Use of models and economic theory in Norges Bank
Governor Øystein Olsen
Schweigaard lecture, University of Oslo
8. September 2011
Monetary policy regimes in Norway since 1816
Smithsonian agreement
December 1992 1946
August 1971
December 1978 May 1972
October 1990 December 1971 March 1973
Bretton Woods system
The European snake
Trade-weighted currency basket Fixed exchange rate against ECU Floating exchange rate
Floating exchange rate
Stability against European currencies May 1994
March 2001 Inflation targeting and floating exchange rate Gold standard
1874 1842 1816
Silver standard
Floating exchange rate
1931
Floating exchange rate 1933
Fixed exchange rate against GBP/USD 1823 Conversion to silver standard
”The snake in the tunnel”
Monetary policy in Norway
Inflation target of 2.5 per cent
Monetary policy shall contribute to stabilising output and employment
The instrument is the key policy rate
Different horizons – different models
Long term 0-1 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 inflation
Percentage annual growth. Average
0 1 2 3 4 5 6 7 8 9
0 1 2 3 4 5 6 7 8 9
1980s 1995-2010
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 inflation
Percentage deviation from trend
-2 -1 0 1 2
-6 -4 -2 0 2 4 6
1994 1997 2000 2003 2006 2009
Output gap, left-hand scale Inflation gap, right-hand scale
Sources: Statistics Norway and Norges Bank
Output and unemployment
Percentage deviation from trend
-1.5 -1 -0.5 0 0.5 1 1.5
-6 -4 -2 0 2 4 6
1994 1997 2000 2003 2006 2009
Output gap, left-hand scale
Unemployment gap, right-hand scale
Sources: Statistics Norway and Norges Bank
Unemployment and wage growth
Percentage deviation from trend
-4 -3 -2 -1 0 1 2 3
-4 -3 -2 -1 0 1 2 3
1994 1997 2000 2003 2006 2009
Wage gap
Unemployment 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
3 Wage gap
Inflation gap, domestically produced goods and services
Sources: Statistics Norway and Norges Bank
The interest rate is an endogenous variable
Interdependency between the interest rate and other variables in the economy
Demanding to identify the effects of interest
rate changes
VAR model
(Vector Autoregressive Model, structural)
Mainland GDP
Inflation (CPI-ATE)
Exchange rate
Interest rate
Effect of monetary policy shocks, different models/estimation periods
GDP
Per cent
-0.8 -0.6 -0.4 -0.2 0 0.2 0.4 0.6
-0.8 -0.6 -0.4 -0.2 0 0.2 0.4 0.6
0 8 16 24 32 40
Inflation
Percentage points
-0.8 -0.6 -0.4 -0.2 0 0.2 0.4 0.6
-0.8 -0.6 -0.4 -0.2 0 0.2 0.4 0.6
0 8 16 24 32 40
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
The central bank sets the interest rate with a view to minimising the loss function:
Modelling monetary policy
The central bank sets the interest rate with a view to minimising the loss function:
given the structure of the economy:
Modelling monetary policy
Effect of monetary policy shocks in the VAR models and in NEMO
GDP
Per cent
-0.8 -0.6 -0.4 -0.2 0 0.2 0.4 0.6
-0.8 -0.6 -0.4 -0.2 0 0.2 0.4 0.6
0 8 16 24 32 40
NEMO
Inflation
Percentage points
-0.8 -0.6 -0.4 -0.2 0 0.2 0.4 0.6
-0.8 -0.6 -0.4 -0.2 0 0.2 0.4 0.6
0 8 16 24 32 40
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
-1 0 1 2 3 4 5 6
-4 -3 -2 -1 0 1 2 3 4
2008 2010 2012 2014
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
0 1 2 3 4 5 6 7 8 9
0 1 2 3 4 5 6 7 8 9
2008 2009 2010 2011 2012 2013 2014
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
0 1 2 3 4 5 6 7 8 9
0 1 2 3 4 5 6 7 8 9
2008 2009 2010 2011 2012 2013 2014
Baseline scenario
Higher price and cost inflation Lower growth abroad
Source: Norges Bank
90% 70% 50% 30%
-15 -10 -5 0 5 10 15
2000 2004 2008 2012
US UK
Euro area
0 25 50 75 100 125 150
2000 2004 2008 2012
US UK
Euro area
Euro area threshold
Budget balances
Per cent of GDP. 2000 – 2012
Government debt
Per cent of GDP. 2000 – 2012
Source: OECD Economic Outlook 89
Euro area threshold
