Norway—Recent Economic Developments

This paper examines the development of general government finances in Norway during 1988–96. The paper looks at general government revenue and expenditure in detail, examines the importance of revenue from the petroleum sector for general government finances, and reviews developments in the general government balance sheet. The paper also analyzes the conduct of fiscal policy over 1988–96, and compares the development of the authorities’ estimates of the state budget’s fiscal impulse with the development of the IMF staff’s estimates of changes in the non-petroleum, general government structural balance.

Abstract

This paper examines the development of general government finances in Norway during 1988–96. The paper looks at general government revenue and expenditure in detail, examines the importance of revenue from the petroleum sector for general government finances, and reviews developments in the general government balance sheet. The paper also analyzes the conduct of fiscal policy over 1988–96, and compares the development of the authorities’ estimates of the state budget’s fiscal impulse with the development of the IMF staff’s estimates of changes in the non-petroleum, general government structural balance.

Norway: Basic Data

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Source: Ministry of Finance; Norges Bank; Statistics Norwya; WEFA, INTLINE Database; IMF, International Financial Statistics; and staff estimates.

Official estimates and projectiopns as of December 1996.

Exclues items related to petroleum exploitation and ocean shipping.

From 1996, definitional cha ges result in a half percentage point increase in the reported unemployment rate.

Through November 1996.

End-November 1996.

6/ Fiscal year beginning April 1. Estimates for 1996/97 based on staff forecasts.

I RECENT FISCAL DEVELOPMENTS1

A. Introduction

1. The Norwegian authorities adhere to an active fiscal policy at the central government level. Fiscal policy plays the primary role in stabilizing the domestic economy, with monetary policy geared towards maintaining a stable exchange rate. In the downturn of the late 1980s and early 1990s, the state budget was progressively loosened in order to stimulate activity and employment. With the onset of recovery in 1993, the direction of fiscal policy was reversed, and since 1994 the state budget has been gradually tightened. However, the central government exercises only limited influence over local government finances so the pattern of general government finances need not follow that of central government.

2. This paper examines the development of general government finances over the period 1988–96. New data for this period have become available in connection with the overall revision of the Norwegian national accounts and are not strictly comparable with data for earlier years.2 The first section below looks at general government revenue and expenditure in detail, examines the importance of revenue from the petroleum sector for general government finances, reviews developments in the general government balance sheet, and places the position of general government in Norway in an international context. The second section looks at the conduct of fiscal policy over the period 1988—96, and compares the development of the authorities’ estimates of the state budget’s fiscal impulse—the change to the cyclically–adjusted, non–petroleum state budget balance—with the development of the staffs estimates of changes in the non–petroleum, general government structural balance.

B. General Government Finances 1988–96

3. The tabulation below and Table 1 provide detailed information on the development of general government finances for the period 1988–96 (Chart 1). From 1988 to 1992, the general government balance moved from a surplus of 2.7 percent of GDP to a deficit of 1.7 percent. A rise in expenditure on consumption and transfers to the private sector, as well as a decline in gross tax revenue, accounts for the deterioration in the overall balance over this period. Since 1992, the general government balance has strengthened, reaching a surplus of 6.3 percent of GDP in 1996. The earlier rise in expenditure on consumption and transfers has been reversed and the gross taxy–to–GDP ratio has recovered somewhat. In addition, transfers from state enterprises (especially in the petroleum sector) have risen sharply, and more than sufficiently to offset a gradual decline in net interest (and dividend) revenue. It is notable that in the entire 1988–96 period, Norway recorded a general government deficit only twice, in 1992 and 1993, altogether amounting to only 3 percent of GDP.

Table 1.

Norway: General Government Revenue and Expenditure

(Percent of GDP)

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Sources: Statistics Norway; Ministry of Finance; staff estimates.
CHART 1
CHART 1

NORWAY GENERAL GOVERNMENT FINANCES

(In percent of GDP)

Citation: IMF Staff Country Reports 1997, 026; 10.5089/9781451829631.002.A001

Sources: Ministry of Finance; and Statistics Norway.1/ Consistent with Maastricht criteria.

General Government Finances - Overview

(Percent of GDP)

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Sources: Statistics Norway; Ministry of Finance; staff estimates

Gross taxes minus transfers to the private sector.

4. From 1988 to 1996, general government revenue and expenditure have fluctuated around 50 percent of GDP. In 1988, total revenue stood at 52.1 percent of GDP; the revenue–to–GDP ratio fell to 49.7 percent in 1993 but rose again to 52.1 percent in 1996. Taxes and social security contributions account for about 80 percent of total revenue, with interest and dividends and transfers from state enterprises and Norges Bank making up the rest. Direct taxes on income and wealth account for between 55–60 percent of tax revenue, indirect taxes on production and consumption between 30–35 percent, and taxes on the petroleum sector the remainder.

