NorwegiaN moNetary policy seeN from abroad64

* TheauthorwouldliketothankGoranKatinicforallhelpwithcollectingandpresentingthedatainthisarticle,AndyFilardoforpermissiontousedatafromFilardoandHofmann(2014)inFigures8a–8d,andSveinGjedrem,EricLeeper,JesperLindé,ArentSkjaevelandandJanQvigstadforhelpfuldiscussions.Theopinionsexpressedinthisarticleare,however,thesoleresponsibilityoftheauthor.TheyshouldnotbeinterpretedasreflectingtheviewsofSverigesRiksbank.

NorwegianmonetarypolicyseenfromabroadAndersVredin*TheauthorisHeadoftheGeneralSecretariat,SverigesRiksbank

‘Who wants transparency when you can have magic? Who wants prose when you can have poetry?’ – Duke of Windsor, in the TV series ‘The Crown’.

1 IntroductionTheNordiccountriesinEuropehavemanythingsincommon,buthaveforvariousreasonschosendifferentstrategiesfortheirmonetarypolicies.FinlandisamemberoftheEuropeanUnion(EU)andtheeuroarea.DenmarkandSwedenaremembersoftheEU,butnotoftheeuroarea.Denmarkhas,however,chosentopegthevalueofitscurrencytotheeuro,whereasSwedenhasaflexibleexchangerateandinsteadfocusesonstabilizingthedomesticvalueofitscurrencythroughanexplicitinflationtarget.NorwayandIcelandalsohaveflexibleexchangeratesandinflationtargets,butunlikeSwedentheyarenotpartoftheEU.BeingoutsidetheEU,atleastformally,thesetwocountrieshavesomewhatlargerdegreesoffreedomwhenitcomestocentralbankgovernance.

ThispaperhasbeenwrittenonthesuggestionoftheMinistryofFinanceinNorwayandisbasedonapresentationmadeataconferenceonexperiencesofinflationtargetingorganizedinOsloon16January2017.ThetaskgivenwastocommentonmonetarypolicyinNorwayfromaSwedishperspective.Forobviousreasons,beingacentralbankofficial,IhavechosennottocommentonthecurrentimplementationofmonetarypolicyinNorwayandSweden.Instead,Iwilltakeamoregeneralandlongtermperspectiveandhighlightsomesimilaritiesanddifferencesbetweenthetwocountries’strategiesformonetarypolicy.

Insummary,thepresentationandthepapercontainthefollowingmainmessages.First,thefactsthattherehavehistoricallybeensmalldifferencesinnominalandrealinterestratesinNorwayandSweden,and,inparticular,thatthenominalexchangeratehasbeenverystable,suggestthattherehavebeensmalldifferencesinmonetarypoliciesbetweenNorwayandSweden.Second,thesimilaritiesinmonetarypoliciescanbeobserveddespitedifferencesininstitutionalframeworks,asreflectedforexampleincentralbanklaws.Takentogether,thesefirsttwoobservationsprobablyreflectthatbothNorwayandSwedenarehighlydependentonthedevelopmentintherestoftheworld.Third,monetarypolicyinNorwayandSwedenfacesimilarchallengesinthenearfuture.Theexperiencesduringthelastdecade,thatis,sincetheglobalfinancialcrisis,haveraisedquestionsabouttheinflationtargetingstrategy,forexampleasregardstheproperdefinitionoftheinflationtargetandthelinksbetweenmonetarypolicy,fiscalpolicyandfinancialstability.

2 Howdifferentaretheframeworksformonetary policyinNorwayandSweden?SomesimilaritiesanddifferencesbetweenNorwegianandSwedishframeworksaresummarizedinTable1.AnimportantsimilarityisthatSwedenandNorwaybothfollowthestrategycalled‘flexibleinflationtargeting’.Anexplicitinflationtargetwasannounced

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inSwedenin1993andinNorwayin2001,butthedetailsofthisstrategyhavedevelopedovertime.Forinstance,NorgesBankstartedtopublishforecastsfortheirowninterestratein2005andSverigesRiksbankstartedwiththisin2007.Bothcentralbanksareconsideredtobeamongthemosttransparentcentralbanksintheworld,althoughtherearesomedifferencesintheirpractices,andofcoursestillroomforfurtherimprovement.1

Table 1. Comparison of the frameworks for monetary policy in Norway and Sweden

Similarities Differences

Explicit,butflexible,inflationtargets EU

Transparency Thedegreeofindependence

Interestrateforecasts Governance

Small,efficientcentralbanks NBhasbroadermandate

SeparateFinancialSupervisoryAuthorities 2.5percentvs2percent

Fiscalrules Communicationaboutleaning

Smallopeneconomies Oil

SomeofthecommoncharacteristicsofNorgesBankandSverigesRiksbankmaynotseemdirectlyrelatedtothemonetarypolicystrategy,butcanarguablyaffectthecredibilityoftheinflationtargets.Bothcentralbanksarerelativelysmallbyinternationalstandards,andsincetheystillperformsimilartaskstoothercentralbanks,theyshouldthereforebeconsideredrelativelyefficient.Ahighdegreeoftransparencyandopennessisalsoconducivetoefficiency.Efficiency–andtransparency–inturnshouldpromotelegitimacyfortheinstitutionandtherebycredibilityforthetargetandstrategythecentralbankchoosestoformulate(ifthetargetandthestrategyareconsistent).

BothNorwayandSwedenhaveseparateFinancialSupervisoryAuthoritiesthatarenotpartofthecentralbank(unlikethesituationinsomeothercountries,forexampleFinlandandtheUK).Theadvantagesanddisadvantagesofsuchseparationaresubjecttoaninternationaldiscussionamongpolicymakersandresearchers.Thereareargumentssuggestingthatcoordinationwouldleadtobetteroutcomesforbothmonetarypolicyandsupervision,buttherearealsoargumentswhyseparationmaybebeneficial(see,forexample,Acharya,2015,andSchnabel,2016).

