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- [00:01]
A
All right, welcome everyone. I'm happy to see so many faces, some new, some old. I am very proud to have Governor Olson here today. I understand it's his first time at lse, so we should ask him lots of really tricky questions today. I'm sure you will do that. And I would like to say a few words about the Systemic Risk center, which is a shiny new ESRC center. Our purpose is to understand systemic risk and hopefully find some ideas to trickle down to the policy making body at the same time. Today's talk is in the intersection of systemic risk and the macroeconomy. So I'm very proud to have another as the chair today. We have Sir Charles Bean from the center for Macroeconomics. So we cover both sides of today's speech and I'm very proud of the panel. We have over above the Governor Olson, we have in Charlie Bean, we have an academic and we have a policy person because Charlie was chief economist of the bank of England and then Deputy Governor. We have Sushil Bhadwani at the end who also has many hats. He has the academic hat having been lecturing economics here at lse. He has a policy hat, having been on the, on the MPC committee at the bank of England. Sushil has a banker's hat, so he knows how banks work, has been at Goldman Sachs and he has the notorious shadow banking hats having been in a bunch of hedge funds. So I think we should cover all aspects of the problem today and only at LSE I think, can you achieve such greatness. And now I'll let Charlie as the chair, please.
- [01:43]
B
Thank you very much. First of all, I should mention that this address is being recorded and will be available on the LSE's website and as a podcast. So you may want to be aware of that. Particularly for the Q and A. The topic of today's address is a particularly important, important one. Obviously ahead of the financial crisis, monetary policy was focused on steering the macroeconomy, stabilizing inflation. Prudential policy was supposed to keep the bank stable, but there was a missing bit in the middle, the systemic risk aspect. And as a result of the financial crisis, there's been major changes in the thinking of the monetary policy framework and also the institutional arrangements that support them. Now the Norgus bank actually has a long history of thinking about these issues even before the crisis. So it's particularly apposite to have the Governor of the Norgate bank here today. Eystein Olsson has been in that position since the beginning of 2011, prior to that, in the early part his career was spent at Statistics Norway primarily. And then from 1999 to 2005 he was Deputy Secretary in the Economics department of the Norwegian Ministry of Finance, where I discovered he was actually a backbencher at an international meeting in Paris that I used to go to. We never actually formally met there, but we had actually been in the same room on a number of occasions from 2000. From 2005 to 2011 he was the Managing Director of Statistics Norway and then of course moved to be governor of the Nordisk Bank. As I said at the beginning of 2011, he's also held a chair at the Norwegian School of Management. And with that I will turn the floor over to you. Oyster.
- [04:13]
C
Thank you, Charles. Professor Bean and I would also like to thank in advance Dr. Madhwani and also Jean Pierre Segrand on behalf responsible for this institute or this center, this systemic Risk Center. And also, let me just supplement and confirm what is being said that this is my first visit. I should have been in long before, perhaps through my research career. But it's great to be here now for the first time in the London School of Economics area, to put it that way. It's also true that as John mentioned, that we actually met in this very interesting meeting in the OCD WP3 compiling the G10 countries. The reason actually why we perhaps did not meet in that sense is that there's a difference between a chair of a meeting and being a backbencher in the Swedish delegation. So just to say that. But it's great to be here and talk on this subject. It's great to be here in this center which brings forward research and applied knowledge in a subject that has now become a key issue in central banking. Because since the recent financial crisis in 2008-9, central banks and academia have put systemic risk and interlinkages between monetary and financial stability high on the agenda. The crisis showed that keeping inflation low and stable was not sufficient to prevent imbalances in financial system. It also showed that the financial system is prone to extreme excessive risk taking. And we were reminded of how costly a financial crisis can be. Another lesson, perhaps more specific to central banks, is that there are gains from closer integration of analysing the interlinkages between financial stability and monetary policy. So clear macro potential dimension has now been incorporated into banking regulation. Examples of this new orientation are the introduction of a systemic risk buffer and a time varying countercyclical buffer for banks. The new macroprudential toolkit is being accompanied by higher permanent Capital requirements and new regulations on banks capital structure. The aim is to make the financial sector more resilient to shocks and to prevent and mitigate the build up of systemic risk. As the new regulatory regime has been introduced, another dimension has been added to the discussion. The question being asked is the do reformed banking regulation and new macro prudential instruments relieve monetary policy of any responsibility for financial stability? A good starting point for the discussion is Tinbergen's basic principle which states that a wider set of policy instruments makes it possible to achieve a wider set of objectives. Furthermore, each instrument should be assigned to the objective it can achieve most efficiently. The comparative advantage of monetary policy is the control inflation and smooth fluctuations in output and employment. The first line of defence against shocks in the financial system is, on the other hand, regulation and monitoring of financial institutions. Macro prudential policy is part of this defence. It should also bear in mind that experience of the new regulatory regime and the macroprudential toolkit is still limited. It is too early to assess the effectiveness of new instruments. On the other hand, we do know that interest rates affect house prices and debt. This suggests that monetary policy should take into account the risk of financial stability. We have some slides here which I need to continue so and to operate them. I click. I click.
- [09:28]
D
I click.
