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The Norges Bank Watchers

28.02.2007

The Norwegian economy presents some unique challenges for monetary policy, conludes Norges Bank Watch 2007, an independent review of monetary policymaking in Norway, published by BI Norwegian School of Management.

Centre for Monetary Economics (CME) at the BI Norwegian School of Management has for the eight time invited a committee of leading economists for Norges Bank Watch with the objective of evaluating monetary policy in Norway.

The Norges Bank Watch 2007 which this year has been undertaken by a trio of experienced macroeconomists, Marvin Goodfriend of Carnegie Mellon University, Knut Anton Mork of Handelsbanken Capital Markets, and Ulf Söderström of Bocconi University, was released on 19 February 2007.

The report was commented by Norges Bank Governor Svein Gjedrem.

New monetary regime

The main task of the committee has been to evaluate how well Norges Bank has fulfilled its monetary policy mandate given by the Norwegian Government. The committee should also evaluate the communication strategy of Norges Bank.

Norway adopted an inflation target for the monetary policy six years ago, in March 2001. Although some countries had pursued inflation targeting for many years, this type of monetary regime was still in its infancy.

Norges Bank operates a flexible inflation target, where weight is given both to low and stable inflation, and to stable output and employment.

The Norwegian case

The Norwegian economy presents some unique challenges for monetary policy, not only because it is smaller and more open than most, but also because of the many supply shocks that the country has experienced in recent years, such as the rise in oil prices, the sharp decline in the prices of imported consumer goods, the substantial inflow of foreign workers, and important productivity improvements in key sectors.

This contrasts with the common emphasis on demand shocks in monetary-policy studies and serves as an important reminder that the objective of monetary policy is not to prevent business-cycle fluctuations, but to help the economy attain its full potential. In the presence of supply shocks, this potential does not develop smoothly over time, but is itself subject to fluctuations.

“Norges Bank appears to have managed monetary policy well in 2006. However, we see considerable scope for improving the framework within which Norwegian monetary policy is conducted”. This is the main conclusion of Norges Bank Watch 2007.

Reduce the inflation target

Norges Bank Watch 2007 makes the following recommendations (a selection of recomandations is given. Read executive summary and full report):

In particular, references to the exchange rate should be removed from the Regulation on Monetary Policy; the inflation target should be reduced from 2.5% to 2%, which has become the de facto international standard; and the inflation target should be defined more precisely in terms of a core index covering those consumer goods and services that are most subject to price stickiness. The central bank and the government should explore the potential for an index of domestically-produced non-energy goods and services, adjusted for indirect tax changes, to serve this purpose.

The report encourages the Bank to communicate even more effectively with the public, by releasing minutes from its policy meetings, with public policy statements by all Board members, by making available in a timely manner ex ante information employed in its policy decisions, and by being quantitatively more explicit about the role of judgment in conjunction with models in its reasoning.

The report recommends that Norges Bank strengthen its research on issues regarding the openness of the economy and on price and wage stickiness in Norway.