InbothNorwayandSweden,fiscalpolicyisrestrictedbysomeexplicitrules.InSweden,thereisasurplustargetfornetgovernmentlendingoverthebusinesscycle.InNorway,thereisinsteadalimitforthedeficit,morepreciselyalimitonhowmuchofthegovernmentpensionfund,basedonrevenuefromoilproduction,thatcanbeusedeachyear.Somemacroeconomistshaveemphasizedthatinflationtargetscanbecredibleonlyinsofarasthestrategiesformonetaryandfiscalpolicyfulfilcertainconsistencyrequirements(see,forexample,Leeper,2016,andSims,2016).

ThemostimportantsimilaritymaywellbethatbothNorwayandSwedenaresmallandtrade-dependenteconomiesthatareheavilyinfluencedbyeconomicdevelopmentsintherestoftheworld.Thisputssomelimitsonhowmonetarypolicycanbedesigned,andonwhatitcanachieve.Buttherearealsodifferencesinthisregard.AsamemberoftheEU,SwedenhasagreedtocomplywiththeprinciplesoftheMaastrichtTreaty.ThisisonereasonwhySverigesRiksbankhasahigherdegreeofindependencefromthepoliticalsystemthanNorgesBank.AccordingtoSwedishlaw,nopublicauthoritymaydeterminehowtheRiksbankshalldecideinmattersofmonetarypolicy,andtheRiksbank’sExecutiveBoardmay

1 AccordingtoDincerandEichengreen(2014),NorgesBank’s‘transparencyindex’is10.0andSverigesRiksbank’s14.5,whereastheaverageforcentralbanksinEuropeis8.4.Forsuggestionsastohowcommunicationcanbeimproved,seeforexampleNorgesBankWatch2016(Lommerudetal.,2016)andGoodfriendandKing(2016).

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neitherseeknortakeinstructions.InNorway,incontrast,theGovernmenthastherighttogiveinstructionstoNorgesBank.2

Therearealsootherdifferencesintheinstitutionalframeworksforthetwocentralbanksthatmayhaveimplicationsforhowmonetarypolicyisconducted.Thereare,forexample,differencesregardingthecompositionofthecentralbanks’BoardsandtherolesoftheGovernor.TheRiksbankisgovernedbyanExecutiveBoardconsistingofsixfull-timeemployedmembers,theGovernorandfiveDeputyGovernors.NorgesBankhasanExecutiveBoardconsistingofthreeinternalmembers,theGovernorandtwoDeputyGovernors,andfiveexternalmembers.NorgesBank’sgovernancemodelresemblesthatoftheReserveBankofAustralia,whiletheSwedishmodelismoresimilartothoseinChile,BrazilandSwitzerland.

NorgesBankclearlyhasamuchbroadermandatethanSverigesRiksbank.ThesinglelargestdifferencebetweenthetwoinstitutionsisprobablythatNorgesBankmanagesthegovernmentpensionfundbasedonrevenuesfromoilproduction,especiallyconsideringthesizeofthefund(aroundthreetimesthesizeofNorway’sgrossdomesticproduct(GDP)).NorgesBankisalsorequestedbythegovernmenttogiverecommendationsregardingcommercialbanks’counter-cyclicalcapitalbuffers,incontrasttothesituationinSwedenwheretheFinancialSupervisoryAuthorityhasthisrole.AnotherexampleofdifferencesinmandatesisthattheNorgesBankActincludesageneralclausesayingthat‘TheBankmayimplementanymeasurescustomarilyorordinarilytakenbyacentralbank’.TheSverigesRiksbankAct,incontrast,saysthattheRiksbank‘mayonlyconduct,orparticipatein,suchactivitiesforwhichithasbeenauthorisedbySwedishlaw’.

Althoughcentralbanklegislationandpracticesdevelopovertimeandareaffectedbymanyandtime-varyingcircumstances,thefactsthatSverigesRiksbankhasbothahigherdegreeofindependenceandalsoamorenarrowmandateareprobablynotcoincidental.Politiciansandthegeneralpublicmaybemorewillingtogiveahigherdegreeofindependencetoacentralbank(andotherpublicauthorities)aslongasthemandateisnottoovagueorbroad.Forsomeargumentsalongtheselines–mainlypositive,notnormative–seeAcharya(2015)andArcher(2016).

TherearealsosomenoteworthydifferencesbetweenthedesignsoftheflexibleinflationtargetingregimesinNorwayandSweden.NorgesBankhasahigherinflationtarget(2.5percent)thantheRiksbank(2percent).NorgesBankhasalsobeenquiteexplicit,since2012,aboutthefactthatit,tosomedegree,is‘leaningagainstthewind’inmonetarypolicy.Thisexpressionisusedbymacroeconomiststodescribeamonetarypolicythatnotonlystrivestostabilizeinflationandeconomicactivitybutalsohastheambitiontodampenriskstofinancialstability.3InSweden,therehasbeenadiscussionaboutwhethertheRiksbankpractised‘leaning’during2010–2012and,ifso,whattheeffectsmighthavebeen.4 But at leastsince2014,theRiksbank’smonetarypolicyhasbeenfocusedonachievingtheinflationtarget,despitethefinancialinstabilityrisksidentifiedbytheRiksbankitselfand,forexample,theInternationalMonetaryFund(IMF).InTable1,thedifferencebetweenNorwayandSwedeninthisregardhasbeendeliberatelydescribedas‘communicationaboutleaning’;howmuchoftheeasilyidentifieddifferenceincommunicationthatisalsoreflectedinactualpolicyandoutcomesforforexampleinflationandeconomicactivityremainsanopenissue.