- [09:30]
C
Thank you very much, Mr. Professor Bean. Norges bank has in periods which I will return to different several times we have kept the interest rate somewhat higher than implied by medium term inflation and output gap considerations. In other words, we have been leaning against the wind. Just a few words on the Norwegian economy. Norway is, as I guess all of you know, a large exporter of petroleum. And our economy has benefited now for at least 40 years, but especially the last 15 years. We have benefited from high oil prices well, until relatively recently. Unemployment has been low and consumer price inflation has been close to 2.5%, which is the inflation target. But at the same time, house prices have been rising sharply and household debt is at a historically high level. Hence, our monetary policy trade offs have in recent years at least differed quite a lot from those of our neighboring countries and trading partners. Before I return to the interlinkages between financial stability and monetary policy, let me describe some concrete elements of our system or regime of macroprudential policy in our country. Banking regulation has recently been reformed in Norway in accordance of course with the Basel 3 Regulations and Directives issued by the European Union. Capital requirements have been increased and the countercyclical capital buffer has been introduced. And the central bank Norgisbank is responsible for conducting analysis and providing advice on the level on this countercyclical buffer level, the Ministry of Finance is left with a finer decision on this buffer. The current decisions requires Norwegian banks to hold a countercyclical capital buffer as from July this year. The banks have also increased their capital levels over the past few years. As a result, the financial system in Norway is now more resilient shocks. Then an accountable and credible macro prudential policy must be based on an understanding of how systemic risk arises. The academic research on macroprudential policy issues is growing, but let us admit, or at least that's my view, we are still at an early stage. Some conclusions however seem to be robust. Many studies single out rapid credit growth as a symptom of rising systemic risk. This is also in line with the recommendations from the Basel Committee and the EU which state that decisions on the countercyclical buffer in particular should be based on the credit cap. In preparing its advice on this countercyclical buffer, Norgis bank adds three other variables as key indicators. These are as shown in the chart house prices, commercial property prices and banks wholesale funding ratio. Together the four indicators contain considerable amount of information about how cyclical systemic risk evolves or may occur. A number of studies have indicated that credit growth, real estate prices and banks funding ratio show a systemic systematic pattern ahead of financial crisis at Norgis Bank. We have examined data from 16 OECD countries to see whether such a systemic systematic pattern exists. We have developed empirical models for estimating the probability of a crisis. The model based predictions can be interpreted as the probability that the economy is in a pre crisis period. This chart shows estimated crisis probabilities for the us, Spain, Norway and the uk. The band reflects various combinations of explanatory variables and trend estimation methods. The data set covers the period from 1970 to 2013 with a total of 27 events which can be defined as a crisis and as you can see from the chart, the estimated probability of a crisis increased marketing in the years ahead of the financial or the most recent financial crisis in 2008-2009. The UK is however the exception in this picture. Crisis probabilities also increased in the US ahead of the US savings and loan crisis, in the UK ahead of the UK's small bank crisis and in Norway ahead of our banking crisis, our special banking crisis which occurred in the late 1980s and into the early 1990s. All these episodes featured rapid growth in credit and rising real estate prices, so these empirical results support our choice of key indicators of financial imbalances. Household and corporate credit, house prices and banks wholesale funding ratio are statistically significant in a model and clearly influence the estimated probability of a crisis. The results also indicate that a low equity ratio in the banking sector can be an early warning of future instability. Now, while models are useful always and while indicators and empirical models can provide support in the assessment of financial imbalances, they can of course only go so far. Their ability to produce a precise estimate of a systemic risk is limited. In addition, the assessment of systemic risk must include an analysis of the consequences of a crisis assessment. Systemic risks are therefore always and they have to be based on judgment. The primary aim of the countercyclical buffer is to make banks more robust. The buffer may to some extent also dampen the build up of financial imbalances. However, it's its impacts on markets would depend on how banks increase capital ratios. Roughly speaking, banks have two options at their disposal. One, they can increase equity capital or two, they can reduce risk weighted assets. Over the past years, in order to meet the new requirements, the six largest Norwegian banks taken together have almost doubled their capital ratio measured by Common Equity Tier 1 capital. This is primarily the result of a significant increase in capital. Retained earnings contributed the most and banks actually widened their lending spreads in 2013. Especially, equity issues have been of minor importance. The second option I mentioned involves improving capital ratios by reducing risk weighted assets rather than slowing lending. Norwegian banks in practice have reduced their risk weighted assets through lower risk weights and changes in the composition of their lending portfolios. Lending has increased more in the residential mortgage market, which features lower risk weights than corporates. Norwegian banks practice. Their actual adjustment strategies have reminded us that macroprudential policy can affect economic activity through various channels and thus price stability. Market prudential policy could also have an impact on the transmission mechanism of monetary policy. For instance, if new regulations reduce households ability to borrow against home equity, the credit channel of monetary policy is likely to become weaker. Monetary policy, for its part, can be one of several factors contributing to a buildup of financial imbalances. We have learned again that long periods of low interest rates can increase the risk that debt and asset prices will reach unsustainable levels. And as we have witnessed, low interest rates tend to prompt agents to intensify the search for yields from high risk assets. Hence, even though the objectives and the instruments are different, monetary policy on the one hand, and macroprudential policy on the other hand, cannot be viewed as completely separate. Indeed, these two policies, monetary policy and macro potential policy instruments, can work in the same direction if the economy is booming with rising inflation prospects and the risk of a buildup of financial imbalances. A simultaneous tightening of monetary policy and a macro prudential tool, for instance, the countercyclical buffer can underpin the objectives of both policies. Likewise, a pronounced economic downturn with increased bank losses can be addressed by lowering both the policy rate and the capital buffer. But in other situations, it may be a problem to reduce the key policy rate while at the same time, at least principally, raising the level of the capital buffer. If, for instance, there are prospects that inflation will become too low at the same time as debt and house prices are rising rapidly, the key policy rate will be reduced in line with its primary task of maintaining a nominal anchor for the economy. Unwarranted negative effects on financial stability of lower interest rates could in this case be counteracted by raising the level of the countercyclical buffer. Macroprudential policy and stricter banking regulation helps to reduce systemic risk. But we cannot act on the assumption that tighter regulation alone will be sufficient to prevent future crisis. Monetary