Abstract
This 2001 Article IV Consultation highlights that the real mainland (non-oil) GDP of Norway is estimated to have grown well below potential in 2001, at 1¼ percent. Although high oil prices supported household confidence and domestic activity through most of the year, the global slowdown has recently begun to affect Norway. Labor market conditions remain tight in service sectors, but weakened in technology and traditional export industries. Despite high domestic cost increases, consumer price inflation has been held in check by low krone import prices.
On behalf of the Norwegian authorities we would like to thank the staff for a thorough and well written report on the 2001 Article IV consultation on Norway. The staff report covers important aspects of the Norwegian economy, both in a short and long term perspective. As a response to the changes in guidelines both for fiscal and monetary policy on March 29, 2001, this report is particularly interesting.
Economic outlook - recent projections
Norway’s terms-of-trade weakened considerably as a result of the decline in oil prices following the global downturn last year. Prices for Norwegian export goods have shown a downward trend since spring 2001, and exports declined towards the end of last year. However, the effects on the activity level in the Norwegian economy have been limited. The negative demand impulses from exports have, to a large extent, been counteracted by growth in private and public consumption and in housing investment. Moreover, the fall in oil prices has not deterred oil companies from revising planned investments upward. Thus the Norwegian economy may weather the downturn with a substantially smaller impact on the level of activity and employment than most other countries. The latest projections for mainland GDP provided by the authorities indicate a growth rate of around IV2 percent in 2002. Thereafter, GDP growth is expected to pick up towards 2 percent.
Unemployment has edged up in the last few months, while employment growth has been limited. Still, the labour market remains tight. Long-term unemployment is low, and spells of unemployment are generally brief. Hence, there is a risk of high growth in labour costs following this spring’s wage negotiation round.
Fiscal policy
Regarding the transition to a new macroeconomic policy framework in Norway, the staff generally commends a more explicit rule based approach to macroeconomic policy. However, concerns are expressed about the long-term sustainability of the new fiscal policy guidelines. The new fiscal policy rule implies that oil revenues will be phased into the budget in accordance with the expected real return (estimated at 4 percent per year) on the Petroleum Fund. When assessing this rule several concerns should be taken into consideration.
Due to the very high oil revenues at present, the total budget surplus is more than 15 percent of GDP and the Petroleum Fund is rapidly building up. The experience of other countries in similar situations is that strict fiscal rules may support sound macroeconomic policies. But such rules have to be clear and easy to understand - otherwise they will not be credible. Such considerations have been important when establishing the present policy guidelines:
All oil revenues are transferred to the Petroleum Fund. The Fund is invested abroad with about 40 percent in equity markets and 60 percent in bond markets. Thus, the economy is insulated from the large swings in petroleum revenues.
The new fiscal rule limits the use of petroleum revenues to the expected real return on the capital in the Fund. This rule implies a gradual and cautious increase in the spending of petroleum revenues. Ten years ahead the non-oil deficit is estimated at just above 5 percent of GDP. This is lower than the corresponding deficit at the beginning of the 1980s. The fiscal rule is based on spending the real return on the Fund - the real value of the Fund is thereby preserved for future generations.
By most comparisons the Norwegian policy approach must be regarded as quite cautious. The new fiscal rule states that the use of oil revenues shall equal the return on capital already accumulated in the Petroleum Fund, and not depend on uncertain future proceeds. The Norwegian authorities would like to emphasize that the fiscal policy rule implies continued growth in the Government Petroleum Fund. The Fund has grown to USD 70 billion (42 percent of GDP) at the end of 2001, and is expected to reach 100 percent of GDP through 2009. The policy framework allows the Fund to serve as a buffer against fluctuations in petroleum receipts.
The consequences for economic stability were strongly emphasized when the new policy guidelines were introduced. Chart A-D illustrates three long-term scenarios for economic developments in Norway. The assumptions regarding oil prices, oil production, productivity growth and interest rates are the same as in the IMF staff calculations. The three scenarios differ in the following ways:
The baseline or reference scenario is characterized by an unchanged tax system, and it is assumed that no new social reforms are introduced over the whole projection period.
The unsustainable policy scenario is equal to the baseline scenario with one exception - the growth in public employment continues at the same pace as in the 1990s (1½ percent per year). In this scenario, a need for tightening of policy is building up. Technically, the change in policy is postponed for 20 years, i.e. until the budget deficit has passed 10 percent of GDP.
The new fiscal rule scenario implies that oil revenues are phased into the economy in line with the expected real return on the Petroleum Fund (4 percent per year).
The new fiscal rule scenario implies a somewhat more expansionary budget policy than in the baseline scenario over the first decade and a somewhat tighter one from around 2020. But the phasing in of oil revenues is smoother and more gradual under the new fiscal rule than in the baseline. This is also reflected in the charts showing employment paths of the public and manufacturing sectors. Finally, in both scenarios the Petroleum Fund will stabilize at a high level, even if the level is slightly lower in the fiscal rule scenario than in the baseline.