5. Petroleum taxes are not the only way in which the petroleum sector impacts the general government finances. Additional revenue accrues through interest and dividends on the state’s stake in the petroleum sector, while the state has in the past also incurred expenditure related to the petroleum sector. The tabulation below identifies petroleum related revenue and expenditure in the period 1988–96.

General Government Finances and the Petroleum Sector

(Percent of GDP)

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Sources: Statistics Norway; Ministry of Finance; staff estimates

6. Net petroleum revenue has fluctuated considerably. It was only marginally positive in 1988 but reached 7.1 percent of GDP in 1996; in between it was 5.1 percent of GDP in 1990 and 2.8 percent in 1994. This partly reflects volatile oil prices but also rapidly rising petroleum output and declining petroleum related expenditure; in 1996, the petroleum related expenditure item in the general government accounts was, in fact, negative to the tune of 1.1 percent of GDP as earlier contributions to the sector were repaid. The picture of the non–petroleum balance is somewhat different than that of the overall balance. The non–petroleum balance, at a surplus of 2.6 percent of GDP, was very close to the overall balance in 1988; it subsequently worsened as a result of the economic downturn and the government’s active fiscal policy, to a negative 5.9 percent of GDP in 1992. The non–petroleum deficit has since narrowed but remained at 0.8 percent of GDP in 1996, in contrast to an overall general government surplus of 6.3 percent of GDP.

7. The expenditure-to-GDP ratio started out at 49.4 percent in 1988, rose to 52.2 percent in 1992 but fell to 45.8 percent by 1996. Consumption expenditure and transfers to the private sector each account for about 40 percent of total expenditure, with interest and capital expenditure making up the bulk of the remainder.3 Of the transfers to the private sector, about 75 percent is to households in the form of old age and disability pensions, health care and maternity leave allowances, child support, and unemployment benefits, and 25 percent to businesses, mainly in agriculture and food processing.

8. Table 2 shows the distribution of general government expenditure by function. Welfare accounts for by far the largest share of expenditure, or in excess of one third; welfare’s share in total expenditure has gradually risen in recent years, from 32.7 percent of the total in 1988 to 36.5 percent in 1995, the most recent year for which information is available. Education and health care account for almost equal shares of total expenditure of between 13–14 percent. It is notable that, while education’s share has been on a gradual upward trend, the share of health care has been broadly stable, and equivalent to between 6–7 percent of GDP. Expenditure on business subsidies has fallen from around 8 percent of the total in 1988 to 6.6 percent in 1995. Administration, defense and justice account for about 13 percent of general government expenditure, a share that has remained very stable in the recent period.

Table 2.

Norway: General Government Expenditure by Function

(Percent of total expenditure)

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Source: Statistics Norway; staff estimates.

9. Norway’s tradition of general government surpluses is mirrored in a strong net financial asset position. Table 3 shows the general government balance sheet for the period 1988–95.4 General government gross financial assets hovered around 80 percent of GDP in this period, while gross debt generally fluctuated between 40–50 percent of GDP, although it briefly reached 55.9 percent of GDP in 1993. The bulk of financial assets are held in financial institutions or in non–financial enterprises and the bulk of the debt is owed to financial institutions. General government net financial assets stood at 42.4 percent of GDP in 1988. They subsequently declined to a trough of 30.8 percent of GDP in 1993 before rising to 32.6 percent of GDP in 1995.5 The consolidated gross debt of general government (Maastricht basis), which inter alia nets out debt between the various levels of government, stood at 33 percent of GDP in 1988; it rose to 40.9 percent of GDP in 1993 before easing to 35.5 percent in 1995.

Table 3.

Norway: General Government Balance Sheet 1/

(In percent of GDP)

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Source: Statistics Norway; staff estimates.

Year-end figures.

Maastricht basis.

10. Norway’s general government finances compare favorably with those of other industrial countries. In 1995, Norway’s general government position, a surplus of 3 percent of GDP, was stronger than that of any other industrial country, and its consolidated gross debt at 35.5 percent of GDP was smaller than that of any country other than Luxembourg.6 While many of the EU member countries struggle to meet the Maastricht fiscal criteria, Norway, while a non-member, would thus satisfy them easily.7 Net revenue from the petroleum sector (see above) is an important reason behind the strength of Norway’s general government finances in relation to those of other industrial countries.