policy, on the other hand, has well documented effects on house prices and debt. And again, as mentioned, mitigating the risk of a build up of financial imbalances, at least in the case of Norway, is giving weight in our monetary policy decisions. By taking financial stability considerations into account, we seek better, more stable outcomes for inflation and output in the longer run. And we think that a simple, analytical, at least relatively simple here, can serve to illustrate this point. Let me use a few words to explain the stylized framework. Because it is stylized, consider a central bank with a flexibility inflation targeting regime. This means that the central banks gives way to inflation as well as to fluctuations in output. The expected future paths for inflation and output are included in a loss function. Let us in addition include a variable that captures the transmission of financial market instability to the wider economy. In the stylized model, the variable called set enters the aggregate demand function. To simplify the picture or the events, we assume that there are only two states with respect to financial stability. Either we have normal times with well functioning financial markets or we have a situation of financial market stress and this is represented by this alpha parameter. If instability in financial market emerges, that is the case with alpha equals one, the impact on the real economy will depend on the level of the financial imbalances. Within this framework, the risk of financial instability is endogenous and monetary policy can influence the risk. This risk, a higher risk of instability can depress expected growth and inflation. When the central bank assesses the future path of inflation and output. It therefore has an incentive to dampen the buildup of financial imbalances. So in this way, the central bank can contribute to a smoother, a better expected path for inflation, output and employment over time. Let us then assume an economic state, an economic economic situation in a country, for instance Norway, not unlike the one we have experienced in recent years, namely the situation where interest rates abroad decline. They decline further and there are prospects that they will remain low for a long period. This results in a widening of the differential between interest rates at home and abroad, leading to an exchange rate appreciation. This in turn could lead to lower inflation and economic activity in Norway. And obviously the response of the central bank is to lower the policy rate. There is then, as a point of reference for this model exercise, assume and Here I deviate from the formal framework I just showed. Let's assume as a point of reference that neither the central bank nor the agents recognize that financial stress could arise. The blue lines in the panel show the path for the policy rate, the output gap, inflation and the financial imbalances. In this case, capacity utilization increases and inflation returns to target. However, the low interest rate level leads to an increase in the financial imbalances. And then let us go back to the framework shown to the extended model, where the central bank recognizes that financial stress could arise and takes into account the possible impacts of financial imbalances on inflation and output. This scenario is represented in the chart by the red lines. The policy rate is still reduced, but to a lesser extent. In this scenario, it takes longer for inflation to move up to top. The policy stance also results in a somewhat weaker increase in activity. At the same time, the slightly higher policy rate contributes to mitigate the build up of financial imbalances. So far in the presentation, as shown by the headlines of the chart, we have assumed that financial stress actually has not occurred. Hence, we have so far not reaped the benefits of the leaning against the win strategy. Now let us see what occurs if financial stress does arise at some point further out. The red lines in the panel again shows a scenario where the central bank does take into account the possible effects of monetary policy on financial stress. When financial turbulence occurs, the economic setback is less pronounced and less prolonged than if the central bank had not taken this risk into account in monetary policy policy, as illustrated again by the reference blue scenarios. The blue lines, the benefit gained from keeping the interest rate somewhat higher in the short term is in this case a more stable path for inflation and output over time. As mentioned a couple of times, this formal framework is highly stylized in the actual implementation of monetary policy, we are faced with a number of uncertainties and difficulties. First, developments in debt and house prices depend on a number of factors in addition to the interest rate. Second, both costs and benefits from leaning against the wind are highly uncertain. What we do know, however, is that the economic consequences of a financial crisis are so serious that some kind of insurance premium is worth paying. Let me now, at the end of my speech, return to the realities in the Norwegian economy and the trade offs that we actually have conducted and met in recent interest rate setting in Norway. As I said earlier, the key policy rate in Norway has in recent years been kept slightly higher than implied by medium term outlook for inflation and outlook in order to mitigate the risk of a buildup of financial imbalances. However, through last fall, oil prices, as we all know, fell sharply and the overall growth outlook for the Norwegian economy weakened markedly. On this background, Norgisbank cut the key policy rate with 25 basis points to 1.25. In December 2014, weight was given to countering the risk of a pronounced downturn in the Norwegian economy. Again as a response of this, the fact that oil prices have been cut to half. Financial stability considerations were not taken off the table, but a new and quite serious risk had entered the scene. Now, throughout the next months, throughout this year's winter months, developments in the Norwegian economy were broadly in line with our expectations. The effects of the fall in oil prices on the real economy have been, and I'm referring to our March decisions now on the interest rate had been relatively small. Inflation remained close to target, close to 2.5% and unemployment also remained low and stable. At the same time, house prices continued to rise rapidly. Therefore, balancing of the different kinds of risks, the risks of a pronounced downturn in the economy versus the risk of a build up of financial imbalances again shifted slightly from December. An overall assessment led Norgisbank to keep the key policy rate unchanged at this occasion at 1.25%. At, as I said, the policy meeting in March this year. However, we also communicated an intention to lower the key policy rate if developments in the economy ahead proved to be broadly as we projected in March. And I could add at the same time, Norgaspank advised the Ministry of Finance to keep the countercyclical buffer unchanged at 1%. But the bank added that if house prices continued to rise rapidly and credit growth increased, it would be a appropriate to advise the Ministry to raise the level of the countercyclical buffer effectively. From the summer 2016, Mr. Chair. In my introduction I posed a question. Do reformed banking regulation and the new macro prudential instruments relieve monetary policy of any responsibilities for financial stability? So let me conclude on this. While increased capital requirements and macro prudential policy can strengthen banks solidity and mitigate the buildup of imbalances, we cannot proceed under the assumption that new regulations alone will eliminate the risk of of financial instability. A robust monetary policy, in our view, should therefore take into account the risk of a build up of financial imbalances. Monetary policy could then contribute to more stable economic developments over time. At the same time, monetary policy can and should not be overburdened. Banking regulation and supervision must be the first line of defence against shocks to the financial system. When assessing the monetary policy trade offs central banks must pursue in the longer run the primary objectives of monetary policy which remains low and stable inflation. So thank you for your intention.
