THE ECONOMY OF NORWAY AND A PREDICTION O

K1442940

THE ECONOMY OF NORWAY
AND A PREDICTION OF THE
NEXT STEP IN ITS MONETARY
POLICY
Case Study

Abstract

This case study discusses the Norwegian economy and show that the
developments in the monetary policy implemented by Norges Bank in the postcrisis period has more or less been efficient. The study also supports findings
that the Norwegian Krone is positively correlated with the price of oil and
interest rate differentials through an econometric analysis, and shows that the
decline in the price of oil the last years has had a big impact on the economy of
Norway. It also considers the low interest environment and the fast increase in
housing prices and the accumulation of debt. It concludes with a prediction of
the next step in Norges Ba ks’ o etary policy.

2

Table of content
INTRODUCTION ............................................................................................................................ 4
CENTRAL BANK POLICY SINCE GFC................................................................................................. 5
CURRENT SITUATION IN NORWAY ................................................................................................ 6
BALANCE OF PAYMENTS ............................................................................................................... 8
OIL PRICE ................................................................................................................................... 10
EXCHANGE RATE AND INTEREST RATE DIFFERENTIALS ................................................................. 12
ECONOMETRIC ANALYSIS ........................................................................................................... 13
GROWTH AND PROSPECTS INTERNATIONALLY ............................................................................ 14
WHAT IS NEXT? .......................................................................................................................... 14
APPENDIX .................................................................................................................................. 15
1.1
EVIEWS OUTPUT ........................................................................................................................ 15
REFERENCES ............................................................................................................................... 16

3

Introduction
The glo al fi a ial isis i
GFC had u a gua l a ig egati e i pa t o the o ld’s

economy. The results that followed were rising unemployment, slower growth, huge
movements in exchange rates and debt ratios going the wrong way. The central banks were
subject to huge challenges regarding monetary measures and the way of implementing
poli ies to help the e o o ies a k up. This ase stud ill shed light o No a ’s e o o
after the GFC and discuss some core indicators of concern to Norges Bank and its monetary
policy.

4

Central Bank policy since GFC
The financial crisis in 2008 gave us a reminder that low and stable inflation does not come
with guarantees for financial stability. However, inflation targeting as the main mandate has
been an efficient tool for low and stable inflation (chart 1.2). That has also been the
mandate of Norges Bank since 2001, but not without challenges. In the aftermath of the
GFC, Norway experienced a rising figure of unemployment as indicated in chart (1.1) below.
(1.1)

Policy rate and Unemployment

PR

U

7.00

0.000000000

6.00

0.500000000

5.00

1.000000000

4.00

1.500000000

3.00

2.000000000

2.00

2.500000000

1.00

3.000000000

0.00
01:01:07

01:01:08

01:01:09

01:01:10

01:01:11

Policy rate

01:01:12

01:01:13

01:01:14

3.500000000
01:01:15

Unemployment

Source: FRED ECONOMIC DATA and Norges Bank

Although the mandate of Norges Bank is to keep the inflation close to 2.5%, they also have
to consider the whole economic picture. Macroeconomic figures as unemployment, rising
housing prices and accumulation of debt will eventually affect the inflation, which is

illustrated in chart (1.2) below. Apart from the monetary policy, regulation in the banking
system and macroprudential policy measures are the main tools for preventing financial
instability. Drastic cuts in the policy rate was also the case in Norway as with other big
economies hit by the GFC. This is sharp decline in the policy rate, which was a response to
the rising unemployment and other macroeconomic factors is illustrated in the chart1 above.

1

The policy rate is represented in the left axis and unemployment on the inverted left axis.
Both measured in percentage points. Policy rate data is from Norges Bank and
unemployment data is from FRED ECONOMIC DATA.
5

(1.2)

CPI
6
5
4
3

2
1

Sep-16

Jan-16

May-16

Sep-15

May-15

Jan-15

Sep-14

May-14

Jan-14

Sep-13

May-13

Jan-13

Sep-12

Jan-12

May-12

Sep-11

Jan-11

May-11

Sep-10

Jan-10

May-10

Sep-09

May-09

Jan-09

Sep-08

May-08

Jan-08

0

Source: FRED ECONOMIC DATA

Current situation in Norway
Extraordinarily low rates have been prominent across the world after the GFC and the case
has not been otherwise in Norway. Fast increase in public debt the last couple of years due
to low rates and increasing housing prices as indicated in chart (1.3.2) should, and have been
great concerns to Norges Bank lately.
(1.3.2)