C. Structural Balances

11. Active demand stabilization—going beyond the use of automatic stabilizers—is one of the principles governing fiscal policy at the central government level in Norway. During the early late 1980s and the early 1990s, when the economy faltered, the authorities sought to bolster activity and employment through an expansionary fiscal policy. Since the current upswing began in 1993, the direction of policy has been reversed through a gradual tightening of the fiscal stance through expenditure restraint, while taxes have been maintained.8

12. To gauge the effects of the state budget on the level of domestic demand—the fiscal impulse—the authorities estimate a cyclically–adjusted, non–petroleum budget balance.9 Their estimates for the period 1988–96 are shown in the tabulation below (Chart 2).

State Budget’s Fiscal Impulse

(Percent of GDP, unless otherwise indicated)

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Sources: Ministry of Finance; staff estimates
CHART 2
CHART 2

NORWAY STRUCTURAL BALANCES

(Percentage points of GDP)

Citation: IMF Staff Country Reports 1997, 026; 10.5089/9781451829631.002.A001

Sources: Ministry of Finance; and staff estimates.

13. According to this measure, fiscal policy became expansionary in 1989 and remained so through 1993. The cumulative stimulus imparted to domestic demand over this period—corresponding to the weakening of the cyclically–adjusted, non–petroleum state budget balance—was equivalent to 7 percentage points of GDP. On the other hand, the cumulative tightening of the fiscal stance over 1994–96 was 3½ percent of GDP, leaving a considerable margin before the earlier weakening of the structural budget balance will have been reversed.

14. The authorities’ estimates of the fiscal impulse cover only the state budget, which in a national accounts framework is most closely related to the central government accounts.10 The staff has prepared estimates of the development of the general government structural balance over the period 1988–96 using Fund standard methodology, with some specific modifications for Norway.

15. According to the Fund methodology, the structural balance is defined as the difference between revenue and expenditure that would result if the economy were at full potential. The structural level of revenue is calculated from the actual level based on the output gap and an estimate of the revenue elasticity, whereas structural expenditure is determined from actual expenditure on the basis of the deviation of actual unemployment from the estimated NAIRU. Typically, all revenue (save interest) is assumed to be cyclically sensitive, while unemployment benefits are the only expenditure item assumed to be so affected. Performing these calculations requires estimates of the output gap and unemployment benefits. For Norway, special allowances need to be made because of the large petroleum sector, which can exhibit very different cyclical behavior than the non–petroleum, or mainland, economy. It is therefore necessary to relate cyclically sensitive non–petroleum revenue to the deviation of mainland output from potential, or the mainland output gap, and subtract petroleum expenditure from total expenditure to arrive at an estimate of Norway’s non–petroleum, structural general government balance. The measure so derived can aid in the assessment of the effect of general government activities on domestic demand but is less suitable for use in an international comparison of structural balances because the petroleum sector is after all an integral part of the Norwegian economy; for this purpose adding back net petroleum revenue to the cyclically–adjusted, non–petroleum balance gives a broader view of the level of the general government structural balance.11

16. Staff estimates of the cyclically–adjusted, non–petroleum structural balance, as well as the overall structural balance (with net petroleum revenue included), are shown in the tabulation below.12

General Government Structural Balance

(Percent of GDP)

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Source: Staff estimates

Includes net petroleum revenue.

Positive numbers indicate output above potential.

17. The actual non–petroleum balance moved from a surplus of 2.6 percent of GDP in 1988 to a deficit of 5.9 percent in 1992, a deterioration of 7.5 percentage points of GDP. However, as mainland output was sharply above potential in 1988 and somewhat below potential in 1992, the deterioration of the cyclically–adjusted, non–petroleum balance was considerably smaller, or 5.3 percentage points of GDP. The actual non–petroleum deficit narrowed to 0.6 percent of GDP by 1995, and remained broadly unchanged in 1996. The cyclically–adjusted, non–petroleum balance also improved over 1993–95 but by less than the actual balance, or by 3.7 percentage points of GDP vs. 5.3 percentage points, as the mainland output gap was closed; in 1996, the non–petroleum structural balance actually worsened by 0.7 percentage points of GDP.

18. The staffs estimates of the changes to the cyclically–adjusted, non–petroleum structural balance of general government are broadly in line with the authorities estimates of the state budget’s fiscal impulse, with important differences. First, the cumulative deterioration in the non–petroleum general government structural balance in the period 1989–1993 was smaller that the cumulative state budget’s fiscal impulse over the same period (4.7 percentage points of GDP vs. 7 percentage points). Second, while the state budget continued to withdraw demand from the economy in 1996 (by 0.9 percentage points of GDP), the non–petroleum general government structural balance worsened. Both these facts can be interpreted as an indication that local government finances may impart an element of pro–cyclicality to the general government finances. This is not an altogether unexpected result given that local governments account for about one third of general government expenditure and that taxes constitute around one half of their revenue; in an upswing, additional tax revenue allows local governments to increase their expenditure.