Finally,averyimportantdifferencebetweenNorwayandSwedenistheNorwegianoilproduction.Thisdifferencedoesnotonlymeanthatthecentralbanksfacedifferent

2 AccordingtoacertainindependenceindexpresentedbyDincerandEichengreen(2014),SverigesRiksbankisalmostasindependent(0.77)astheECB(0.81),andthesecentralbanksaremuchmoreindependentthanforexampleNorgesBank(0.47)andBankofEngland(0.23).Ofcourse,formaldifferencesinlegislationmayoverstatetheactualdifferencesinpolicyimplementation.MycolleaguesinNorwayhaveemphasizedthatthegovernment’srighttoinstructNorgesBankhasonlybeenusedtwicesince1985.First,whentheinflationtargetwasannouncedin2001,and,second,whenNorgesBankreceivedthetasktogiverecommendationsonthecounter-cyclicalcapitalbufferin2013.3 Woodford(2012)offersatheoreticalargumentforsuchastrategy.Theliteraturewithargumentsforandagainst‘leaningagainstthewind’istoolargetobedescribedhere,butrecentandshortsummarieshavebeenpresentedbyMester(2016)andSchnabel(2016).4 SeeJansson(2014)andGoodfriendandKing(2016).

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challengesregardinggovernance(becauseNorgesBankmanagesthegovernmentpensionfund)andthatmonetarypolicyhastoconsidertheeffectsofquitedifferentterms-of-tradeshocks–therevenuesfromoilproductionalsoimplyquitedifferentchallengesforfiscalpolicyandfinancialstability,challengeswhichmayalsohaverepercussionsonmonetarypolicy.

Intherestofthispaper,Iwillcomebacktothedifferencesregardingtheinflationtargetsandoil,andtothesimilarityofbeingsmallopeneconomies,butIdonothavemuchmoretosayabouttheothersimilaritiesanddifferenceslistedinTable1.

3 Long-termdevelopmentsofnominalandreal exchangerates3.1ExchangeratesandGDPGiventhatoneimportant,andperhapstheprimary,objectiveofmonetarypolicyistostabilizethevalueofdomesticmoney,anaturalwaytomeasuredifferencesinmonetarypoliciesshouldbetolookatchangesinnominalexchangeratesbetweendifferentcurrencies.5Thecountriesintheeuroareahavethesamecurrencyandthereforeacommonmonetarypolicy.ButDenmark’smonetarypolicycannotbeverydifferenteither,sinceDenmarkhaschosentopegthevalueofitscurrencytotheeuro.Fromthisperspective,itisveryinterestingtonotethatthevalueoftheNorwegiancurrency(NOK)intermsoftheSwedishcurrency(SEK)hasbeenverycloseto1mostofthetimeforthelasttwohundredyears–seeFigure1.Forexample,thecurrentexchangerateisveryclosetotheleveloftheexchangeratein1850.Between1875and1914,NorwayandSwedenwerepartoftheScandinavianCurrencyUnion,sotheexchangeratewasfixedatexactly1.Butevenduringothermonetarypolicyregimestheexchangeratehasnotdeviatedmuchfrom1–comparedwithhowmuchnominalexchangeratesbetweenothercountrieswithdifferentcentralbanksandmonetarypoliciesnormallyfluctuate.AscanbeseenfromFigure1,thevaluesofboththeNOKandtheSEKhavefluctuatedmuchmorevis-à-vissterling(GBP).WhiletheNOK/SEKexchangeratenowhasaboutthesamelevelasduringtheScandinavianCurrencyUnionandthegoldstandard,bothcurrencieshaveappreciatedaround40percentsincethenvis-à-vistheGBP.

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Figure 1. Nominal exchange rates

5 Tosaythatstabilityofthevalueofdomesticmoneyisaprimaryobjectiveofmonetarypolicydoesnot,ofcourse,implythatthisshouldbethecentralbank’sonlyobjective.

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Acommonviewofthedevelopmentofnominalexchangerates,atleastintheshortrunandaslongastheyarenotdeliberatelyfixedthroughacurrencyunionorsimilararrangement,isthattheyareunpredictable.Nominalexchangeratesareoftencharacterizedasrandomwalks.TheNOK/SEKexchangerateisclearlynotarandomwalk.Itisnotacoincidencethatthecurrentlevelisaboutthesameasin1850.ThestabilityoftheNOK/SEKexchangeratereflectsthatmonetarypoliciesinNorwayandSwedenhavebeenverysimilarandthatdifferencesinstructureandshockshittingthetwoeconomieshaveevenedoutoverthislongerperiod.6

Ifwetakeasomewhatshorterperspectiveandfocusonthedevelopmentduringthelastfiftyyears,thingslookabitdifferent.BoththeNOKandtheSEKappreciatedstronglyagainsttheGBPafterthebreak-downoftheBrettonWoodssystemofpeggedexchangerates.Butsincethemid-1970s,therehasbeennocleartrendintheNOK/GBPrate(althoughithasbeenquitevolatile),whiletheSEKhasexperiencedadepreciatingtrendvis-à-vistheGBP.ThisofcoursealsomeansthattheNOKhasappreciatedvis-à-vistheSEK,byaround1/3,sincetheearly1970s.Thistrendhowevercametoahaltabouttwentyyearsago.Duringthelasttwodecades,theNOK/SEKrateagainhasbeenquitestable.

Changesinnominalexchangeratesdonotnecessarilyreflectchangesintherealvalue,thatisthepurchasingpower,ofthecurrenciesinquestion.Itisacommonlyheldviewthatchangesinnominalexchangeratesatleastpartlyreflectdifferencesininflation(thatischangesinthedomesticpurchasingpower)betweenthecountriesinquestion.If‘purchasingpowerparity’holds,nominalexchangeratesadjustexactlyone-for-onewithchangesinthedomesticpricelevelsothattherealexchangerateisconstant.TherealexchangerateisheredefinedasQ = EP*/P,whereEisthenominalexchangerate(forexample,NOK/SEK,sothathigherEmeansaweakerNOK),Pisthepricelevelathome(forexampleNorway)andP* the pricelevelabroad(forexampleSweden).