- [36:55]
B
Okay. As called you a discussant commentator. It's probably a better Description. We have Dr. Sushil Wadhwani. Sushil was a student here, undergraduate and graduate, and a member of the economics department until the late 80s or early 90s.
- [37:15]
E
91.
- [37:15]
C
91, okay.
- [37:18]
B
When he left to go off to the city to Goldmans and then Tudor and from there was an early member of the bank of England's monetary policy committee between 1999 and 2002 and after he completed his term there founded an asset management company, Wodwani Asset Management. I should also add that Sushil is the co author of an early paper on the question of whether monetary policy should take account of financial stability concerns. And as the jargon goes, lean against the wind with Hans Genberg and Steve Cecchetti. So he's particularly well placed to discuss this particular issue.
- [38:13]
E
So Sushil, thank you very much and thank you Mr. Governor. May I sit?
- [38:19]
C
Yes, yes, yes.
- [38:23]
E
I really enjoyed your talk and learned.
- [38:26]
C
A lot from it.
- [38:28]
E
I should say that of course I'm somewhat biased, as Charlie was alluding to earlier. This is quite a controversial area and certainly about 15 years ago a lot of US central bankers were opposed to leaning against the wind. Famously Chairman Greenspan and then Chairman Bernanke. So whenever a central bank says that he thinks it's a good idea to lean against the wind, it certainly gladdens my heart.
- [39:02]
F
So.
- [39:05]
E
You certainly get a huge endorsement from me. Now of course this is a difficult area and Charlie also wrote a very interesting and important early paper in this area. So we've all been trying to, I would say, wrestle with a number of difficult issues. Around this important topic. So in the spirit of that, I'm going to ask you, Mr. Governor, a few questions, if I may. So my first question really related to some very interesting charts that you showed us and essentially what those charts showed us. And I should say at the outset that I know next to nothing about the Norwegian economy and I'm embarrassed that I might make a mistake. So think of me as a man from Mars, sort of looking down on earth and asking some questions that seem intuitively attractive but which may be wrong. But looking at the numbers you put up, you showed that the credit to GDP ratio was at an all time high. You showed that real commercial property prices were pretty elevated and both house prices, the house price disposable income ratio and the wholesale funding ratio were also pretty high. And these were the four. These were four of your five favorite indicators which were signaling concern from a financial stability perspective. So given that, I would have expected your settings either for your macro proof tools or interest rates to be acting quite forcefully. But then I look at your interest rate, it's only 1.25%. Now I know I say only because compared to the ECB it's pretty high, but it's 1.25% with an inflation rate of two and a half. So you've got a negative real rate of minus 1.25%. Notwithstanding these significant concerns about financial stability, you also say in your speech that interest rates are only slightly higher. They're only slightly higher relative to some benchmark related to your medium term inflation and output forecast. So I would certainly want to know, want to get some sense of what slightly means in this context and also whether slightly is in fact appropriate. If you have significant financial stability concerns, should you be putting so much weight on the macro proo tools? So that's my first question and I guess my surprise deepened when you talked about the conjuncture because yes, you've had the, you know, very significant oil shock, which should have a big impact on your economy. But you pointed out yourself that so far the impact had been modest. One can't help but notice that headline inflation in Norway is high by the standards of other industrial countries at the moment, notwithstanding the oil shock. So that just sort of made me wonder again about your monetary policy stats. But if I now turn to macro proo, there is of course this reliance on these countercyclical buffers which made me a little nervous because we know that they didn't really work in Spain. And again, I don't know enough about your country, but relying on your own speech, you do point out that lending hasn't really slowed and indeed has increased in terms of the residential mortgage market, which again certainly caused worry to me. And in your speech you also refer to another possible tool to do with the equity ratio of banks. But in the study that you refer to, the Norgis bank study, that particular indicator didn't play a significant role in the 1980s crisis.
- [44:01]
C
Which indicator was that?
- [44:02]
E
The equity ratio. So essentially I was wondering whether you were looking for more macro pro instruments, because it seemed to me that the two that you've chosen, you know, it's at least possible that they might not be working. So I'd be quite intrigued to hear, you know, what other research you're doing in terms of other tools that you might deploy. Going back to monetary policy. I was also interested in your line about the exchange rate and of course I recognize the dilemma. If you tighten in response to financial stability concerns, you can certainly damage your export sensitive industries in terms of the pressure that it puts on the exchange rate.
- [45:04]
C
However.
- [45:07]
E
Your exchange rate over the, you know, average over the last 12 months is considerably weaker than it's been for some time. You're coming from incredibly elevated levels, levels relative to PPP to getting much closer to ppp, so far as I could tell. And it made me wonder whether this was actually a good opportunity to essentially lean against the wind more forcefully with monetary policy, given the clearly emerging risks in the financial stability arena.
- [45:50]
C
I also.
