Monetary policy and interrelationships in the Norwegian economyGovernor Øystein Olsen

Different horizons – different models

Long term0-1 year 1-4 years

Statistical models (SAM)

Equilibrium models

Business cycle models(NEMO)

Horizon

Main requirements for a model for monetary policy 1. Monetary policy controls inflation

2. Expectations must be included

3. Based on theory and empirical data

4. Understandable and easy to communicate

Growth and inflationPercentage annual growth. Average

1980s 1995-20100123456789

Inflation (CPI)Mainland GDP

Sources: Statistics Norway and Norges Bank

Main requirements for a model for monetary policy 1. Monetary policy controls inflation

2. Expectations must be included

3. Based on theory and empirical data

4. Understandable and easy to communicate

“Essentially, all models are wrong, but some are useful.”

George Box (1979)

Output and inflationPercentage deviation from trend

1994 1997 2000 2003 2006 2009-6

-4

-2

0

2

4

6

-2

-1

0

1

2Output gap, left-hand scaleInflation gap, right-hand scale

Sources: Statistics Norway and Norges Bank

Output and unemploymentPercentage deviation from trend

1994 1997 2000 2003 2006 2009-6

-4

-2

0

2

4

6

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5Output gap, left-hand scaleUnemployment gap, right-hand scale

Sources: Statistics Norway and Norges Bank

Unemployment and wage growthPercentage deviation from trend

1994 1997 2000 2003 2006 2009-4

-3

-2

-1

0

1

2

3

-4

-3

-2

-1

0

1

2

3Wage gapUnemployment gap

Sources: Statistics Norway and Norges Bank

Wage growth and inflation Percentage deviation from trend

1994 1997 2000 2003 2006 2009-3

-2

-1

0

1

2

3

-3

-2

-1

0

1

2

3Wage gap

Sources: Statistics Norway and Norges Bank

The interest rate is an endogenous variableThe effect of a change in the interest rate depends on: The reason for the change Whether the change is a surprise Whether the change is temporary or of

long duration

VAR model (vector autoregressive model, structural)

Mainland GDP Inflation (CPI-ATE) Exchange rate Interest rate

Isolated effect on GDP of an interest rate increase in two different VAR modelsPer cent

0 3 6 9 12 15 18 21 24 27 30 33 36 39-1

-0.5

0

0.5

1

-1

-0.5

0

0.5

1

Estimation period 1996-2009

Estimation period 1986-2009

Quarters Source: Norges Bank

Maximum impact of a 1 percentage point interest rate increase, different estimation periods

GDPPer cent

-0.8

-0.6

-0.4

-0.2

0.0

-0.8

-0.6

-0.4

-0.2

0

1986- 1989- 1992- 1995- 2009 2009 2009 2009

InflationPercentage points

-0.4

-0.3

-0.2

-0.1

0.0

-0.4

-0.3

-0.2

-0.1

0

1986- 1989- 1992- 1995- 2009 2009 2009 2009

Source: Norges Bank

Number of quarters to maximum effect of interest rate change, different estimation periods

GDP

02468

101214

02468101214

1986- 1989- 1992- 1995- 2009 2009 2009 2009

Inflation

02468

101214

02468101214

Source: Norges Bank

1986- 1989- 1992- 1995- 2009 2009 2009 2009

Effect of monetary policy shocks, different models/estimation periods

GDPPer cent

0 5 10 15 20 25 30 35 40-0.8-0.6-0.4-0.20.00.20.40.6

-0.8-0.6-0.4-0.20.00.20.40.6

InflationPercentage points

0 6 12 18 24 30 36-0.8-0.6-0.4-0.2

00.20.40.6

-0.8-0.6-0.4-0.200.20.40.6

Quarters Quarters Source: Norges Bank

NEMO (Norwegian Economy Model)

General equilibrium model (DSGE)

Forward-looking participants

Monetary policy controls inflation and gives weight to stabilising output

No long-term trade-off between inflation and unemployment

Estimated on Norwegian data

Effect of monetary policy shocks in the VAR models and in NEMO

GDPPer cent

-0.8-0.6-0.4-0.20.00.20.40.6

-0.8-0.6-0.4-0.20.00.20.40.6

NEMO

InflationPercentage points

-0.8-0.6-0.4-0.20.00.20.40.6

-0.8-0.6-0.4-0.20.00.20.40.6

NEMO

Quarters Quarters Source: Norges Bank

Projected inflation and output gap in the baseline scenario from MPR 2/11 Per cent. Quarterly figures. 2008 Q1 – 2014 Q4

2008 2010 2012 2014-4

-3

-2

-1

0

1

2

3

4

-1

0

1

2

3

4

5

6

Output gap, left-hand scale

CPIXE, right-hand scale

Sources: Statistics Norway and Norges Bank

Projected key policy rate in the baseline scenario from MPR 2/11 with fan chart Per cent. Quarterly figures. 2008 Q1 – 2014 Q4

2008 2009 2010 2011 2012 2013 20140123456789

0123456789

Source: Norges Bank

90% 70% 50% 30%

Key policy rate in the baseline scenario and in the alternative scenarios from MPR 2/11 Per cent. Quarterly figures. 2008 Q1 - 2014 Q4

2008 2009 2010 2011 2012 2013 20140123456789

0123456789

Baseline scenarioHigher price and cost inflationLower growth abroad

Source: Norges Bank

90% 70% 50% 30%

Summary: Response pattern in interest rate setting Empirically anchored Theory-based Professional judgement Learning