Figure2ashowsthelong-runpricelevelsinNorway,SwedenandtheUK,andFigure2bshowsthecorrespondinginflationrates(percentagechangesofthepricelevels).ItcanbeseenthatinflationintheUKhasbeenhigherthaninflationinNorwayandSwedensincetheearly1970s,soagainstthisbackgroundthedepreciationinthenominalvalueoftheGBPvis-à-vistheNOKandtheSEKisunderstandable.Butapparentlydifferencesininflationdonottellthewholestorybehindchangesinnominalexchangerates.TheSEKhasdepreciatedvis-à-visboththeNOKandtheGBPduringthelasttwodecades,despitethefactthatinflationhasbeenlowerinSwedenthaninNorwayandtheUK.

6 Itshouldbenotedthathavingsimilarinflationtargetsdoesnotimplyastablelevelofthenominalexchangerate.Withaninflationtargetthedeviationsfromthetargetareaccumulatedinthepricelevelovertime,sothepricelevelbecomesanon-stationaryprocess.Thiswillbereflectedinthenominalexchangeratebetweentwoinflation-targetingcountriesalsobeingnon-stationary.

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Deviationsfrompurchasingpowerparity,or,equivalently,levelsofrealexchangerates,areshowninFigure3.7Itcanbeseenthatthepurchasingpower,therealvalue,oftheGBPwasquitehighintheearly1800s;thattherealvalueoftheSEKwasquitehighaftertheSecondWorldWar;andthattherealvalueoftheNOKhasappreciatedversustheSEKsincethemid-1960s.Inbroadterms,thesepatternsshouldnotbesurprising.Thepricesofgoodsandservicesshouldtypicallyberelativelyhighinrichcountrieswhereconsumershavehighincomestospend.IndustrializationoccurredearlierintheUKthaninNorwayandSweden,whichisonereasonwhyincome,spendingandpriceswererelativelyhighintheUKinthe1800s.SwedenwasnotdirectlyinvolvedintheSecondWorldWarandcouldthereforemaintainarelativelyhighlevelofproductionandspendinginthe1950sand1960s.OildiscoveriesinNorwayhavemaderelativelyhighproductionandspendingpossibleduringthelastfortyyears.8

7 TherealexchangeratesinFigure3(Q)arejusttheproductsofthenominalexchangeratesinFigure1(E)andtheratiosofthepricelevels(P/P*)inFigure2a.IncontrasttoFigure1,wherethenumbersontheverticalaxisreflectactualpricesusedoncurrencymarkets,thenumbersontheverticalaxisinFigure3havenoeconomicinterpretation,becausethepricelevels(inFigure2a)arejustindicesofconsumerpricesmeasuredindifferentwaysindifferentcountries.8 Theuseoftheword‘relatively’isdeliberatelysomewhatsloppyhere,inordertosimplifythepresentation.Sometimesitrelatestoahistoricalperspective,sometimestoacomparisonacrosscountries,orboth.

NorwegiaN moNetary policy seeN from abroad70

ThedevelopmentofGDPpercapitainNorway,SwedenandtheUKisshowninFigure4.RealGDPpercapitaisnowaround35percenthigherinNorwaythaninSweden.9IfweexcludeoilproductionandcomparetheGDPlevelinjustmainlandNorwaywithGDPinSweden,realGDPpercapitainNorwayisaround12percenthigher.Betweenthefirstandsecondworldwars,realGDPpercapitawasataboutthesamelevelsinNorway,SwedenandtheUK.AftertheSecondWorldWar,productionandincomegrewfasterinNorwayandSweden,butthelevelsinthesecountrieshavegrownapartsincearound1970.

Norway Mainland Norway Sweden United Kingdom

Note. Index series, Norway 1968 = 100, levels of Sweden and UK adjusted to match Purchasing Power Parity-adjusted GDP (according to the Organisation for Economic Cooperation and Development (OECD)) 2010.Sources: Edvinsson (2014), Grytten (2004b), Thomas and Dimsdale (2016), Bank of England, IMF, Norges Bank, Macrobond, Statistics Norway and the Riksbank

Figure 4. Real GDP per capita

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UsingdatathathavebeenusedinFigures3and4,itispossibletoestablishasystematicrelationbetweenrealexchangerates(Q = EP*/P)andrelativeGDPlevels(Y/Y*)–seeFigures5aand5b.10WhenGDPinNorwayhasbeenrelativelyhighinrelationtoSwedenandtheUK(Y/Y* high),Norway’srealexchangeratehasbeenrelativelystrong,or,equivalently,thepricesofgoodsandservicesinNorway,measuredincommoncurrency,high(thatis, Q = EP*/P low).11ThecorrelationbetweenrealexchangeratesandrelativeGDPlevelsisnotperfect,ofcourse.TherearemanydifferentfactorsthatinfluencethedevelopmentsofbothrealexchangeratesandGDP.Yet,therelationbetweenrelativespendingandrelativepricelevels–measuredincommoncurrency–hasimplicationsformonetarypolicy.Iwillreturntothisissuebelow,afterashortdigressionontheroleofthecurrentaccount.

3.2ThedevelopmentofthecurrentaccountinNorwayandSwedenOnevariablethatiscommonlyusedinanalysesof‘competitiveness’and‘equilibrium’or‘sustainable’realexchangeratesisthelevelofthecurrentaccount.Sometimesapersistentcurrentaccountsurplusisinterpretedasasignofan‘undervalued’currency(ofteninbothrealandnominalterms).SincebothSwedenandNorwayhavehadpersistentsurplusesinourcurrentaccountsduringthelasttwentyyears,whiletheUKhasexperiencedpersistent

9 TheGDPpercapitalevelsinFigure4arebasedonrealGDP(andpopulation)datafromeachcountry,whichmeansthattheyarealsobasedontheuseofdifferentpriceindices(tocomputerealGDP).ThismakesitdifficulttocomparerealGDPlevelsindifferentcountries.ThedatainFigure4havehoweverbeenscaledtomatchdifferencesinpurchasingpower-adjustedrealGDPpercapitaby2010,accordingtoestimatesofsuchdifferencesfromtheOECD.TheverticalaxisinFigure4(or,rather,therelationbetweenthelevelsofseries)canthusbegivenaneconomicinterpretation.10 ThedatainFigure4areGDPpercapita,whilethedataonYandY*inFigures5a–barebasedonlyonGDPserieswithoutanyadjustmentsforpopulationsize.11 TherelationbetweentherealexchangerateandtherelativeGDPlevelinSwedenandtheUK(notshown)ismarginallyweakerthanthecorrespondingrelationbetweenNorwayandtheUK.