House price index Norway (2010=100)
150.00
140.00
130.00
120.00
110.00
100.00
90.00
80.00
70.00

Source: Eurostat

6

As see f o g aph . . , No a ’s households have a large debt to income ratio
compared to other countries. A further decrease in the policy rate would probably boost the
developments in housing prices and household debt, and may eventually lead to financial
instability. However, Olsen (2016) argues in the Monetary Policy Report that the impact of a
monetary stimulus in a low interest rate environment is restricted. An increase in the policy
ate o the othe ha d, ete is pa i us, ould lead to huge i ala es i a ks’ ala e
sheets if borrowers were to default on their loans. Therefore, precautions have to be taken
either way, regarding the fast increase in debt and housing prices.

(1.3.1)

Household debt, % of net disposable income
350

300

250

200

150

100

50

Denmark

Norway

Netherlands

Australia

Switzerland

Sweden

Ireland

Korea

Canada

UK

Portugal

Finland

Spain

Greece

Belgium

USA

Frnace

Austria

Germany

Italy

Estonia

Czech Rep.

Slovak Rep.

Poland

Slovenia

Latvia

Hungary

0

Source: OECD

7

(1.3.3)
Public non-financial corporations
Operating profit margin. Per cent
Operating margin. Per cent
Return on total assets. Per cent
Return on equity. Per cent
Equity ratio. Per cent
Current ratio
Ratio of fixed assets to long term capital
Debt-to-equity ratio

2015
11,45
9,19
7,4
0,06
44,75
1,02
1
1,23

2014
18,93
6,03
11,57
-4,83
48,25
1
1
1,07

2013
22,74
27,2
14,47
10,2
51,2
1
1
0,95

Source: Statistics Norway

Balance of payments
As seen in table (1.4), there has been a shift in the current account balance. Balance of
income and current transfers exceeded the balance of goods and services for the first three
quarters of 2016. This shift in the CAB is illustrated in chart (1.4.2) as well, where the CAB as
a percentage of GDP has fallen sharply the last three years. A reasonable explanation for this
shift might be the decline in the price of oil (illustrated in chart 1.5), which is the largest and
most important commodity for Norway in terms of exports.

(1.4)

Source: Statistics Norway

8

(1.4.1)
Balance of Payments, Norway, annual, 2007-2016

2007
287436
12,2
2349861
315222
-27786
971
286436

2008
408286
15,7
2605380
441747
-33461
1138
407123

2009
258198
10,6
2429698
274576
-16378
1120
256784

2010
282704
10,9
2590089
290867
-8163
1268
281143

2011
344901
12,4
2791973
358545
-13644
1499
343127

2012
368586
12,4
2965208
383302
-14716
1279
367276

2013
314225
10,2
3071134
328201
-13976
1377
312817

2014
346018
11,0
3140371
279595
66423
1123
344776

2015
270001
8,7
3117433
169139
100862
870
269083

2016
152232
4,9
3111773
38584
113648
822
151362

Direct investment
Portofolio investment
Other investments
Reserve assets (IMF breakdown)
Net lending, financial account

-992
113957
-5689
8546
115822

70526
646345
-317554
19950
419267

14015
6998
296242
-68184
249071

50746
87479
101457
21011
260693

12957
234973
214211
-19437
442704

-316
297774
-21859
4462
280061

55752
350823
-125098
14178
295655

141707
154590
60070
37972
394339

114464
284828
-261467
-47990
89835

171432
34339
33085
29630
268486

Net errors and omissions
Net errors and omissions, % of GDP

170614
7,26

-12144
0,47

7713
0,32

20450
0,79

-99577
3,57

87215
2,94

17162
0,56

-49563
1,58

179248
5,75

-117124
3,76

Current account balance
Current account balance, % of GDP
Gross domestic product, market values
Balance of goods and services
Balance of income and current transfers
Capital transfers to abroad, net
Net lending, current account

Source: Statistics Norway2

(1.4.2)

Current account balance, % of GDP
18.0
16.0
14.0
12.0
10.0
8.0
6.0
4.0
2.0
0.0
2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

Source: Statistics Norway

(1.5)
2

Statistics Norway is the national statistical institution of Norway (SSB)
9

OIL BRENT
140.00
120.00
100.00
80.00
60.00
40.00
20.00
0.00

Source: FRED ECONOMIC DATA

Oil price
In the summer of 2014, the price of oil started its way down. As indicated in chart (1.6), this
caused huge movements and a sharp depreciation of the Norwegian Krone and a shift in the
current account balance as discussed above. Although the exchange rate NOK/USD
illustrated in the graph is affected by other factors as well, it clearly shows that there is some
correlation. The rate of unemployment also got to feel this sharp decline in the price of oil,
as thousands of workers in the North Sea had to quit their jobs due to restructuring in the
sector.

