Norges Bank Watch believe that Norges Bank did its best to contribute to curbing the risk premiums during the first wave of the pandemic. But are critical regarding how the central bank handled higher money market premiums in the second half of 2020.
NBW supports Norges Bank’s decision to use the whole policy leeway by cutting the rate to zero. Granted, unlike in normal circumstances, the policy was neither able to nor aimed towards boosting activity in an economy heavily constrained by virus containment measures. However, we monetary policy could give its contribution through keeping financial conditions as easy as possible, reducing interest-rate costs for strained businesses and households with debt, and thereby lifting the room for recovery after the crisis.
Norges Bank was not informed about the lockdown
The first non-scheduled policy announcement was made on the morning of 13 March, one day after the lockdown was announced by the Prime Minister on the 12 March. Norges Bank was not informed in advance about the announcement. Given the harsh economic consequences of the lockdown, we believe that the central bank should have been informed.
Also, given the severity of the situation in March, with the unprecedented shock hitting both the economy and the financial markets, we do believe that Norges Bank was slightly too hesitant in its decision making. The central bank advised the Ministry of Finance to cut the countercyclical capital buffer from 2.5% (the maximum level) to 1%, instead of to 0% (the minimum level). Ex-post, we know that the situation in the economy and the financial markets did improve in the course of the next months. However, judged in real-time, the decision seems overly conservative, and we question whether the framework is flexible enough to handle severe shocks in a good way. Also, the policy rate was cut to 0.25% in March, whereas the final cut to 0.00% was delayed until early May. As downside risks were much less mounting at that point in time, the delayed cut seemed to result from a renewed reflection regarding the lower effective bound of the policy rate, rather than resulting from a decision to hold off the last cut - to “wait and see” how the situation evolves. However, we do not believe that the delay of the last 0.25%-point cut has had a significant negative effect on the economy.
Encourage Norges Bank to have
NBW believe that Norges Bank did its uttermost to contribute to curbing the risk premiums during the first wave of the pandemic. However, we are critical regarding how the central bank handled higher money market premiums in the second half of 2020 that stemmed from domestic conditions. The absence of sufficient measures to reverse a nearly quarter percentage point rise in the Nibor, in a situation in which the central bank wishes to provide a maximum amount of monetary stimulus, is puzzling, in our view.
NBW remarks that 2020 did not turn out to be a year with clear improvements or innovations in Norges Bank’s communication. We certainly acknowledge that the focus paid on evolving communication rightfully was overshadowed by the overwhelming turn of events, leading to even more intense analytical work than normal. However, the statement given by Olsen in January leaves an impression of lacking ambitions to make large innovative changes in the communication. We, in line with many preceding committees, encourage Norges Bank to have bolder ambitions. Specifically, we urge that the central bank introduces minutes to give further details on the discussions and elaborations.
Good experiences with flexible inflation
In our opinion Norway basically has had good experiences with flexible inflation targeting during the twenty years since its introduction in March 2001. The average core inflation has since its introduction in December 2003 been 1.8 percent, which is 0.2 percent units under the present inflation target. The policy has additionally chiefly contributed both to production and employment stability, as well as financial stability.
The policy management has changed substantially. In the first place it has been more flexible and has given room to more discretion. Secondly, it has paid increasingly more attention to financial stability. Thirdly it has become more open and transparent.
The development seems to have followed some general patterns:
- Firstly, the central bank has often adapted its policy to macroeconomic circumstances.
- Secondly, the central bank has chiefly acted with rapid and appropriate reactions to macroeconomic shocks.
- Thirdly, the central bank has competently used its room of manoeuvre.
- Fourthly, the central bank has learned from the shocks and adapted the system to them.
Quantify how the different consideration are weighed
The NBW believe that the guidelines for monetary policy objectives and trade-offs are helpful for understanding monetary policy, but we encourage Norges Bank to quantify how the different consideration are weighed against each other. The trade-off between flexible inflation targeting and financial stability remains unclear.
We believe that the drop in the output gap during the initial phase of the pandemic was substantially lower than estimated by Norges Bank. We encourage Norges Bank to reconsider the estimate of the output gap during this period. It is worth emphasizing that we still think the substantial cut in policy rates was warranted.
The NBW welcomes the clarification given in the new framework for advice on the countercyclical buffer. We encourage Norges Bank to develop their analysis further. Currently, the analysis mainly consists of comparing indicators to their historical average and comparing with their developments before the banking crisis and the financial crisis. An important exception is the so-called stress test, which is presented in the report on financial stability. We encourage Norges Bank to add this analysis to the monetary policy reports.
Download the report from here: Norges Bank Watch 2021