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deficits(duringthelastthirtyyears)–seeFigure6a–onemaywonderwhytheSEKhasdepreciatedvis-à-vistheGBPinrealterms,whiletherealNOK/GBPratehasbeenrelativelystable.

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(EP*/P)=156.4 – 82.1(Y/Y*); Correlation coefficient = −0.45(b) Norway and the UK

(EP*/P)=121.6 – 16(Y/Y*); Correlation coefficient = −0.43

Sources: See Figures 1, 2 and 4, where Norway's GDP includes oil income

ThisbecomeslesspuzzlingonceoneconsidersthedifferentfactorsbehindthecurrentaccountsurplusesinNorwayandSweden.Norway’scurrentaccountsurplusesaremainlydrivenbyproductionandexportsofoil.OilrevenueenablesacurrentaccountsurplusandacapitaloutflowfromNorwaytotherestoftheworld.Atthesametime,thisenablesacurrentaccountdeficitformainlandNorway,thatisacapitalinflownotfromtherestoftheworldbutfromtheNorwegianoilfields.ThispermitsspendingtobehigherthanincomeinmainlandNorwayandputsupwardpressureonpricesinNorwayvis-à-vistherestoftheworld,whichtendstoappreciatetherealexchangerate.

InSweden,bycontrast,thecurrentaccountsurplusratherreflectsarelativelylowlevelofspending(inrelationtoincome),bothintheprivateandthepublicsector.Theeconomiccrisisintheearly1990sledtolargechangesineconomicpolicyandhouseholds’behaviourinSweden.HouseholdsavingsasashareofdisposableincomeareshowninFigure6b.Asmentionedabove,fiscalpolicyhasalsoaimedforpositivenetsavingsinthepublicsector.Hence,incontrasttomainlandNorway,Swedenhasthusgeneratedacurrentaccountsurplusthroughlowspending.Thisisonereasonwhypricesofgoodsandserviceshavebeen

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Figure 6. Current account and household savings (a) Current account as a share of GDP (b) Household savings as a share of disposable income

subtraction of household consumption expenditure from household disposable income, plus the change in net equity of

NorwegiaN moNetary policy seeN from abroad72

relativelylow(thatisadepreciatedrealexchange)comparedtobothNorwayandtheUK.Insummary:therealappreciationoftheNOKvis-à-vistheSEKduringthelastfortyyears

reflectsthefactthatincomeandspendinghasgrownfasterinNorwaythaninSweden,puttingstrongerupwardpressureonpricesinNorway.Themainreasonforthehigherincomeandspendingistherevenuefromoilproduction,whichalsoexplainswhyNorwayhasexperiencedacurrentaccountsurplusdespitearelativelystrongrealexchangerate.InSweden,bothprivateandpublicsavingshavebeenhigh,andspendingrelativelylow.Thishasresultedinaweakrealexchangerateandacurrentaccountsurplus.

3.3Lessonsforpolicy,partIStructuralfactorshavegeneratedarealappreciationoftheNOKvis-à-vistheSEKsincethebreak-downoftheBrettonWoodssystem.TheNOK/SEKratehasappreciatedbyaround1/3,inbothinrealandnominalterms.Incontrast,theSEKwasstronginrealtermsduringthefirsttwentyyearsaftertheSecondWorldWar.

Monetarypolicycannotdomuchabouttheneedforlong-termadjustmentsinrealexchangerates(Q).Evenso,monetarypolicydetermineshowmuchofthechangesinrealexchangeratesthatoccurthroughchangesinthenominalexchangerate(E)orthroughchangesinrelativepricelevels(P/P*).Interestingly,andsomewhatparadoxically,therealappreciationoftheNOK/SEKrateduringthefirsttwentyyearsafterthebreak-downoftheBrettonWoodssystem,whenbothSwedenandNorwayhadtheambitiontostabilizethenominalvaluesoftheircurrencies,tooktheformofanominalappreciationoftheNOK.(InflationwashigherinSwedenthaninNorway,sothenominalNOK/SEKratehadtoappreciateevenmorefortherealexchangeratetoappreciate.)Duringtherecenttwentyyears,whenbothcountrieshavehadtheambitiontostabilizeinflationandlettheircurrenciesfloat,thenominalNOK/SEKratehasactuallybeenquitestableandtherealNOK/SEKappreciationhasinsteadoccurredthroughdifferencesininflation(higherinflationinNorway).

ThismeansthatthepatternofrelativepriceadjustmentsbetweenNorwayandSwedenduringthelasttwentyyearslargelyresemblethosethatwouldhavetotakeplaceinacurrencyunion.Acommonviewisthatadisadvantageofacurrencyunionisthatchangesinrealexchangeratescannottakeplacethroughnominalexchangerateadjustmentsbutinsteadhavetooccurthroughchangesinnominalprices.Thelatterareassumedtobemorepainful.ButthenecessaryadjustmentoftherealexchangeratebetweenNorwayandSwedenduringthelasttwentyyearshasapparentlybeenpossiblewithoutanysignificantchangeinthenominalexchangerate.This,inturn,impliesthatdifferencesinmonetarypolicybetweenNorwayandSwedenmaynothavebeenveryimportant.

