Further background for the modernisation of the regulation and the change in the regulation

Over time a difference between the wording of the regulation and the conduct of monetary policy has evolved. There has been broad consensus about how monetary policy has been conducted among economists, the social partners and within the Ministry Finance.

In spring 2016, the Ministry of Finance started the work on modernising the regulation. The Ministry has placed emphasis on ensuring a transparent process, involving relevant academic communities.

The objective of monetary policy is monetary stability. This was defined in the regulation from 2001 and remains unchanged in the new regulation.

Inflation targeting has been positive for the Norwegian economy
The experience with the inflation targeting as an operational regime for monetary policy has been positive. Low and stable inflation is the best contribution monetary policy can make to promoting a high level of welfare and economic growth over time.   

Through the years of inflation targeting, monetary policy has contributed to dampening fluctuations in the Norwegian economy, and the role of monetary policy in stabilising the economy has become increasingly clear. The regulation from 2001 read that monetary policy shall underpin fiscal policy by contributing to stable developments in output and employment. The prevailing understanding is that monetary policy is the first line of defence in stabilisation policy.

The modernised regulation builds on the lessons gained over the past 17 years and reflects the prevailing perception of the role and conduct of monetary policy.

The numerical target is 2
When inflation targeting was introduced, Norway was experiencing a period where substantial oil revenues were to be phased into the economy. This would entail a real appreciation of the krone, and the reasoning was that this could occur in the form of somewhat higher inflation than in other countries. This was a key reason for setting the inflation target at 2.5 percent. The period of phasing in oil revenues is now largely behind us. A key argument for maintaining a higher inflation target than other countries is therefore no longer relevant. Against this background, the inflation target for Norway is now set at 2 percent, in line with that prevailing in comparable countries.

The new regulation reads:

Inflation targeting shall be forward-looking and flexible so that it can contribute to high and stable output and employment  and to counteracting the build-up of financial imbalances.

The formulation contribute to high and stable output and employment is consistent with the purpose clause as recommended by the Central Bank Law Commission in its proposal on a new central bank act. This replaces the formulation contribute to stabilising developments in output and employment in the regulation from 2001. The word «high» is new compared to the previous regulation. Monetary policy cannot assume primary responsibility for high employment, but it can make a contribution in conjunction with a well-functioning wage formation process, appropriate framework conditions for the labour market and a fiscal policy that promotes growth and stability.

The consideration of counteracting the build-up of financial imbalances is a new element. Norges Bank has given weight to this consideration in its conduct of monetary policy, and there appears to be broad support for this practice among Norwegian economists. In periods of rapidly rising asset prices and debt, vulnerabilities in the economy increase, with growing risks of a future crisis and severe downturn. The regulation and oversight of financial markets are the primary means of ensuring financial stability, but monetary policy can also make a contribution to counteracting financial imbalances.  

A stable exchange rate and exchange rate expectations were key elements of the regulation from 2001, and helped build a bridge from the former fixed exchange rate regime. In a small open economy like Norway, the exchange rate is important for inflation, output and employment. It will always be given weight in the monetary policy assessment. Nevertheless, there are good arguments for toning down the krone exchange rate and exchange rate expectations as objectives in themselves. Experience shows that the krone can be a useful shock absorber when the economy is exposed to disturbances. The oil price decline in 2014 was followed by a sharp depreciation of the krone – which benefitted Norwegian industries exposed to international competition. The references to the krone exchange rate have been omitted from the new regulation, but it must still be understood that unnecessary fluctuations in the krone exchange rate may entail costs that Norges Bank will address in its conduct of monetary policy.

The Ministry of Finance has today informed the Storting (Norwegian parliament) of the new regulation in a white paper. Norges Bank has submitted its comments on the new regulation before it was laid down, in line with the provisions of the Act relating to Norges Bank and the Monetary System. Norges Bank’s submission is appended to the white paper.

 

Appendix:

The new Regulation on Monetary Policy is laid down by Royal Decree on 2 March 2018 pursuant to Section 2, third paragraph, of Act No. 28 of 24 May 1985 on Norges Bank and the Monetary System etc (Norges Bank Act). 

Section 1 Monetary policy shall maintain monetary stability by keeping inflation low and stable.

Section 2 Norges Bank is responsible for the implementation of monetary policy.

Section 3 The operational target of monetary policy shall be annual consumer price inflation of close to 2 percent over time. Inflation targeting shall be forward-looking and flexible so that it can contribute to high and stable output and employment and to counteracting the build-up of financial imbalances.

Section 4 Norges Bank shall regularly publish the assessments that form the basis of the implementation of monetary policy.

Section 5 This regulation enters into force immediately. Regulation No 278 of 29 March 2001 on Monetary Policy is repealed from the same date.