D. Conclusion

19. Norway’s general government finances, underpinned by rising petroleum revenue, are very healthy in comparison to the finances of other industrial countries, both as regards financial balances and asset positions. The authorities have used their room for maneouvre to engage in fiscal activism at the state level in order to stabilize domestic demand. There is some evidence that the effectiveness of this fiscal activism may be offset by an element of pro–cyclicality in local government finances.

II. NORWAY’S POLICY FRAMEWORK AND THE KRONE13

The monetary policy to be conducted by Norges Bank shall be aimed at maintaining a stable krone exchange rate against European currencies, based on the range of the exchange rate maintained since the krone was floated on 10 December 1992. In the event of significant changes in the exchange rate, monetary policy instruments will be oriented with a view to returning the exchange rate over time to its initial range. No fluctuation margins are established, nor is there an appurtenant obligation on Norges Bank to intervene in the foreign exchange market14

The main economic policy objectives…are to secure a durable basis for sustainable economic growth and full employment, and to this end the best contribution monetary policy can make is to maintain low price and wage inflation in the long term. A stable exchange rate is a prerequisite for achieving this. However, if the economy is affected by serious disturbances or long-term and wide cyclical fluctuations, the intermediate exchange rate target ought to be adapted to the long–term objective of monetary policy.15

A. Introduction

20. Oil income is a highly volatile source of revenue whose generation involves the dissipation of wealth and whose spending can erode the competitiveness of other sectors. In Norway, the inflationary pressure created by the consumption of oil wealth in the 1980s contributed to a sharp rise in the real effective exchange rate that undermined manufacturing output, employment and exports.16 Employment in the sheltered public sector, however, rose sharply as a share of total. Countervailing measures succeeded in reining in inflation in 1990 and reversing some of the loss in competitiveness experienced in the previous decade.

21. The prospect for increasingly large oil–fired current account surpluses is likely to complicate exchange rate policy implementation well into the next century. If this wealth were to be consumed, as it was in the 1980s, the real effective exchange rate would be inexorably raised and the non–oil exposed sectors of the economy gutted in the process characterized as the “Dutch disease”. Once Norway’s oil reserves were fully depleted, sometime in the middle of the next century, the economy would be faced with a wrenching adjustment whose prime motive force would be an equally inexorable fall in the real effective exchange rate. Industries lost during the period of real exchange rate appreciation would, however, be unlikely to revive as a result of the subsequent depreciation.

22. To avoid the consequences of such an exchange rate trajectory, the Norwegian authorities place considerable emphasis on the maintenance of exchange rate stability. Indeed, with the exception of a brief period in 1971, Norway has never pursued a freely floating exchange rate regime. Instead, the Norwegian authorities have attempted to support the monetary policy target of exchange rate stability with a restrictive fiscal stance since 1993 aimed at relieving the upward pressure imposed on the exchange rate by large external surpluses. This fiscal policy—oriented toward limiting the impact on domestic demand of the exploitation of oil wealth by accumulating and preserving that wealth for future generations in foreign financial assets—has resulted in the accumulation of assets equivalent to 6 percent of GDP in the State Petroleum Fund (SPF) in 1996. The final leg of policy—incomes policy implemented through centralized wage agreements among the government and the social partners—seeks to promote competitiveness and employment through wage moderation, thereby complementing the objective of maintaining a stable exchange rate.

B. Norway’s Macro Policy Framework

23. Norway’s macro policy framework has three legs: fiscal policy oriented toward short–term stabilization and the long–term preservation of oil wealth, monetary policy focused on exchange rate stability, and incomes policy targeted at employment growth and the preservation of competitiveness.

Fiscal policy

24. Norwegian fiscal policy has two main dimensions: stabilization in the short run and the preservation of oil wealth over the longer term.17 In an upswing, as at present, these dimensions are in harmony as the need for fiscal tightening to dampen inflationary pressure and sterilize the impact of oil wealth on domestic demand is consistent with accumulating oil revenue in the form of foreign financial assets. In the current upswing, for example, fiscal policy’s stabilization function is focused on expenditure restraint and asset accumulation to dampen excess demand pressure. The resultant fiscal surpluses have permitted in 1996 the accumulation of assets in the SPF equivalent to 6 percent of GDP. In downturns, however, budgets have freely made use of oil revenue to stimulate the economy, effectively precluding the preservation of oil wealth in the form of financial assets.18 The assets accumulated in the SPF would be run down to finance non–oil budget deficits in a cyclical downturn.