NorgesBankWatch2016(Lommerudetal.,2016)hasraisedthequestionwhetherNorgesBank’sinflationtargetof2.5percentshouldbeloweredtothesamelevelasinNorway’s‘neighbours’.ThisisaquestionofhowimportantitisforNorwaytohaveastablenominalexchangerate.WithlowerinflationinNorway(orhigherinflationinNorway’stradingpartners)therealexchangerateadjustmentthathasbeennecessarywouldhaverequiredalargerchangeofthenominalvalueoftheNOK.Fromthisperspective,thedifferencebetweenNorway’sandSweden’sinflationtargets–2.5percentvs2percent–isunderstandable.HigherinflationinNorwaythaninSwedenallowsmorestabilityinthenominalNOK/SEKexchangerate.Lookingforward,itisquitepossiblethatbothNorway’sandSweden’srealexchangerateswillhavetoappreciate–giventhecurrentaccountsurplusesinthesecountries.Ifso,stabilityoftheNOK/SEKexchangeratecouldbeconsistentwithmoresimilarinflationtargets.

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4 Long-termdevelopmentsofnominalandreal interestratesSofar,thediscussionhasbeenmostlycastintermsofatwo-countryworld(NorwayandSweden)withoccasionalreferencestothedevelopmentinthe‘restoftheworld’(representedbytheUK).Butitisofcoursemisleadingtoanalysetheeconomicdevelopment–andmonetarypolicy–inanysmallopeneconomyasbeinginfluencedbythedevelopmentinonlyoneforeigncountry(ortwocountries).ThecurrentlowlevelsofnominalinterestratesinNorwayandSwedenarenotprimarilytheresultsofmonetarypoliciesinthesetwocountries,butreflectionsofalong-term,global,downwardtrendininterestrates–seeFigures7aand7b.

Thedownwardtrendinnominalinterestrateshasapparentlybeenmorepersistentthancentralbankshaveexpected.Figures8a–8dshowthedevelopmentsofthepolicyratesinSweden,Norway,theCzechRepublicandNewZealandtogetherwiththeforecastsofthepolicyratespublishedbytheunusuallytransparentcentralbanksinthesecountries.

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Figure 7. Government bond yields and central banks' policy rates (a) 10-year yield on nominal government bonds (b) Central banks’ policy rates

4.1Whyhavecentralbanksmadesystematicforecasterrors?DataliketheonesdescribedinFigures8a–8dofcoursegiverisetocriticismofcentralbanks.Howcomethecentralbanksmakesuchbadforecastsevenforthepolicyratesthattheysetthemselves?

OnepossibilityisofcoursethatthedatainFigures8a–8darenotrepresentativeofcentralbanksingeneral,andthatthecentralbanksthatareunusuallytransparenthavealsobeenunusuallybadforecasters.Itis,however,hardtobelievethatcentralbankswhohavebeenunwillingtopublishinterest-rateforecastshavesystematicallymadebetterforecasts.Unfortunately,suchhypothesescannotbetested.

Anotherpossibilityisthatthecentralbanksinquestion–andperhapsallcentralbanks–relytooheavilyonobsoletemodels.Thishasbeenacommoncritiqueagainstcentralbanksduringthelastdecade.GoodfriendandKing(2016)have,forinstance,criticizedtheRiksbank’suseofmodels.Thatparticularcritiquedoesnotseemtobejustified.Iversenetal.(2016),usingrealtimedata,showthatforecastsfromtheRiksbank’smodelsarenotsystematicallyworsethantheforecaststhathavebeenpublished,andthatareinfluencedbybothmodelsandjudgements.LindéandReslow(2017)alsoshowthattheRiksbank’sforecasterrorshavenotbeenmainlydrivenbytheuseofdeficientmodels.Ontheotherhand,itisclearthattherearemanyweaknessesinthedominatingmacromodelsmoregenerally–seeforexampleFaustandLeeper(2015)andLindé,SmetsandWouters(2016).

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Figures8a–8dshouldleadustosearchforexplanationsbehindtheforecasterrorsnotinpeculiarmodelsorotherconditionsinindividualcountries,butforsomefactorsthatarecommontosmallopeneconomies–andperhapsalsolargereconomies–withintheentireworldeconomy.Figures7aand7bshowthatbothshort-termandlong-terminterestratesintheworldeconomyhavenotonlygonedownbutalsoconverged.Oneexplanationforthisisthatdifferencesinmonetarypolicieshavebecomesmaller.Mostcountrieshavehadtheambitiontostabilizeinflationatalowlevel,irrespectiveofwhethertheircentralbankshaveexplicitinflationtargets.Thedownwardtrendinnominalinterestratespartlyreflectsadownwardtrendininflation,andtheconvergencepartlyreflectssimilaritiesinexplicitorimplicitinflationtargets.

Butinterestrateshavebeentrendingdownwardsevenwhenthedevelopmentofinflationistakenintoaccount–seethedevelopmentofrealinterestratesinFigure9.12 There alsoseemstohavebeenaconvergenceinrealinterestrates,althoughthisislessobvious.Theworldeconomyhasnodoubtbecomemoreopen,bothfinanciallyandthroughtradeofgoodsandservices.TradehasincreasedfasterthanGDPandlabourandcapitalmobilityhasalsoincreased.Thisshouldindeedbeexpectedtoleadtoaconvergenceofrealinterestrates.

Theglobaldownwardtrendinrealinterestrateshasreceivedincreasedattentionfromresearchersandpolicymakers,seeforexampleRachelandSmith(2015)andFischer(2016)fortworecentsummaries.Demographicchanges,fiscalpolicies,higherinequalityandhigheruncertaintyarefactorsthathaveallcontributedtopersistentlylowerrealinterestrates.Therealsoseemstohavebeenaslowdownintheratesoftechnicalprogressandproductivitygrowth.Thesefactorsarepartlyrelatedandoftencommonacrosscountries.Throughtradeingoodsandservicesandmobilityofproductionfactorstheyarealsotransmittedacrosscountries.

Itis,ofcourse,fairtoaskwhythedownwardglobaltrendinrealinterestrateshascomeasasurprisetocentralbanks.ButthefactthatAlanGreenspantalkedabouta‘conundrum’backin2005(thatisbeforethefinancialcrisis;seeGreenspan,2005)togetherwiththefactthatthenormalleveloftherealinterestrateisstillbeingdebated(seeRachelandSmith,2015,andFischer,2016)suggeststhatcentralbanks,ingeneral,havebeengenuinelysurprisedbythelowlevelofrealinterestrates,andthereforeofnominalpolicyrates,notonlyintheirhomecountriesbutglobally.