- [45:53]
E
You can see I'm not giving many views, I'm just asking lots of questions. But that's because you have significant experience in this area. So another question that I had is that I'm sure you've observed the use of leaning against the wind type policies in your neighboring country, Sweden, with great interest. Now, of course, this in the blogosphere has become very controversial. I guess it started with Lars Wenssen and then Per Janssen and Stefan Inglis have responded quite cogently, I would say. But I'd love to have your backbencher perspective, if I may, on how you see the efficacy, how you assess the efficacy of lean against the wind in Sweden. And my final question, and I'll stop there, is essentially relating to the argument that one big advantage that monetary policy has versus Macro proo instruments is that it gets into all the cracks and it stops nasty people like me sort of trying to innovate in the shadow banking sector. So I just wondered as to what lessons you've learned in managing the Norwegian economy in. In that regard. Thank you.
- [47:34]
B
I shall turn the Floor back to you at this point to call you to qa.
- [47:41]
C
Yeah, I can remain busy city. Yeah. Oh, yes, we have a dialogue. Yes, that's good. Well, thank you, Dr. Vadvani, for this very core. These are core questions which we have caused. I think you do know a lot about regional economy. That's my implicit impression. And some of your questions are related. Let me start by sort of an obvious response from a central bank when they are challenged on their way of waiting different weight forces and dilemmas referring to a special period of decisions. Then the general question is of course that we have an optimal decisions are always optimal. And it's definitely true in the sense that it's obvious that we see the best possible balance between different considerations. And so I'm not going to go back and return or go back on the views we have had, especially in recent years. But you're very correct that we are faced with some dilemmas in the Norwegian economy, which is a small open economy, slightly up north, well equipped by natural resources. And we have faced some developments in our economy which have been quite divergent compared to our neighboring countries for quite some time now. Even. Well, the last, the last 15 years, as I mentioned, even throughout the financial crisis, I mean, we had a slight small dip and then we pursued a very expansionary. This was a good, very market response in policy, in monetary policy, they reacted forcefully in the central bank. This was well below 4 before my time, so it's a credit of others. But then also fiscal policy was changed and it was quite expansionary and we spent money we had while many other countries. Well, I think many other countries also did the right thing at the time that they spent money they didn't have. So again, we came well, throughout the crisis, there was a small dip in. For a small cause in the, in the development in house prices. But just right after crisis, house prices started to take off again. And while European economies went into a sort of second phase of the financial crisis, with European economies among the core countries increased focus on debt levels, the response was further lowering of rates and 0 showed not the lower bound in a strict sense at least monetary policy was stretched beyond that, as we all know. So if you compare that with the developments we've had, you see the difference. And the dilemmas then are obvious for a small open economy and also for a central bank which at the end cannot achieve any goal. I mean, we have basically, we say, and we mean that we basically in monetary policy has a one instrument. It could be supplemented by communication, but it comes back with one instrument. And so our primary goal has to be, as I said at the end, we cannot neglect nominal developments. So the primary aim has to be at the end to secure low and stable inflation, again as when that is achieved. And I think it's also correct that central banks in general over the years has, have learned some lessons and monetary policy has become more flexible in many countries. So we have allowed inflation to come to come down and we still regard it as low and stable. And given that we have been also able to balance other things, we have a clear look on the outlook for the output in the medium term especially. And then the overall development both for prices and output for a small open economy is very much affected by the currency channel. So, so, so. And there then we are very close to the primary task of monetary policy. So the current currency development remain very important. So we have to put a lot of weight to that. And that poses a dilemma when at the same time house prices just go up and up and up and debt levels by households especially follow. And again, I mean, I guess Robert Schiller or I guess other, many prominent economists around the world, when they come to our country and look at these figures, the debt figures and our housing prices, the developments and debt ratios, debt levels as raised compared to as share of our economy or as share relative to disposable incomes by household. They are very clear in their advice. They call it a bubble. I don't use that word, actually, we don't use that word. I think it's very. Even though our debt level or debt by houses as shareholder is close to 200% of disposable incomes by households. And I don't think you find many countries which you could compare with that. It could be Denmark, right? I think it's Denmark. But they have had a reaction, a strong reaction in the last years. But what I'm trying, what I'm heading at is that we have, we have to give way to. We have, we have a primary goal, low unstable inflation. We have a flexible inflation target regime which is very good. Then we have two asset prices, two asset markets. You have the housing market, housing prices. And we have. And we have another very important asset price for a small open economy which should not, it should not be more oil. This has been the views, they say until recently when oil prices were high. Even then we were very much aware we could not rely only on oil because oil will not last forever. We cannot rely on prices to remain at $100 per barrel. So there are both common sense and good Economic analysis tell us that our economy perhaps or should not be more oil dependent than it was or it has been so. Therefore, the competitive situation for the rest remaining part of our manufacturing industries or competitive industries in general remain an important issue, important for employment also. And obviously, as we all know, fluctuations in the currency, especially in our case goes directly into the inflation prospects. So we have these dilemmas which are, which have been extremely important and difficult to handle. But I would say that I'm referring now to a longer period than my own in the central bank that it has, it has gone well, I mean, and if you can compare the fluctuations, the fluctuation in the real. In the currency in the real. In real terms, we have had, we have had a real appreciation of our currency. Yes, we have also had experienced fluctuations in the nominal exchange rate. But if you compare those movements and especially the fruit situations with those of other raw material countries, Canada, Australia, and there are more we have, it's been relatively stable. We could come back to some possible reasons for that. It's not only because some monetary policy decisions. It has also to do with fiscal policy or fiscal policy framework, I think. But all in all, I think policy policies have proved relatively good results. So I think the judgments and the weighting of different forces have been sensible and balanced in a good way. And of course, if we had been not an island, but say much more close, a closed economy to a larger extent, I mean, with all the strong growth and the sort of close to booming house market we have experienced for many years, I mean, interest rates should not be 1% or shouldn't be 100% should be much higher, much higher. So for all domestic reasons, interest rates should be higher. Agree. But we are Norway's a small open economy with these important, this important channel. And the only reason why interest rates are low and I've been low for quite some time in Norway is the fact that interest rates abroad have been brought to zero or lower. So that's the fact. We have to take that as a fact. And Also you referred Dr. Valdhwana to the. The recent developments after oil prices dropped. I follow you in your reasoning because what happened is that until the summer last year we have experienced, as I said, steady, relatively steady, real appreciation. The correlation between oil prices and the currency until that time was not very close. The exchange rate is affected by so many forces and it's volatile. But from the summer last year until now, you will see a very close correlation between the curve for the declining oil price and the corresponding development in the currency. So and we have been very aware of that in monetary policy deliberations throughout last fall and also in March this year. And I said several times that.