10

(1.6)3

TWE & Oil price

70.00

140.00

75.00

120.00

80.00
100.00

85.00
90.00

80.00

95.00

60.00

100.00

40.00

105.00
20.00

110.00
115.00

TWE

0.00
Trade Weighted Exchange Rate

Oil price

Oil

Source: Norges Bank and FRED ECONOMIC DATA

3

TWE-axis is inverted to illustrate a depreciation of the Norwegian Krone. TWE denotes the
Trade Weighted Exchange Rate and is de i ed f o a geo et i a e age usi g OECD’s t ade
weights. NOK agai st No a ’s 5 ai t adi g pa t e s. No ges Ba k,

11

Exchange rate and interest rate differentials
The sharp depreciation of the currency illustrated in chart (1.5) has with little doubt had a
positive impact on the economy and certainly a factor Norges Bank has appreciated. The
reason for this, and what the following econometric analysis will show, is mostly explained in
the sharp decline in oil price and further cuts in the policy rate (1.6). Higher prices on
imports has put a pressure on inflation upwards, and higher demand for exports has been a
result of this depreciation. However, the central bank of Norway has had to look at the
developments in the currency markets with great caution. Too high inflation and slow
domestic growth is not a good combination, as they both argues for a policy rate in two
different directions.
As Galati, Heath and McGuire (2007) argues, the interest rate differential can have a great
impact on the exchange rate movements. The policy rate in Norway has the last decade
more or less followed the rates in US, EU and UK. This has contributed to a stable exchange
rate as the interest differentials have been moderate. Although the exchange rate is not
mentioned in the mandate, it has definitely been an important tool for Norges Bank in
adjusting the economy to meet its requirements.
(1.7)4

TWE & Policy Rate

70.00

7.00

75.00

6.00

80.00
5.00

85.00
90.00

4.00

95.00

3.00

100.00

2.00

105.00
110.00

1.00

115.00

0.00

TWE

Trade Weighted Exchange Rate

Policy rate

PR

Source: Norges Bank

4

TWE on the left axis (inverted) denotes the Trade Weighted Exchange Rate and PR on the
right axis denotes the Policy Rate.
12

Econometric analysis
To strengthen the arguments discussed above, the following econometric regression analysis
will show some factors driving the exchange rate. I have constructed a model which tries to
explain the movements in NOK/USD. Theory suggest that developments in interest rate
differentials and the price of oil can have a big impact on the exchange rate and for that
reason, the log-linear regression will include those as independent variables and can be
written as:
log(ER)=  +  oil +  ��

� +  IRUSD

5

Where log(ER) is the log of NOK/USD, (oil) is the oil price and (IRNOK) and (IRUSD) denotes
the 3-month interest rates in Norway and USA respectively. A tabulate summarising the
results can be found below.6
Variable
C
OIL
IRNOK

Coefficient
2.106898
-0.002855
-0.016608

Std. Error
0.023583
0.000237
0.005544

t-statistic
89.33849
-12.06278
-2.903807

Prob.
0.0000
0.0000
0.0046

Data source: FRED ECONOMIC DATA

As the dependent variable is NOK/USD, a decrease in this variable would imply an
appreciation of the Norwegian Krone relative to the US dollar. Hence, a one-dollar increase
in the price of oil will according to this model lead to a 0.29% appreciation of the Norwegian
Krone relative to the dollar, holding all other variables constant. Similarly, a 1% increase in
the Norwegian interest rate leads to a 1.7% appreciation of the Krone. Both of these
observations are in line with empirical evidence and economic theory. The former supports
the findings of Akram and Mumtaz (2016) which argues that long run correlation between
the price of oil and changes in the exchange rate has increased. The latter support the
research of Galati, Heath and McGuire (2007), who states that interest rate differentials can
have a big impact on movements in the exchange rate. It is also providing evidence that the
well-known theory of uncovered interest parity does not hold.