25. Through its demand stabilization function, fiscal policy is meant to support monetary policy in maintaining a stable exchange rate. Under this approach, a suitably tight fiscal policy would relieve upward pressure on the exchange rate by dampening domestic demand and shifting the expenditure of oil revenue from the domestic economy to foreign financial assets. The stabilization role of fiscal policy is critical in view of the potentially procyclical cast of a monetary policy that targets exchange rate stability. For example, such a monetary policy would not respond restrictively to a surge in oil revenues, as the goal of exchange rate stability would dictate against an interest rate rise that could place even greater upward pressure on the exchange rate.

26. Over the longer term, the Norwegian authorities seek to avoid excessive reliance on oil revenue (the better to withstand sharp changes in oil prices), and prepare for the eventual depletion of this asset. The goal of preserving oil wealth is given further impetus by the budgetary exigencies projected to be imposed by an aging population, demands likely to mount just as oil receipts are forecast to decline.19 To meet this longer term challenge and create a cushion for oil price variability, the budget’s surpluses are being accumulated in the SPF20 whose assets are invested abroad as a means of sterilizing the impact of oil revenue on the rest of the economy and contributing to the maintenance of the competitiveness of the non–oil tradable sector (Box 1).

The State Petroleum Fund’s Rationale

The SPF is designed to further three objectives: the promotion of intergenerational fairness and capital preservation, the avoidance of inflationary pressure and erosion of competitiveness, and the reduction of oil dependence and vulnerability to oil price variability. Underlying the SPF’s establishment is the realization that the surpluses projected to mount over the medium term and drop off rapidly early in the 21st century do not themselves form the sustainable basis for growth in output and employment, a role that ultimately only the mainland economy can fulfill.

The ultimate objective of the SPF is to allocate oil revenue over time, thereby preserving for future generations some of the benefits of Norway’s oil wealth. Since part of the oil revenue accruing to the budget represents the depletion of oil wealth, accumulating oil revenue in the SPF furthers the objective of capital preservation.

The SPF is also designed to contribute to the dampening of excess domestic demand pressure and the erosion of competitiveness that would result from the attendant real appreciation of the krone. The investment of the SPF’s portfolio in foreign financial assets helps preserve the competitiveness of the mainland economy by relieving upward pressure on the real effective exchange rate. Domestic investment, in contrast, would increase domestic demand, erode competitiveness, and result in the allocation of funds to low-yielding ventures.

Investing the SPF in foreign financial assets also serves to diversify Norway’s assets and reduces its vulnerability to oil price changes. The income from the SPF’s assets are likely to be less volatile than, and imperfectly correlated with, the price of oil. In addition, the capital accumulated in the SPF could also serve to smooth the adjustment to a collapse in oil prices.

Monetary policy

27. During the 47 years through the end of the krone’s link with the ECU in December 1992, Norwegian exchange rate policy followed a series of fixed exchange rate regimes. Norway participated in the Bretton Woods system during 1945–71, the Smithsonian Agreement during 1971–7321, and the EC’s snake during 1973–78.22 When the ERM was created for selected EU members in 1979, Norway opted for its own currency basket weighted according to the direction of Norwegian exports, which it targeted until the adoption of the ECU as the exchange rate anchor in October 1990. Despite its commitment to a fixed exchange rate regime, Norway frequently resorted, until 1986, to devaluations aimed at offsetting excessive wage and price increases. The 1990 link with the ECU was meant to strengthen the credibility of the authorities’ anti–inflationary stance and signal to both employers and employees the need for moderation in price and wage increases. The krone initially demonstrated little variation from its central parity against the ECU, remaining well within the targeted ±2¼ percent intervention bands until the ERM turmoil of 1992. By December 1992, however, in the wake of the ERM crisis and the delinking of the Finnish markka and Swedish krona, the pressure on the krone overwhelmed central bank efforts to support the currency23 and the fixed link with the ECU was suspended indefinitely on December 10 (Chart 1). The goal of stability against the ECU was maintained without, however, specifying either a precise target rate or a definite fluctuation band, a policy that was confirmed by the May 1994 royal decree quoted at the opening of this paper.

CHART 1
CHART 1

NORWAY EXCHANGE RATES: NORWEGIAN KRONE VIS-A-VIS ECU AND DM 1/

(Percent deviation from central rates)

Citation: IMF Staff Country Reports 1997, 026; 10.5089/9781451829631.002.A001

1/ An upward movement indicates appreciation.

