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16 February 2012

Øystein Olsen: Economic perspectives


Address by Mr Øystein Olsen, Governor of Central Bank of Norway, to the Supervisory Council of Norges Bank and invited guests, Oslo, 16 February 2012.

Four years after the financial crisis engulfed the world, a European version has now emerged. Both market participants and the authorities failed in their assessments after the introduction of a single currency. Prior to the introduction of the Economic and Monetary Union, there were wide differences between interest rates facing different European countries, which primarily reflected different inflation expectations across countries. But through the 1990s, long-term interest rates drifted down to German levels. Over the next 10 years, sovereign interest rates were fairly similar – and very low – for all euro area countries despite wide differences in debt levels, budget deficits and growth rates. Market participants did not take into account differences in sovereign creditworthiness. Sovereign debt was treated as virtually risk-free, both in the markets and by the authorities. The period contrasts with the recent two to three years, during which interest rates on sovereign debt have widened sharply. For many countries, interest rates have reached very high levels. In retrospect, we see that market participants failed in their risk assessment through the 10 years following the introduction of the euro. Economic policy also failed. EU rules relating to budget deficits and public debt were disregarded early on when Germany and France exceeded the limits they had so eagerly advocated when the European Monetary Union was established. Other countries followed their example. Low interest rates made it easy to finance deficits by issuing new debt.

The combination of large deficits and growing demographic problems is particularly challenging, as is the case for southern European countries where fertility rates are well below the replacement rate and lower than the average for advanced countries. The demographic challenge will be even greater ahead. In some of the countries the number of pensioners will be close to the number of economically active. The basis for economic growth is thus weakened. The burden of rising debt and pension payments will be heavier. Financial markets are already now demanding a high interest rate on loans to troubled countries.

In order to prevent inflation from becoming too low and to dampen the impact of weaker developments abroad on the Norwegian economy, the key policy rate was reduced to 1.75 per cent in December 2011. With high money market premiums and elevated credit premiums, low key rates are not passing through fully to banks’ lending rates. The difference between various lending rates is unusually wide at present. Many households pay a mortgage interest rate of around 4 per cent, and rates on corporate loans are between 5 and 6 per cent.

There will be a need for higher capital buffers when economic growth is solid and debt builds up. This may restrain the build-up of imbalances. But when there are no clouds on the horizon, it is easy to lose sight of more long-term considerations. The government authorities should therefore provide a clear mandate that ensures independence and delegates the responsibility for determining capital buffers. In this regard, we can build on the experience with the framework for monetary policy. And any change in capital requirements must be made on the basis of an assessment of the overall risk in the financial system – not only in a single institution.

During the financial crisis, extensive government bank bailouts were necessary in many countries in order to sustain economic activity. When the bridge is unsteady, the authorities need to stabilise it. But when taxpayers foot the bill, banks take on excessive risk. Not until owners have to bear losses will banks’ balance sheets fully reflect risk.

While times are difficult abroad in our day too, there are bright spots. Growth in Asia remains robust and some figures for the US economy have been positive recently. Europe is facing the challenge of remedying economic imbalances in the face of weak growth prospects. For many countries, demographic developments will in a few years add to the pressure on fiscal budgets. While austerity measures will improve government finances, in the short term they will stifle activity and delay a recovery. This is a very difficult balancing act. But euro area countries have no choice. There is a need to agree on measures to restore confidence in financial markets.

Just like 80 years ago, it is difficult to predict where we are heading. The Norwegian economy should be able to hold a steady course. But we will have to take into account that the return on the Fund’s investments may be lower than expected a decade ago. And wage and price inflation is likely to be low for some time to come.

Full speech



© BIS - Bank for International Settlements


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