12 Thereisnoobviousandsimplewaytocalculateandcomparerealinterestratesindifferentcountries.ThedatainFigure9arebasedonobservedinterestandinflationrates.Ideallyonewouldliketocomputerealinterestratesusingexpectationsofinflationratherthanoutcomes.

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4.2Lessonsforpolicy,partIIWhencomparingpolicyratesandotherinterestratesinNorwayandSweden,itisnotthedifferencesthatarestriking,butthesimilarities.Andnotonlythesimilaritiesbetweenthesetwocountries,butalsothestrongcorrelationswithinterestratesintherestoftheworld.ThecurrentlylowlevelsofthepolicyratesinNorwayandSwedenarereflectionsofgloballylowinterestrates.Itisnotsurprisingthatthelongruntrendsinnominalandrealinterestratesarestronglyrelatedacrosscountries.Thecommontrendinrealinterestratesreflectsahighdegreeofintegrationoftheworldeconomy.Thecommontrendinnominalinterestratesinadditionreflectsahighdegreeofsimilarityininflationtargetsandmonetarypolicystrategies.

Takentogether,these‘stylizedfacts’seemtosuggestthatdifferencesinmonetarypoliciesbetweencountries,includingNorwayandSweden,havebecomelessimportantovertime.Onereasonisthatthedifferencesinmonetarypolicyitselfhavebecomesmaller.Theapplicationofsomeversionof(explicitorimplicit)inflationtargetinghasincreasedovertime.Anotherreasonisthattheworldeconomyhasbecomemoreintegrated.Thisleadstosmallerdifferencesinrealinterestratesandpossiblylessscopeformonetarypolicytoaffecttheeconomiccyclesindifferentcountries.Asallreaderscanobserve,theseconclusionsarenotbasedonverydeeptheoreticalorempiricalstudiesbutratherspeculative.Morecarefulstudiesareneeded.

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Note. Difference between 10-year yield on nominal government bonds and the CPI for all countries.Sources: Bureau of Labor Statistics, Macrobond, Office for National Statistics, Statistics Norway and Statistics Sweden

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5 ChallengesformonetarypolicyinbothNorway andSwedenIntheprevioussectionsIhavearguedthattherearemanysimilaritiesbetweenthemonetarypoliciesinNorwayandSweden.Differencesinthedegreeofcentralbankindependence,governancemodels,levelsofinflationtargets,etceteradonotseemtohaveledtolargedifferencesininterestratesorexchangerates.Onereasonforthismaybethatbotheconomiesaresmallandopenandhighlyintegrated.Oneimportantdifference,though,isthatNorway’sproductionofoilhasledtoanincreasingdifferencebetweenthelevelsofincomeinthetwocountries.Capitalmobilitymayimplythatdifferentincomelevelsareconsistentwithsmalldifferencesinrealinterestrates,butadjustmentsinrealexchangeratesareneededintheshorttermsincepartsoftheconsumptionbasketsconsistofnon-tradedgoods.

Againstthisbackground,NorwayandSwedenfacesimilarchallengesfortheirstrategiesformonetarypolicy–despitethehigherincomeduetooilproductioninNorway.

Onesetofstrategicquestionsthathasreceivedincreasedattentioninrecentyearsconcernsthedefinitionoftheinflationtarget.TheBankofCanadahaveintheirlasttworeviewsoftheirinflation-targetingstrategyaskedwhethertheinflationtargetshouldbeloweredorraised.NorgesBankandSverigesRiksbankhavereasontoconsiderthesamequestions.Thesequestionscannot,ofcourse,beansweredindependentlyofthedefinitionoftheinflationtarget.Thereisanon-goingdiscussioninbothNorwayandSwedenoftheimplicationsofdifferentdefinitionsoftheinflationtargets;forexampleaboutwhetherthetargetsshouldbeexpressedintermsofheadlineCPIorsomemeasureof‘core’inflation(seeGoodfriendandKing,2016,Lommerudetal.,2016,andSverigesRiksbank,2016).13InSwedenthereisalsoadiscussionaboutwhethertheinflationtargetshouldbecombinedwithsomeintervalindicatingthecentralbank’stolerancefordeviationsorthegeneraluncertaintyininflationforecastsetcetera(seeSverigesRiksbank,2016).

Anotherquestionconcerns,aswehaveseen,estimatesofthepolicyrateinasteadystate,thatiswhentheeffectsoftemporarydisturbanceshavedisappeared.Ifonereasonforthecentralbanks’forecasterrors,showninFigures8a–8disthatthesteadystatelevelofthepolicyratehasbeenoverestimated,theresulthasprobablybeenthatthepolicyrate

13 Afterthispaperwaswritten,SverigesRiksbankreformulateditsinflationtargetintermsofCPIFinsteadofCPI,whichwasannouncedon6September2017.

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hasbeenhigherthandesirable.Findingbetterwaystoestimatethe(possiblytime-varying)steadystatelevelisthusimportantforaproperimplementationofmonetarypolicy.

Riskstofinancialstabilityinvolvefurtherchallenges.First,theriskshavetobeidentified.Second,theimplicationsformonetarypolicyhavetobedecided.Therearenosimpleanswerstothesequestions.Asshownabove,bothNorwayandSwedenhavehadpersistentcurrentaccountsurplusesduringrecentdecades.Thismeansthatthecountries’netindebtednessvis-à-vistherestoftheworldisnotincreasingbutratherdecreasing.Theprivatesectors’grossdebthasneverthelessbeenincreasing.Andhighlevelsofgrossdebtandrapidincreasesinresidentialprices,asinNorwayandSweden,areknowntobeleadingindicatorsoftherisksoffinancialcrises.