28. Monetary policy is now oriented toward exchange rate stability against the ECU, an alignment expected to contribute to low inflation and stable economic growth, two subsidiary goals of monetary policy. However, unlike the ECU link that prevailed from 1990 until the currency market turbulence in 1992 that led to the managed float of the krone, there is no commitment to defend a particular parity and no fluctuation margins have been established. While exchange rate stability is the goal under the current guidelines, the instruments available to the central bank to maintain exchange rate stability—interest rate adjustments and market intervention—are not to be used to the same extent as they would be in the pursuit of a fixed exchange rate regime. Although there is no central parity rate, there is a central range based on the movements of the krone between its float on 10 December 1992 and May 6, 1994, when the royal decree on the exchange rate was issued (about 103–106 on the inverted ECU index). There is no precise fluctuation band around this central range, however. The target of exchange rate stability is to be achieved over time, in principle allowing latitude to those interpreting and implementing the guidelines. In particular, the guidelines afford the time needed to determine whether exchange rate movements are likely to be self–correcting, or reflect a more fundamental economic shock. The flexibility of the exchange rate also offers some latitude to target krone stability in a way that also contributes to the dampening of fluctuations in the domestic economy.

Incomes policy

29. Under the policy framework, exchange rate stability is to be complemented by wage moderation to avoid an erosion of competitiveness and promote employment growth in the exposed non–oil sectors. The emphasis on exchange rate stability reflects an attempt by the government and the social partners to put an end to the past cycle of excessive wage settlements, partially offset by subsequent devaluations aimed at recouping the loss in competitiveness, or interspersed with equally futile wage and price freezes. In the first half of the 1980s, for example, the nominal effective exchange rate was repeatedly ratcheted down to compensate the erosion of competitiveness caused by relative price movements (Chart 2).24

CHART 2
CHART 2

NORWAY: EXCHANGE RATES AND RELATIVE PRICES

(Indices: 1990=100)

Citation: IMF Staff Country Reports 1997, 026; 10.5089/9781451829631.002.A001

Sources: IMF, International Financial Statistics; and Statistics Norway.

30. To break this cycle, the social partners agreed—in a framework dubbed the “solidarity alternative”—that a tight fiscal policy, stable krone, and moderate wage settlements would be the best way to increase employment and real incomes. In this context, the commitment to maintaining stability against the ECU—a currency basket dominated by countries committed to low inflation—was a signal to both employers and employees of the need for price and wage moderation. By targeting exchange rate stability, the transparency of the link between wage and price developments and competitiveness was enhanced. Although the consensus on exchange rate stability was initially motivated by a concern to avoid periodic devaluations, the emphasis in the solidarity alternative on the need to preserve competitiveness to promote growth in jobs and real incomes also militates against krone revaluation. While a strong krone would benefit the employed by increasing their purchasing power, it would also erode competitiveness and undermine job growth.

C. Recent Currency Market Developments

31. The recent implementation of the monetary policy framework has been complicated by the different positions of the Norwegian and European economies in the economic cycle, rising oil prices, and speculative interest in the krone, the latter becoming especially keen since September 1996.

30. In the first half of 1996, the upward pressure on the krone was persistent but manageable. In March, given continued upward pressure on the krone and (in the event misleading) indications that growth might be slowing, the central bank reduced its official deposit and lending rates to 4.5 percent and 6.5 percent, respectively, and Norwegian short–term money market rates converged toward ECU rates. The March reduction in interest rates reduced pressure on the krone, and such pressure remained subdued throughout the summer.

33. However, the yield differential of Norwegian short–term rates over those of Germany and the ECU widened in the course of the summer (Charts 3 and 4). The combination of positive yield spreads and strong growth triggered speculative interest, especially after September, as market participants perceived the makings of a one–way bet that offered both higher yields and the likelihood of a currency gain. The resultant upward pressure on the krone was dampened through a rather large level of market intervention.

CHART 3
CHART 3

NORWAY INTEREST RATE DEVELOPMENTS

(In percent)

Citation: IMF Staff Country Reports 1997, 026; 10.5089/9781451829631.002.A001

Sources: IMF, International Financial Statistics; and WEFA, GERF1N Database.
CHART 4
CHART 4

NORWAY RECENT INTEREST RATE DEVELOPMENTS

Citation: IMF Staff Country Reports 1997, 026; 10.5089/9781451829631.002.A001

Sources: IMF, Research Deportment; WEFA, GERFIN Database.