5

Note: a more complicated version of this regression will be used in my dissertation; Covered
Interest Parity, Uncovered Interest Parity and Carry Trade, 2017.
6 The observed results should not be taken as completely valid, as the model may suffer from
misspecifications and spurious correlation. But, it can provide a good picture of the developments in
the exchange rate NOK/USD, which has been an efficient tool for the central bank of Norway to
control the macroeconomic figures of concern.

13

Growth and prospects internationally
As mentioned, Norway is a big exporter of oil. That means that its economy does not only
rely on what happens domestically, but also outside its borders. The global picture both
politically and economically has the last year changed drastically. Brexit changed the outlook
for the European economy as a whole and made the pound sterling fall hard, but there is still
uncertainty regarding the outcome of this matter. The presidential election in US has also
had its impact on the financial markets. All-time highs on the stock exchange and more
government spending seems to be the immediate effect of this, given that the president will
go through with his promises. The FED has approached the monetary policy with a clearly
hawkish attitude, saying that a further raise in the policy rate is very likely in the near future.
Then there are also new elections in Europe in the year to come. Together with a heavily
indebted Greece and Italy, this has ise uestio s a out the Eu opea U io ’s futu e.

What is next?
A further increase in the price of oil is not something that I see as unlikely in the near future,
given that OPEC fulfils its statements that it will cut the production drastically. This will boost
the Norwegian economy domestically but will probably be slowed down by a stronger
currency. As mentioned, a dovish monetary approach has been prominent in the
presentations from Norges Bank.
Faster growth in Europe and the US with increasing rates is an argument for higher rates in
Norway as well, but uncertainty regarding the political developments both in Europe and in
the US argues for great caution when setting the policy rate. Considering that the NOK is still
weak seen from a historical perspective, rising public debt domestically, low rates globally
and dovish comments in earlier presentations, this leads to my informal prediction of the
e t step i No ges Ba ks’ o eta poli , namely that the rate will stay at the current
level of 50 basis points after the meeting on 16th of March 2017, given that the variables
examined do not fluctuate too much.

14

APPENDIX

1.1 Eviews output
Dependent Variable: LNOKUSD
Method: Least Squares
Date: 02/10/17 Time: 12:51
Sample: 2007M02 2015M03
Included observations: 98
Variable

Coefficient

Std. Error

t-Statistic

Prob.

C
OIL
IRNOK
IRUSD

2.106898
-0.002855
-0.016608
-0.007798

0.023583
0.000237
0.005719
0.005544

89.33849
-12.06278
-2.903807
-1.406470

0.0000
0.0000
0.0046
0.1629

R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
F-statistic
Prob(F-statistic)

0.677608
0.667319
0.049866
0.233738
156.8315
65.85696
0.000000

Mean dependent var
S.D. dependent var
Akaike info criterion
Schwarz criterion
Hannan-Quinn criter.
Durbin-Watson stat

1.784807
0.086454
-3.119010
-3.013501
-3.076334
0.182866

Data Source: FRED ECONOMIC DATA

15

References
Akram, F. and Mumtaz, H. (2016). The role of oil prices and monetary policy in the
Norwegian economy since the 1980's. [online] 1. Available at: http://static.norgesbank.no/pages/104571/Working_Paper_01_16.pdf?v=2/2/201642937PM&ft=.pdf
[Accessed 13 Feb. 2017].
Ec. europa.eu. (2017). Home - Eurostat. [online] Available at:
http://ec.europa.eu/eurostat/ [Accessed 13 Feb. 2017].
Fred.stlouisfed.org. (2017). LIBOR Rates | FRED | St. Louis Fed. [online] Available at:
https://fred.stlouisfed.org/categories/33003 [Accessed 12 Feb. 2017].
Galati, G., Heath, A. and McGuire, P. (2007). Evidence of carry trade activity. BIS
Quarterly Review. [online] Available at:
http://www.bis.org/publ/qtrpdf/r_qt0709e.pdf [Accessed 12 Jan. 2017].
Norges-bank.no. (2017). Exchange rates. [online] Available at: http://www.norgesbank.no/en/Statistics/exchange_rates/ [Accessed 14 Feb. 2017].
Olsen, Ø. (2017). Monetary Policy Report. [online] http://www.norges-bank.no/en/.
Available at: http://static.norgesbank.no/pages/105894/MPR_4_2016.pdf?v=12/15/201622042PM&ft=.pdf [Accessed
13 Feb. 2017].
Ssb.no/en. (2017). External economy. [online] Available at:
http://www.ssb.no/en/utenriksokonomi?de=Balance+of+payments [Accessed 14
Feb. 2017].

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