Following a period of a very tight monetary policy in Norway, there was a clear expansionary shift in economic policy in 2003. Norges Banks key interest rate was reduced markedly, while the expansionary stance of fiscal policy was more modest. This has probably contributed to bringing the cyclical downturn to a halt and avoiding a deep recession. Preliminary figures and calculations based on quarterly national accounts figures show that the output gap, i.e. the gap between actual growth and trend GDP growth in the mainland economy, has been very moderate. In addition, unemployment has shown a smaller rise during this cyclical downturn than in the downturns witnessed since the 1970s. Against this background, stabilisation policy can be said to have been successful through 2003.
Nominal developments in the economy cannot, however, be said to have been as successful when measured against the policy objectives as formulated three years ago. Confidence in the ability to adhere to an inflation target and, if necessary, conduct an interest rate policy irrespective of developments abroad has probably been weakened. In recent years, exchange rate developments, which cannot be seen independently of the interest rate policy conducted, has had an impact on cyclical developments and the business sector that most observers would perceive as adverse. Over a period, competitiveness deteriorated at a much faster pace than was the intention underlying the fiscal rule for phasing in petroleum revenues into the Norwegian economy. Even if todays krone exchange rate is not contributing to weakening relative cost competitiveness, exchange rate developments over recent years are still having considerable lagged effects on the real economy. Moreover, we have now experienced and recognized that the krone exchange rate can fluctuate widely under our current monetary policy regime. This increased uncertainty and hence weakens the operating conditions for internationally exposed industries in Norway.
At the beginning of 2004, there are still many factors that are contributing to a favourable situation in the Norwegian economy. With low price and cost inflation and idle resources, an upturn in the economy may come about via growth in internationally exposed industries, which will not be rapidly countered with sharp tightening measures. In spite of the krone depreciation and considerably lower wage growth in 2003, the level of labour costs (and price level) in Norway still remains markedly higher than among our closest trading partners. Other industries than those relying on Norwegian natural resources, or that are sheltered from foreign competition, are thus having problems expanding in pace with growth in domestic and foreign demand. However, interest rates are contributing to strong growth in household demand, while business investment is still declining somewhat, which is normal at an early stage of a recovery. The consumption-driven upturn is partly based on a falling saving ratio, and a marked decline in net lending, with a relatively large volume of debt financing in the housing market. This is a potential source of imbalances that may lead to weaker-than-expected cyclical developments. The question can be raised as to whether households financial positions are sustainable. The rise in house prices implies a financial vulnerability because future payment obligations depend on the macroeconomic situation and hence the interest rate level.
The main challenges are probably still associated with the growing impact of globalisation on the Norwegian economy. This may counter the effect of more favourable cost developments for Norwegian trade and industry, at the same time as globalisation is placing constraints and limitations on economic policy. Even though Norway has a relatively large degree of financial freedom of manoeuvre, the openness of the economy will limit the freedom of manoeuvre in monetary policy. There are serious concerns associated with the lack of sustainability of financial imbalances in a number of countries and the lack of willingness and perhaps ability to coordinate measures. In particular, the growth and level of US foreign debt suggest that the rest of the world may experience a pronounced fall in US demand for imports and/or intensified competition for US export goods if the dollar should depreciate markedly. Political signals concerning increased protection in the US further underlines this.
External price impulses are expected to be moderate during the upturn, particularly if key currencies in Asia are not allowed to appreciate much, and interest rates are expected be kept low or moderate for a fairly long period. Several factors are contributing to this. The cyclical upturn in the OECD area is not expected to be particularly strong so that unemployment will not fall considerably. This will contribute to moderate growth in wages and costs ahead. Price impulses associated with developments in imports of goods and services from Asian countries are probably a more important factor. Low-price imports are not a new qualitative feature inasmuch as there has been strong export-led growth in most East Asian countries based on low prices for several decades. It is the quantitative aspect that is new, which is the result of strong growth in the Chinese economy, and not least Chinas membership of the WTO, which is now having a significant impact on international trade. There is, however, also a new qualitative feature of developments in these countries. Electronic trade in services from Asia and particularly India is increasingly making knowledge-based services into international products, and companies in these industries in western countries are now exposed to competition to a considerably greater extent than earlier.
Imports from China and similar countries now consist of a far broader selection of manufactured goods than earlier. These goods are sold at very low prices, and are allowing China to win market shares. Since these countries only produce a limited number of products that compete directly with Norwegian exports, lower import prices will in the first round improve Norways terms of trade, with a potential increase in national income and wealth. Whether these gains will actually materialize depends on whether the Norwegian economy is sufficiently flexible to achieve the necessary restructuring. Other OECD countries may be more directly affected by competition in export markets. This involves two opposing effects for the Norwegian economy. Lower prices for finished goods will affect demand for raw materials and semi-finished goods, with an attendant increase in global demand for these goods. Since Norway produces these types of goods to a large extent, the demand effects may be positive for the Norwegian economy. On the other hand, OECD countries will lose market shares, which will generate negative demand impulses to the Norwegian economy.
In this context, Norways somewhat special industry structure appears to be an advantage. This structure reflects to a large extent our particular supply of resources, which is more complementary to Asian countries than that of other European countries. A new feature, however, is the transfer of service production to other regions. This implies that labour in service enterprises will also have to envisage the possibility of a transfer to other regions – something which has so far primarily been the case for goods production. Even if wages for this type of labour may be relatively low in Norway relative to our European neighbours, we are still expensive in relation to Asia. As a result, the widened global division of labour may reduce Norways economic advantage in the form of a highly educated labour force.
Low-price imports from Asia are only a few factors of importance in understanding the causes behind the low level of inflation during the cyclical upturn in the OECD area. Structural policy measures that improve competition in product markets may also entail a lower rise in prices for goods and services for a longer period in Norway and our closest trading partners. EU enlargement will also gradually exert downward pressure on prices for many goods and services. The competitive situation in some segments of the transport sector has already resulted in cost cuts, even cuts in nominal wages. Trade liberalization under the new WTO agreements means that Norwegian agricultural products will be less sheltered from foreign competition. This will probably contribute to a considerable price decline, which could trigger a process that pushes down inflation over a longer period.
Inasmuch as wage growth is influenced by a lower and a more supply-determined rise in prices as described above, fundamental mechanisms in overall price and cost inflation will undergo a marked and long-lasting change. The questions that arise are whether the formulation of monetary policy has allowed for such features of international economic developments or whether the demands on monetary policy are too heavy in such a situation. A strict inflation target for monetary policy may entail excessive shifts in the monetary stance in the light of the underlying driving forces and developments among our closest trading partners. It is not easy to determine the importance of such factors when drawing up policy. A key factor in this context is the impact on the krone exchange rate of an interest rate policy that is peculiar to Norway. When international constraints and the uncertainty associated with factors that determine price developments ahead are greater than previously assumed, one should consider increasing the flexibility of the inflation targeting regime in Norway. In practice, the monetary policy framework should also based to greater extent on actual developments in the international economy, rather than on absolute objectives that have been set partially for Norway.
Norway faces new monetary policy challenges as the world economy becomes evermore closely integrated. Tax policy and incomes policy are also affected to a large extent. Must we accept a weakening of traditional Norwegian values such as low unemployment and a relatively even income distribution if we are to participate effectively in international economic relations, and who will reap the benefits? Or can the formulation and implementation of Norwegian economic policy be adapted to these processes so that central common objectives can be attained?
Published 29 March 2004 © Statistics Norway