34. By mid–September, the krone had appreciated by 1½ percent against the ECU in 1996, for an effective appreciation of ¼ percent, notwithstanding net purchases of foreign exchange equivalent to Nkr39.5 billion (4 percent of GDP). By mid–November, central bank interventions in 1996 had reached Nkr74 billion—Nkr34 billion over the amount of foreign currency needed for the SPF.25 Nevertheless, the krone remained under pressure and interest rates were cut by 50 basis points on November 5 when the krone approached 101 on the inverted ECU index (see Chart 1). In response to this cut, 3-month money market rates fell by 70–80 basis points, bringing short–term spreads broadly in line with ECU rates (see Chart 4). The November rate cut kept monetary conditions unchanged as the krone at that point had appreciated by 2 percent.26

35. In response to unrelenting upward pressure on the krone, interest rates were cut by 50 basis points on January 8, 1997 and a further 25 basis points on January 10, bringing short–term krone interest rates further below those on the ECU. Market intervention in the first nine days of 1997 amounted to Nkr30 billion27 (3 percent of GDP), or half of the amount to be accumulated in the SPF in 1997. Further attempts to stem the appreciation of the krone were suspended on January 10 (with the krone at 98.7 on the inverted ECU index), although Norges Bank asserted its intention to continue to intervene to smooth short–term currency movements. The immediate market reaction to the suspension of intervention was a sharp appreciation of the krone to 95 on the inverted krone index by mid–January, a surge that was partially reversed by end–January, when the krone stood at 96.

36. The futility of massive intervention and the risk of triggering inflation through continued interest rate cuts in the midst of a strong upswing underlie the decision to take a more passive approach to krone movements. The limits of intervention—an instrument designed to smooth short–term market fluctuations that was ill-suited to offset strong and persistent pressure in a single direction—had been reached. As already noted, the current guidelines envisage that interventions should be neutral over the cycle, and not be used to the same extent as might be appropriate under a fixed exchange rate regime. However, the intervention in 1996 and early 1997 far exceeded the Nkr50 billion deployed in 1992 to defend a fixed exchange rate.

D. Conclusion

37. Recent currency market developments highlight a number of tensions to which the Norwegian macroeconomic framework is prone. First, targeting exchange rate stability is potentially procyclical, particularly when oil–fueled revenue boosts both domestic demand and the krone. The procyclicality of the exchange rate target is likely to be intensified when, as now, the Norwegian economy is not in harmony with other European economies. Under these circumstances, a strict interpretation of what constitutes exchange rate stability undermines the goal of using the exchange rate as an anchor for domestic prices and wages. Second, fiscal policy needs to anticipate domestic demand developments to compensate for its limited flexibility: budgets can be adjusted only twice each year, and the impact of such changes is not immediate. Fiscal policy may also find it difficult to forestall pressure on the exchange rate arising from revisions in the magnitude of Norway’s oil wealth due either to changes in oil prices or estimates of recoverable reserves. Moreover, the accumulation of substantial surpluses in the SPF could conceivably erode the political will to pursue tight fiscal policies. Finally, the ability of centralized wage agreements to deliver the requisite wage moderation to ensure competitiveness could be put at risk by labor market tightness, potentially compounding the erosion of competitiveness arising from upward pressure on the krone.

38. The solidity of Norway’s macroeconomic framework relies on fiscal policy. If, for example, fiscal policy were oriented toward using all oil resources internally, the effect would be a real exchange rate appreciation, a decimation of the exposed sector, an expansion of the sheltered sector, and no accumulation of foreign assets. When the oil was fully consumed, there would be neither a portfolio of accumulated assets nor an export sector to step in to finance the current account, deficits would mount, and the equilibrium exchange rate would fall, without necessarily reviving the industries lost in the period of its ascent. Alternatively, if fiscal policy were more restrictive, the real appreciation of the krone would be dampened, the exposed sectors would have a greater chance of remaining competitive, and a sizeable portfolio of assets would be accumulated. The economy would be better placed to cope with the post–oil era, and a wrenching adjustment through a sharp exchange rate depreciation would not be necessary.

References

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1

Prepared by Birgir Arnason.

2

Statistics Norway is revising older data in line with the new standards; results are expected in late spring 1997.

3

Transfers abroad, chiefly official development assistance, accounts for about 2 percent of total expenditure, or close to 1 percent of GDP.

4

The balance sheet does not include accrued pension liabilities but neither does it include the state’s share in Norway’s petroleum wealth, the magnitude of which is of the order of 100 percent of GDP.

5

With the large general government surplus—6.3 percent of GDP—recorded in 1996, the net financial asset position is bound to have strengthened further, to close to 40 percent of GDP.

6

Jon Petter Nossen, Public Finances in Norway Compared to the EU Countries, the USA and Japan, Economic Survey 4/96, Statistics Norway, May 1996 (in Norwegian). In 1995, Luxembourg was the only other industrial country to record a general government surplus, 1 percent of GDP.