Thehighlevelsofgrossprivatedebtmaybepartlyexplainedbythehighlevelsofcollectivesavings–accumulatedinthegovernmentpensionfundbasedonoilrevenuesinNorwayandinthepensionfundsbasedonagreementsbetweenemployersandunionsinSweden(seeNilssonetal.,2014,foradiscussionoftheSwedishcase).ThesepensionfundscontributepositivelytofinancialstabilityinNorwayandSwedenbyprovidingbuffersagainstunfavourabledevelopmentsofforexampledemographicsorproductivity.Butthehighdegreeofcollectivesavingsalso,byconstruction,meansthattheprivatesectorismoreliquidityconstrainedcomparedtoasituationwithalargershareofindividualsavings.Theneteffectonfinancialstabilityrisks,andtheimplicationsforcentralbankpolicy,shouldbesubjecttomorecarefulanalyses.

Evenifhighlevelsofprivatedebtandrapidincreasesinresidentialpricesareassociatedwithriskstofinancialstability,itisnotobviousthatthisshouldbethecentralbank’sresponsibility,andevenifthecentralbankhasaresponsibilityinthisfield,itisnotobviousthatitshouldhaveanyimplicationsformonetarypolicy(seeforexampleMester,2016,andSchnabel,2016forrecentreviews).Newmeasuresintheareaofmacro-prudentialpolicyareoftensaidtobethe‘firstlineofdefence’againstfinancialinstabilityrisks.Butevenso,somecoordinationofmonetaryandmacro-prudentialpolicymaybebeneficial.Coordinationisofcoursesimplerifthesetoolsarehandledbythesameauthority,asinthecaseoftheUKandtheBankofEngland.InNorwayandSwedenandothercountrieswheretheFinancialSupervisoryAuthoritiesarenotpartofthecentralbank,otherformsofcoordinationhavetobefound.InNorway,thecentralbankhasbeengiventhetasktogiverecommendationsonthecounter-cyclicalcapitalbuffer.ThishasledtoregularpublicationsofassessmentsoffinancialstabilityinNorgesBank’sreportsonmonetarypolicy.SverigesRiksbankhasnoformalresponsibilityformacro-ormicro-prudentialpolicybutstillpublishesFinancialStabilityReportswithanalysesandrecommendations.ThereisaFinancialStabilityCouncilwhererepresentativesoftheGovernment,theSwedishFinancialSupervisoryAuthority,theSwedishNationalDebtOfficeandSverigesRiksbankregularlymeettodiscussissuesoffinancialstability.InbothNorwayandSweden,theinteractionsbetweenthegovernment,thecentralbankandtheFinancialSupervisoryAuthoritywillpresumablybefurtherdevelopedinthenearfuture.

Regardingthecoordinationor‘policymix’ofmonetaryandfiscalpolicy,bothNorwayandSwedenhavemadereformsduringthelast15–25yearsthathavebeenfocusedoncreatingclearrulesforthedifferentpoliciesseparately,withnoambitionsofcoordination.Monetarypolicyhasbeenreformedtoestablishcredibilityfortheinflationtargetsandfiscalpolicyhasbeenreformedtoensureasustainablelongtermdevelopmentofgovernmentdebt.Leeper(2016)andSims(2016),amongothers,havestressedtheimportanceofformulatingconsistentrulesformonetaryandfiscalpolicy.TheirargumentssuggestthatfiscalpoliciesinEuropeandelsewheremayhavebeentoomuchfocusedon‘austerity’inrecentyearsandthatthismaybepartoftheexplanationforpersistentlylowinflation.TheimplicationsoftheseanalysesandargumentsformonetaryandfiscalpolicyinNorwayandSwedenremainopenissues.ButeconomistsatNorgesBankandSverigesRiksbankshouldbeabletomakeconstructivecontributionstoadiscussionofsuchissues.

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Anambitiontopreserveacertainlevelofcentralbankindependencemayposerestrictionsonthecoordinationofmonetarypolicywithmacro-prudentialpolicyorfiscalpolicy.ThefuturedegreeanddesignofcentralbankindependenceinNorwayandSwedenwillbethoroughlydiscussedinthenearfuture,asthecentralbanklawsinbothcountriesarebeingreviewed.Butevenwithahighdegreeofindependencefromthepoliticalsystem,thepossibilitiesforbothNorgesBankandSverigesRiksbanktopursueveryindependentmonetarypoliciesarelimitedbytheopennessofthesesmalleconomies.TheimplicationsofforexamplecapitalmobilityfortheeffectivenessofmonetarypolicyinNorwayandSwedendeservefurthertheoreticalandempiricalstudies.

Finally,bothNorgesBankandSverigesRiksbankneedtoevaluatetheirexperiencesfrombeingamongthemosttransparentcentralbanksintheworld.Publicationsofinterest-rateforecasts(inbothcountries)andofdetailedminutesfromtheBoard’sdiscussionsaboutmonetarypolicy(SverigesRiksbankbeingmoredetailedthanNorgesBankinthisregard)shouldhavehadpositiveeffectsonthecentralbanks’legitimacy,throughimprovedaccountabilityandefficiency.Butthehighlevelofprecisioninthecommunicationmayalsohavecontributedtoanoverlyoptimisticview–perhapsmoreoutsidethaninsidethecentralbank–ofwhatthe‘scienceofmonetarypolicy’canachieve;seeGoodfriendandKing’s(2016)reviewofthecaseofSwedenforsomecriticalcomments.ThemessageintheintroductoryquotationfromtheTVseries‘TheCrown’suggeststhatpeopleoftenwanttobe‘fooled’,perhapsbecauserealismisnotalwayspleasant,andperhapsthisistruealsoofmonetarypolicy.DocumentingandanalysingforecasterrorssuchasthoseshowninFigures8a–8disnotalwayspleasant.Still,beingastransparentaspossibleaboutwhatpolicy,andforecastingmodels,canandcannotachieveisagoodstartingpointforimprovingpolicymakingandanalyses.Howtocombinetransparencywithrigorousanalyseswhilestillemphasizingthatbothpolicyandanalysesareassociatedwithconsiderableuncertaintyremainsanimportantchallenge.

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