be producing petroleum in 40 years’ time, but oil production has declined in recent years after peaking in 2000. Gas production is rising, but not at a pace sufficient to sustain overall petroleum production.

The idea of an oil fund was raised in the beginning of the 1980’s. It was intended to be a buffer fund to smooth variations in government oil revenues.

The Act relating to the Government Petroleum Fund was adopted in 1990 in the midst of the deepest economic downturn in Norway since the Second World War. Those at the Ministry of Finance working on the law at the time were probably in doubt as to whether any savings would ever be accumulated in the fund.

And initially the fund structure was only an exercise in accounting. Government petroleum revenues were deposited in the fund, but the entire amount was transferred back to the central government budget to cover some of the non-oil deficit. But the Norwegian economy rebounded.

It took a generation from the discovery of the first oil field in the North Sea until it became possible for the government to set aside a portion of the economic rent. The first net transfer to the fund of close to NOK 2 billion was made in 1996. Every year since then, as a savings plan, the government has let a substantial share of current income from oil and gas remain as deposits in the fund. At the end of the first quarter of this year, the fund’s market value stood at NOK 2 763 billion.

As the fund increased, the need for a plan for the phasing in of oil revenues became evident. In 2001, the Government and the Storting adopted the fiscal rule, which is based on the deposit of government petroleum revenues in the oil fund. An amount equivalent to the expected real return on the fund, or 4 per cent, as an annual average over time, is transferred back to the central government budget to cover current expenditure. The transfers increase as the fund rises in value.

Along the way, the name of the fund has been changed from the Government Petroleum Fund to the Government Pension fund Global.

There are prospects that new annual transfers to the fund may be made over the next 10 years or so. This implies further growth in the fund, perhaps up to twice the size of today’s fund, which corresponds to one and half to two times annual GDP for Norway. Public expenditure accounts for about half of GDP. Withdrawals from the fund at 4 per cent can therefore finance 15 per cent of public spending in 10 years’ time. This can continue on a permanent basis without reducing the capital in the fund. The fund will therefore lead to smaller cuts in government welfare spending than would have been the case without the fund as the costs related to the aging of the population have an impact on government budgets.

The actual building up of the fund may span a short generation.

A fund with investment abroad enables Norway to separate the revenues generated by oil and gas production from petroleum revenue spending. An alternative could have been to regulate the production rate, keeping our wealth under the sea bed for a longer period, as was attempted in the 1970’s when the production ceiling was set at 90 million standard cubic meters per year. Oil companies currently produce 240 million standard cubic meters per year.

The fund acts as a buffer between widely fluctuating oil revenues and domestic expenditure. The annual spending decision can be made independently of the size of the revenues. Thus, the fluctuations in government oil revenues do not have an automatic impact on the Norwegian economy. The fund also has a stabilizing effect on the krone exchange rate as capital outflows increase when Norway’s petroleum revenues rise.

As a savings plan, the fund enables petroleum revenues to be used by not only the current generation but also future generations. The fiscal rule ensures that this is the case.

International capital markets play an important role for Norway. We drew on borrowing opportunities abroad when the petroleum industry was under development. We did the same in order to expand welfare schemes and to finance the counter-cyclical policy of the mid-1970s and the early 1990s. In the past 15 years, international financial markets have enabled us to convert national oil and gas resources into foreign equities and bonds.

Since its establishment in 1998, the fund’s average annual real return after costs has been 2.9 per cent, or somewhat lower than the expected long-term return. This figure is marked by the challenging character of the financial crisis. The fund lost NOK 633 billion (4) in 2008, but a market reversal in 2009 has resulted in a positive return of NOK 716 billion over the past five quarters. So far, the fund seems to have fared relatively well through the most severe financial crisis for many decades.

We still consider a real return of 4 per cent as realistic over time. This is based on the assumption that investment in sound government securities in the market can provide a reliable real return of about 2½ per cent. At the same time, the fund can reap a return of 2 to 2½ per cent in the long term from the three-fifths equity portion, some gains on corporate bonds and returns from active management.

Substantial oil revenues are now being ploughed into the Norwegian economy. Since the turn of the millennium, annual petroleum revenue spending has increased by a good NOK 100 billion. According to uncertain forecasts in government documents, another NOK 40 billion or so will be phased in over the next ten years.

The cost level in Norway is a thermometer indicating how much the Norwegian economy can sustain without developing a serious case of Dutch disease. The temperature is now high. Measured against Norway’s trading partners, the cost level is now almost 20 per cent higher than the average for the oil age. Norwegian labor has never been as costly as today. Norwegian businesses will often lose contracts given the current high level of spare capacity in other countries. And it has never been more profitable to relocate activities abroad.

The economic geography of Norway will change over the next 10-15 years. Norway’s cost level and low growth in Europe will bring pressure to bear on jobs and businesses in manufacturing communities. Job losses will have the most severe effects in areas where manufacturing is the most important industry. Entire manufacturing sectors may be lost.

We can also ask whether investment in Norway could be an alternative to our investments in international financial markets. It is important to emphasize that the oil fund does not stand in the way of corporate investment. The government can choose the composition, required rate of return and risk profile for its investments without considering the funding requirements of Norwegian enterprises. By the same token, Norwegian companies can choose their debt and equity structure independently of the government’s financial investments. There is a capital market between the government as investor and corporate capital needs. The government’s foreign savings plans do not therefore affect Norwegian companies’ access to capital and required rate of return on their investments.

There are sound arguments for investing in infrastructure, better schools and state-of-the-art research. But this should be possible anyway given the increase in expenditure that is provided for by the fiscal rule.

The profitability of government investments is based on a discount rate of 4 per cent. This secures about the same required rate of return as the government can expect to achieve on its oil fund investments over time. A question that might be raised is whether there is a queue of sound and profitable projects that have to wait because of an excessively tight fiscal policy.

It is difficult to find support for this.

In the National Transport Plan for 2010-2019, which can perhaps be considered representative of government spending, spending on road investments is set at around NOK 140 billion. The profitability of about two-thirds of the investments has been evaluated. The calculations capture time saved and reduced costs related to accidents and the environment. Investment costs and future operating costs are deducted. The projects show a total loss of NOK 20 billion.

There seems to be few road projects that are economically profitable. A rare example is the Finnfast tunnel project that connects the mainland to the beautiful island group here in Ryfylke.

When projects cannot be expected to increase the future revenue base in society, it is important that the investments are financed from current government revenues within a long-term and sustainable framework. Alternatively, projects that involve a large number of users can be financed by user fees. A road, infrastructure or research reports for that matter can provide benefits and satisfaction over time, but they are not liquid and do not generate a flow of returns that can be used for spending. If the investments are made at the expense of the savings plan for the sovereign wealth fund, future generations will have to bear the cost.

Let me conclude.

The adventures of Askeladden are often tales of success. Askeladden embraces every challenge and always comes out ahead.

It is too early to draw conclusions as to how successful Norway has been in managing its oil wealth. In ten years or so, when petroleum production falls markedly and the oil fund is no longer increasing in size, the cost level in Norway will have to be reduced relative to other countries. This process may be painful, even though Norway has its own currency and a floating exchange rate. Our welfare state may also have become too large and the adjustment required here may also prove to be very demanding.

Nonetheless, there are aspects of our oil wealth management that have served us well.

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