7

EU membership was rejected in the November 1994 referendum.

8

Norway undertook a major tax reform in the early 1990s that aimed to broaden tax bases and lower marginal rates, as well as to reduce other distortions such as the wedge between pre and after–tax interest rates.

9

Less importantly, the budget balance is also adjusted for some special factors such as transfers and rental income from Norges Bank and abroad.

10

They are not identical because, for example, the state budget is prepared on a cash basis while the central government accounts are recorded on an accruals basis.

11

For a fuller account of the methodology and the special issues related to Norway see SM/95/17.

12

The calculations assume a revenue elasticity slightly larger than unity and a NAIRU close to 5 percent of the labor force; most of the cyclical adjustment, however, takes place on the revenue side. Mainland output potential is estimated using the HP-filter.

13

Prepared by David J. Ordoobadi.

14

Royal Decree of 6 May 1994 setting forth the exchange rate system for the Norwegian krone.

15

Norges Bank (1994).

16

Chapter 3 considers Norwegian competitiveness in greater detail.

17

Fiscal policy’s contribution to demand stabilization is facilitated by the central role played by the state in the oil sector, with 80 percent of Norway’s oil wealth accruing to the state. The state’s interest in the oil sector takes several forms. First, as titleholder to all petroleum deposits on the Norwegian continental shelf, the state issues exploration and production licenses. Second, through the state oil company—Statoil—the state is directly involved in the exploitation, refining and distribution of petroleum products. Third, the state takes a direct financial interest in the exploitation activities of other oil companies. Finally, it imposes taxes and commands royalties on petroleum activities. The net cash flow to the budget from petroleum activities (which is denominated in kroner) arises from the state’s direct financial interest in Statoil and the activities of other oil companies, dividends on the state’s equity interest in Statoil, and taxes and royalties.

18

In the most recent downturn of 1990–93, the cumulative fiscal stimulus to the economy represented 7 percent of GDP.

19

Norway’s long–term fiscal challenges are reviewed in detail in SM/96/17. The combined impact of declining oil revenue and the mounting costs of an aging population are estimated to result in a deterioration in the fiscal accounts in 2030 of 10 percentage points of GDP.

20

The SPF was established in 1990, only to lie dormant as the government pursued an expansionary fiscal policy to counter the continuing recession. The SPF was first endowed in 1996.

21

The krone floated during August–December, 1971.

22

The rejection of EEC membership in a September 1972 referendum did not preclude Norway’s continued participation in the snake.

23

In the first ten days of December 1992, Norges Bank purchased the equivalent of US$2.5 billion in krone; Norwegian three–month interest rates averaged 690 basis points above the corresponding ECU rate; and the Norwegian one–month money market rate was kept at 40 percent.

24

The last devaluation was in 1986.

25

Central bank foreign exchange purchases have been largely sterilized. Foreign currency accumulated for the SPF is self–sterilizing as the counterpart is a government account with the central bank. The balance has been mopped up by the issuance of (mainly short–term) government paper and fixed rate deposits.

26

The central bank’s monetary conditions index is based on a 4:1 relationship between interest rate and currency movements.

27

Including Nkrl2 billion on January 9 alone.

Table A1.

Norway: Demand and Supply

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Source: Statistics Norway.

Changes in percent of previous year’s GDP.

Excludes items related to petroleum exploitation and ocean shipping.

Table A2.

Norway: Final Consumption Expenditure of Households

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Source: Statistics Norway.
Table A3.

Norway: Household Income and Saving

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Source: Statistics Norway.

Deflated by private consumption deflator.

Table A4.

Norway: Gross Fixed Investment

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Source: Statistics Norway.

Excludes items related to petroleum exploitation and ocean shipping.

Table A5.

Norway: Real GDP by Sector

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Source: Statistics Norway.

Excludes items related to petroleum exploitation and ocean shipping.

Table A6.

Norway: Indicators of Petroleum Activities

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Sources: Statistics Norway; and Ministry of Finance, Nasjonalbudsjettet.
Table A7.

Norway: Indicators of International Competitiveness and Trade Performance

(Annual percentage change)

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Sources: Statistics Norway; and IMF Research Department.
Table A8.

Norway: Exports of Goods and Services

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Source: Statistics Norway.
Table A9.

Norway: Imports of Goods and Services

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Source: Statistics Norway.
Table A10.

Norway: Current Account Balance

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Source: Statistics Norway.
Table A11.

Norway: Net External Debt

(In billions of NKr)

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Sources: Ministry of Finance, NasjonalBudsjettet: and Norges Bank, Economic Bulletin