- [59:59]
E
It'S.
- [59:59]
C
A good thing that we have. At least I'm not discussing membership in any currency unit, but it's a good thing thing in situations like this, especially for an economy like ours to have an old currency. It's a, it's a buffer. It reacts it. If oil prices stay at 50 rather than $110, we need to improve our competitiveness. We have done that already. If things are going like we have, like I briefly described and, and then you could of course say that hasn't it. Has the chrome depreciated sort of sufficiently or perhaps too much? Could we sort of. Could we increase. Could we have interest rates slightly higher? Of course, we are sort of judging on that every time. But I mean, if we increase the currency, we will have immediate reactions. If we increase the rate or signalize that we will have immediate reactions in the currency and we really don't know when that stops. We are afraid also of counteracting the buffer effect I just described. And actually, if you go to our March decision, the critics, or at least some critics, there are always different types when you discuss monetary policy. But the main critics were surprised perhaps was that they think that we should have lowered the rate further because some think that the depreciation that we have experienced is not sufficient. So these are all difficult judgments to make. We all. We think, of course that we do think that we did the right thing, of course, but we are very aware of the dilemmas. I haven't answered all the questions now because some of them, some of those were related. Yes. Thank you very much.
- [62:16]
E
Thank you.
- [62:17]
C
Regarding the. You touched upon the macro proof policy framework. You had a question whether we should seek for more instruments. Now I could just start by saying that the role of the central bank in Norway on the macro proof feed is limited. The role is not limited as regards the role in supervising financial stability in the economy. That's it in the law. But as regards the power of sort of pushing the button and deciding on instruments is limited. We make advice to the. An important advice to the Ministry on this countercyclical buffer. But otherwise we have a separate FSA in Norway. It's not part of the responsibility of the central bank. So you have the whole chain of micro potential instruments which actually in these days are evaluated, given the situation I just described, or to be more precise, our FSA has suggested, they have suggested to extend the Toolkit somewhat and to tighten policy. I could not elaborate more on that because we have a date, 4th of May, and that's the where we should commence on this set of new possible measures that could be coming into this scene. Then you had a question on Sweden.
- [64:08]
E
Yeah, I know.
- [64:09]
C
I realized that. I tried to talk. I talk to avoid coming to that. No, I'm not doing that. But I. But frankly, I think. Well, I'm not commenting on other decisions, other banksy decisions. They have the same dilemmas as we all have, as we have. And obviously they seek the optimal balance. But let me answer by the following. If I go, and I have already underlined that the banks, central banks are seeking to do good things, right things for. And when inflation expectations are enacted, yes, we can see all the goals as well, intermediate goals. But at some point, when the nominal target is challenged, really challenged, we have no choice. And I think Sweden is close to that kind of situation now. And I understand very much their dilemma and their shift. Because inflation, although the economy grows at 2% loss, I think unemployment is slightly lower than it used to be. But inflation is approaching zero. And they are also afraid for deflation in a nominal sense. If we go back to. In our case, we reduced the rate by 25%, 25 basis point in December for the reasons I mentioned in my speech. Last time we lowered the rate was in March 2012. So between that we have 1001 days and nights with constant rates in March 2012. What was the situation in Norwegian economy then? It was booming. The housing market was booming. The growth was much higher than was now. It was high and steady. High, steadily high. But inflation was low due to the continuous appreciation in our currency. And that was actually. And it was below 1% or target 2.5. There was tendencies that it could be even lower if this appreciation of the currency continued. And that was, in short, that was the reason why we actually lowered the rate at the time. Of course, there were critics from the camp that warned against financial instabilities. Again, that was the dilemma we faced at that time.
- [67:05]
B
Thank you very much. I think it would be a good time to open it up to questions from the floor. Can you wait until you get a microphone and can you give your name and affiliation and we'll start there, please.
- [67:23]
D
Amit Kara, also an ex student from lse. So unlike Sushil, I genuinely do not know very much about the Norwegian economy. So pardon my question if it's stupid. You have expressed a lot of concern about higher house price and high household debt to Income ratios in Norway. Now we know from the UK example in the 90s when inflation came down, it was clear that the equilibrium nominal interest rate also came down with it. And partly because of that, the equilibrium household debt to income ratio went up, became easier for people to borrow. Do you think there's a case for raising the inflation rate, the inflation target, say from 2.5% to something higher so that over the long period of time you can potentially have a lower debt to income ratio.
- [68:29]
C
To increase the inflation target?
- [68:31]
D
Yeah. So say you raise the inflation target to 5% or something. So the real equilibrium interest rate will probably not change. The nominal equilibrium interest rate will be higher. It'll make it more difficult for people to borrow. So household debt could come down and.
- [68:54]
C
The effect is that the central bank will contribute to inflate the economy.
- [69:00]
D
Yes, in the short run you'll probably have to hold interest rates a little bit lower, but in the long run you'll hold them higher and that will lower your debt debt levels.