A. Fiscal Budget non-oil deficit.
Percent of mainland GDP
Citation: IMF Staff Country Reports 2002, 044; 10.5089/9781451829686.002.A004
A. Fiscal Budget non-oil deficit.
Percent of mainland GDP
Citation: IMF Staff Country Reports 2002, 044; 10.5089/9781451829686.002.A004
A. Fiscal Budget non-oil deficit.
Percent of mainland GDP
Citation: IMF Staff Country Reports 2002, 044; 10.5089/9781451829686.002.A004
B. The Government Petroleum Fund
Percent of mainland GDP
Citation: IMF Staff Country Reports 2002, 044; 10.5089/9781451829686.002.A004
B. The Government Petroleum Fund
Percent of mainland GDP
Citation: IMF Staff Country Reports 2002, 044; 10.5089/9781451829686.002.A004
B. The Government Petroleum Fund
Percent of mainland GDP
Citation: IMF Staff Country Reports 2002, 044; 10.5089/9781451829686.002.A004
C. Public sector employment
Share of total man-hours worked
Citation: IMF Staff Country Reports 2002, 044; 10.5089/9781451829686.002.A004
C. Public sector employment
Share of total man-hours worked
Citation: IMF Staff Country Reports 2002, 044; 10.5089/9781451829686.002.A004
C. Public sector employment
Share of total man-hours worked
Citation: IMF Staff Country Reports 2002, 044; 10.5089/9781451829686.002.A004
D. Employment in manufacturing industry.
Share of total man-hours worked
Citation: IMF Staff Country Reports 2002, 044; 10.5089/9781451829686.002.A004
D. Employment in manufacturing industry.
Share of total man-hours worked
Citation: IMF Staff Country Reports 2002, 044; 10.5089/9781451829686.002.A004
D. Employment in manufacturing industry.
Share of total man-hours worked
Citation: IMF Staff Country Reports 2002, 044; 10.5089/9781451829686.002.A004
The authorities concur with the staff that the Norwegian economy is facing considerable challenges to public finances as a result of an ageing population and increasing pension expenditures. However, due to the petroleum revenues, Norway is in a better position to deal with these challenges than most other countries. This requires that a significant part of petroleum revenues is set aside to cover pension obligations. But still, a pension reform is needed in order to achieve a better balance between contributions and benefits. Moreover, efforts to make public services more efficient should be undertaken in order to dampen the upward pressure on expenditures other than pensions.
Until the new guidelines were introduced, fiscal policy should be neutral over the business cycle, regardless of the size of petroleum revenues. Given the strong increase in financial wealth in the Petroleum Fund, it was clear that this framework was not credible. There was a need to clarify how and when the petroleum revenues accumulated in the Petroleum Fund should be used. In the view of the authorities, the staff report does not adequately recognize the importance of making the policy framework credible in a situation with high oil revenues and a rapid build-up of financial wealth in the Petroleum Fund.
There is a strong tradition in Norway in emphasising long-term issues when formulating fiscal policy. The long-term horizon of the announced spending plan is in accordance with previous IMF recommendations. The Norwegian authorities are of the view that the fiscal guidelines make a crucial contribution to a sustainable macroeconomic development. A policy based on using the expected real return on the Government Petroleum Fund ensures that the value of the Fund is preserved in real terms. The chart in Box 2 on Page 23 in the staff report, and in particular the sentence “GPF (Government Petroleum Fund) assets would be used up much faster under the new fiscal guidelines,” are therefore somewhat misleading.
Monetary policy
The changes in the monetary and fiscal policy regimes were co-ordinated. Monetary policy shall now be oriented directly towards low and stable inflation. The Norwegian authorities note the staff’s view that an inflation target of 2.5 percent is appropriate given the economic adjustment implied by an increased domestic use of petroleum revenues.
In the description of the new framework the staff refers to a 1 percentage point tolerance limit on either side of the inflation target. The Norwegian authorities would like to emphasize that such a tolerance limit is not included in the regulation. The inflation target is a point target and not a target band. We would like to note that the Ministry of Finance stated in Report no. 29 to the Parliament, 2000-2001 Guidelines for Economic Policy that consumer price inflation in general is expected to remain within an interval of +/- 1 percentage point around the inflation target. Norges Bank has stated that it will place special emphasis on analyzing the causes when underlying inflation deviates from the target by more than +/-1 percentage point.
The staff points out that the central bank should abstain from frequent changes to its definition of the underlying price index so as to avoid any perception that attempts were being made to justify deviation of inflation from its target level. However, the decision to omit temporary influences from the price index is set out in the official monetary policy guidelines issued by the Government. As a response, Statistics Norway started to publish an official separate index for inflation adjusted for tax changes and excluding energy products. Moreover, with a two-years ahead inflation targeting approach the discussion between headline inflation and underlying inflation is irrelevant.
Structural issues
In Norway, the employment rate is among the highest in the OECD area. This reflects both high labour force participation and low unemployment. The picture becomes more mixed when average working hours are taken into account, which are lower in Norway than in many other countries. However, this is partly due to a very high labour force participation rate for women working part-time. Moreover, sickness absence is high in Norway. The authorities endorse the staff’s view that structural reforms in the labour market should be continued with a view to maintaining as large a workforce as possible.
