Sunday, September 16, 2012

Norges Bank Between a Rock And a Hard Place

As I mentioned in my previous post, there is one thing that really bothers me, and it is the record low interest rates dictated by Norges Bank and available to home buyers as well as to folk who fancy a new car, as well as for companies seeking to finance investments. Typically you would expect to see record low interest rates in a weak economic environment when the central bank wants to increase weak aggregate demand and encourage investment. But in Norway the economic environment is currently very strong, by many measures even overheated. Why would Norges Bank want to throw petrol in these flames by lowering the interest rates and keeping them at record lows?

One counter-argument could be that the inflation (CPI) is very low, around 1 %, and so the economy is not overheated and low interest rates are needed to keep the inflation close to the target of around 2 %. How come is the inflation so low? It is certainly not low because there is not sufficient aggregate demand in the Norwegian economy? No. It is low because the prices of imported goods are getting lower when measured in NOK. This is due to low aggregate demand in the U.S. and Europe, which pushes the Fed and the ECB to keep the interest rates at record lows, around 0 %, and in this way make the NOK appreciate vs USD and EUR. To fight this currency appreciation, which makes the Norwegian export industry lose competitiveness by raising its costs compared to foreign competitors, Norges Bank seems to be forced to import the low interest rates from elsewhere in the developed world.

So the hands of Norges Bank are tied when it comes to the interest rate and it has actually quite clearly admitted this by insisting that the rates are low because of the strong NOK, that it does this to protect the export industry, and that it is not the duty of Norges Bank to keep the house prices in check - but that someone else has to take care of that. With the mouth of its governor, Øystein Olsen, it has told that it is worried about the rising level of household debt and house prices. But not able to act to curb that rise because with acting it would invite a stronger NOK and lower the inflation even more.

This is the dilemma Norges Bank faces. I suspect that Øystein Olsen does not feel comfortable about this. With these imported record low interest rates there is a huge risk of forming an economic bubble in a country where the households seem to have an overly rosy picture of the coming years.

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