- [69:09]
C
Well, well, more often than having proposals of increasing the inflation target, I have questions in the opposite direction proposing to bring it down because the, the euro and most many other countries have 2% and 2% is perhaps more common than 2.5% these days. In any case, my answer is we have no plans, we are familiar and we are content and we are managing our inflation targeting regime with our target. And we have seen, there is, we see no reason to propose any other. So that's the short answer.
- [69:51]
B
Lord Myers.
- [69:56]
F
Paul Miners, Chairman of the Council of the London School of Economics and a minister in the last government in the Treasury. Governor, thank you very much for a very interesting presentation. Two questions. You talked about the primary objective of delivering stuff, stable inflation. Does this not mean that secondary or tertiary objectives such as financial stability cannot rely on monetary policy as a contributing force to achieving financial stability? Because under pressure you'll stand back from that secondary responsibility and focus exclusively on your primary responsibility. And secondly, linked to this, Mr. Governor, you make the point that you give advice to your former colleagues at the Ministry of Finance on those levers that the central bank can't pull. What happens if your colleagues at the Ministry of Finance reject your advice on capital ratio? Do you then take a more extreme monetary policy position.
- [71:14]
C
On your first question? If I understand it correctly, you are correct that we have a primary objective in monetary policy, but then we have another very important task as central bank, which is, which is stated in the central bank law in our case also, and that is to supervise and to secure financial Stability in general. And if we have any views, if we have views of any problems in the area, we are obliged either to do something ourselves or to advise the ministry to give advice on their responsibilities. So in that sense, we don't think distinguish between secondary and primary objectives. But when I mentioned the word primary, it's in. That's within our regime or monetary policy. If that was an answer to your question, your second question was very concrete. And the answer is not that difficult. We have, of course we have an opinion and again, we think that when we make an advice that's the optimal composition of instruments and we would like them to follow our advice. But then if they don't, so far they have actually followed our advice. We would just take that. That will not create any strong reaction in our system, at least that. That's my first, that's my response. We would take that as given. We would have an. It would. Yeah, we will just. We look at all decisions made by the Ministry in particular on their responsibilities and then we react on monetary policy based on that. But of course, I think I said in my speech that they interact. There could be situations in the economy where we think that there's a clear linkage, practical linkage between the level of the buffer and the interest rates. So any deviation from our optimal advice principally could have some implication for monetary policy principally.
- [74:04]
B
Any more over there, please?
- [74:09]
G
Nicholas Beale from Saiteb. Mr. Governor, thank you very much for the very interesting speech. And I was intrigued by your charts at the beginning about predictors of systemic crises and two observations from looking at them, first of all, it seemed that the higher estimates were more reliable than the lower estimates. And secondly, it seemed in some cases that the crisis hit after the risk appeared to have peaked and people seemed to be. The risk seemed to be coming down. Do you think that those are generic features of these kinds of warnings?
- [74:50]
C
I understand your question. I think on the latter part of the question, I think the answer is yes. I think it's part of the methodology and the definition of crisis variables that we have applied. So I think you are correct and you're observation on the first part, which was. The first part of your question was.
- [75:13]
G
You had boundaries which was showing the lower and higher estimates.
- [75:17]
C
Yes.
- [75:17]
G
And you notice those higher estimates were probably more reliable than lower estimates.
- [75:24]
C
I doubt, I doubt, but I don't think so. I don't think you can conclude on that. But I have to check that with the experts, which actually is here. But you know, the band. The band is. As I said, I think Is comes by. You have on the left hand of the estimation equation you have frequencies, events in terms of crisis measured as frequencies. And on the right hand you have a number of explanatory points, variables and you vary the letter and also you vary the estimation period and then you get the ban. So I don't think you can conclude as you did in the first part of a question on that. But I have to check actually the question my answers have. If you're interested, you could have more precise answers afterwards.
- [76:24]
G
I don't see the paper.
- [76:26]
C
Yeah, yeah, the paper will also be available not here, but at some point.
- [76:34]
B
One here.
- [76:38]
H
Hi, I'm James Pomeroy, I'm an economist at HSBC with a specialism in Scandinavia. So I do follow your economy rather closely. I have a question which is how does fiscal policy come into the mix? So you talk about monetary policy and macro prudential policy. In Norway, for example, during the recent downturn of the oil price, there is an opportunity for fiscal policies to step in here. You don't necessarily have the financial stability risks of cutting the policy rate or et cetera, but also maybe in regards to competitiveness, maybe fiscal investment can help with the economy rather than just tackling the exchange rate. So I'm intrigued by how you think that interplay works not just in Norway, but sort of across the world.
- [77:17]
C
Yes, obviously in any country fiscal policy is very important along different dimensions. It also could be used countercyclically and we have some traditions for that in Norway still. If you go back in history and if you go throughout the 1990s where fiscal policy actually had that as a primary task, that changed. There was a, a clear decision to change the division of labor in economic policy in 2001, when we got our inflation targeting regime then, and this division of labor more or less prevails now. Then it was stated that monetary policy should be the first line of defense when you have fluctuations in the activity level. While fiscal policy, especially in light of these enormous resources and these revenues that we should feed into the economy over the years and actually that's what we have done, should have a longer term perspective. And that makes sense. So fiscal policy should have a longer term anchor. But at the same time it was also stated in the guidelines that when disturbances occur, which they and 2008, nine is a very good example, fiscal policy should also respond. But there are more lags to have a good conduct of fiscal policy. So it still makes sense that monetary policy plays this role of being a first line of defense. And well, this Is sort of my view at least. But I've said it before as a governor, that so far after oil prices have declined, there is no. There is. We are not close to a crisis. We have no crisis in our economy. I mean, unemployment is 3 or 4%, different, different measures and the economy still growing. The prospects are also relatively positive. So I don't think, I'm not talking on behalf of any government. I don't know what they're going to present for the in the budget or next year, but I think they talk, the politicians, Minister of Finance talk similarly, as I do now, so far at least. And then as you all know, although fiscal policy is not the topic of today's meeting, you know the system that we introduced, the fiscal rule that we introduced should the intention was to shelter the actual fiscal policy from fluctuations in oil prices and we have achieved that. So therefore, even though oil prices have been cut to half, unlike say Russia, that does not at all affect fiscal policy in the short to medium term. And that's a very good thing. Of course, if it stays, if they stay at $50 compared to 110, that will affect our revenues in the longer run. But that's a different issue.
- [80:47]
B
One at the back and one over there. And that'll be the final question.
- [81:02]
I
Hi, Nick Skoropoulos, FX strategist at Barclays. I also follow the scandies quite closely and so I have a question on monetary policy. So it seems to me that with inflation close to 2 and a half percent and inflation expectations firmly anchored, the way I view the dilemma is really whether you are willing to tolerate big deviations of output from target on the one hand and then on the other hand contemplate the increasing financial instability such as higher house prices, etc. So oil prices have actually rebounded quite significantly over the last few months, are currently at $65 per barrel. And so I was wondering if you do not see oil prices dropping back to levels that we saw earlier in the year and with inflation not expected to drop further according to your estimates, actually you are penciling in inflation going higher and the way I understand this is probably a delayed pass through from, you know, a depreciating exchange rate, then is the main emphasis going to be on, on credit measures, the credit measures you mentioned? Because that's the dilemma in my view.
- [82:16]
C
Thank you. Let me. You're very close to Saudi, I hear, I can hear that you follow the Norwegian economy closely. You are close to the actual.
- [82:35]
E
Due.
- [82:35]
C
To the updates and to the, to the, to some consideration, some potential considerations that we're going, that we could should make next time. But for obvious reason, I'm not only a bit hesitant, I'm very hesitant. I'm not going to comment on, I'm not going to give you an update and use signals here because the obvious reason is that we have an interest rate meeting in a few days. Thank you.
- [83:06]
B
And the final question's over there.
- [83:11]
J
Thank you. Colin Birmingham from BNP Paribas. My question just relates to the oil prices. So from last year the oil price fell significantly. Now it has rebounded a bit as we heard from the last question. But given the size of oil exports and the nominal income earned from that, it was a significant terms of trade shock and as a consequence a significant income shock to the economy. So I would have expected to see, you know, an impact in the economy more quickly. In your view, why has it, you know, been quite a, quite a slow burner in that sense? Do you think people are kind of looking to the future and expecting a rebound or, you know, what's your own.
- [83:55]
C
View on that matter?
- [83:56]
J
Thanks.
- [83:59]
C
Excuse me, what's your question? You would expect a more serious situation to occur after the shock. The terms of trade shock.
- [84:08]
B
Quicker and bigger.
- [84:10]
C
Yeah. Okay. Well, yes, It's correct that the oil prices have been cut to half. But I think the answer is. Part of the answer is what I said on fiscal policy, you know, if you take the revenue side coming from oil based on our system, the government takes 80% of the profits. We have tax rate of effectively 77% I think now. So the government takes most of the profit. And we have this fiscal rule and this buffer system through the fund which actually shelters fiscal policy from the impacts. So that's one part of the answer. But then you're very. Then we have then the petroleum sector, if you take the active, not the activity as such, but say the investment is very high, you have big numbers. In Kroon Norwegian Kroner, we have. The investment has reached more than 200 billions Norwegian kroner. That's the level. And just as a comparison, the level of investments in the, in the traditional manufacturing sector In Norway is 25, 25, 30 billion versus 200 billion. And when these 200 billion, when they go down, we have been used to the positive impulses from the activity going up and up. Whether they go down, that has impacts to the rest of the economy. And they have, they will go down this year according to our estimate of 15% and another 10% next year. So over two, three years they will go down by 25, 30%. We do see the impacts. People are laid off, number of engineers are laid off already. House prices in the areas in Stavanger and in the areas where oil panels prices really boomed when things went up, are now going down. So we see the consequences. But you are correct. And we also observed in our case, we were afraid for a more severe downturn. When we met in December in the Monetary Committee, that was actually a main reason for the reduction in the rate, because it was kind of some kind of insurance that we took out. We would be afraid of a more severe downturn, as you also could foresee, but that hasn't occurred. So we have been in that sense positively surprised so far. And I think one of the reasons could be that if you take, if you start out in the labor market, these people are highly educated and. And still a crisis doesn't come that quickly. And there's no crisis in the Norwegian economy. There is no tightening in fiscal policy. It's the other way around. Fiscal policy remains expansionary, both in the central part of the government, also in municipalities. So these engineers, at least a number of them we know, have been employed in the public sector. So all in all, things are going relatively well. I couldn't be more precise than that.
- [88:01]
J
I think.
- [88:03]
B
That'S a very good note to finish on. I mean, clearly the issue, the interface between monetary stability and financial stability, I think is going to be occupying central banks and policymakers and academic researchers for some years to come. I know the bank of England here has a big research program to try and think through these issues. Other central banks are working on the same topics. And of course over time we will acquire more experience of macro prudential instruments. Of course, the real test is going to come in 10 or 15 years time and everybody's forgotten about the. The global financial crisis. There's another cohort of people in the financial markets who say this time is different. The politicians will all be screaming against any attempt to rein back credit growth because they'll say, oh, it's absolutely fine, it's all justified. And the role of central banks will be to remember history and to make sure we don't repeat the mistakes of the past. So would you all join me in thanking Governor Olson again for a very interesting report?