Public Information Notice No. 98/14

Press Information Notice: IMF Concludes Article IV Consultation with Norway

March 9, 1998

The IMF Executive Board on February 23, 1998 concluded the 1997 Article IV consultation¹ with Norway.

Background

Since late 1993 Norway has pursued an economic strategy designed to preserve the competitiveness of the non-oil ("mainland") economy and help ensure that the current period of rapid expansion in oil export revenues is not followed by a contraction of income and employment when oil output begins to decline in the next century. Under this strategy—often referred to as the "Solidarity Alternative"—incomes policy is used to secure moderate wage settlements while monetary policy is oriented toward stabilizing the exchange rate. Fiscal policy is used for demand management and helps to insulate the mainland economy from developments in the oil sector by reinvesting abroad a substantial part of the government’s oil revenues in the State Petroleum Fund (SPF).

Since adopting these policies Norway has experienced five consecutive years of economic expansion in excess of the growth rate of potential output, with low rates of inflation. Most of the fundamentals—growth, unemployment, and the fiscal and external positions—are among the best in Europe. In 1997, mainland GDP grew by 3.9 percent, with domestic demand replacing net exports as the engine of growth. Investment was strong, particularly in the oil sector where it grew by 25 percent, reversing the decline over the 1994-96 period. Private consumption growth remained healthy at 3 percent, fueled by low interest rates, brisk employment growth and the healthy financial position of the household sector. Government consumption grew by 2½ percent, mainly on account of increased local authority spending.

This favorable performance, however, is being threatened by capacity shortages and rising inflationary pressures. The tightness in labor markets has led to shortages of skilled labor in the hotel, health, and construction sectors, and firms are having to advertise across Europe to procure personnel. Continued strong growth in employment is expected to lower the unemployment rate to 3¾ percent in 1998. Inflation (i.e. changes in the CPI) has risen from 0.7 percent in March 1996 to 2 percent in January 1998 and is projected to increase further to at least 2¾ percent by the end of the year. Most non-government forecasters point to risks of even higher inflation, if wage settlements rise significantly during 1998. Asset prices have also risen sharply: housing and stock prices rose by 12 percent and 32 percent respectively, in 1997, although stock prices have fallen back somewhat since the end of last year.

The 1998 budget, which was adopted in November 1997, targeted a tight fiscal stance for the fifth consecutive year. However, the magnitude of the fiscal contraction was considerably less than in each of the previous years despite the signs of overheating of the economy and the accommodative stance of monetary policy. The non-oil structural deficit is expected to decline by ¼ percent of GDP, to slightly below 4 percent of GDP, following a cumulative tightening of 5½ percent over the 1994-97 period. The state budget surplus, which is invested in the SPF, is expected to stabilize at 5.8 percent of GDP in 1998 from approximate balance in 1995. The general government surplus is expected to widen to 7.7 percent of GDP in 1998.

Under policy guidelines adopted in 1994, the primary objective of monetary policy is to stabilize the exchange rate of the krone against European currencies around the level prevailing at the time that the fixed exchange rate system was abandoned in December 1992. The Norges Bank is also expected, to the extent consistent with the goal of a stable exchange rate, to contribute to dampening fluctuations in the domestic economy. While the Norges Bank has some latitude to interpret this policy flexibly, in recent years monetary policy has generally been procyclical as interest rates were reduced to moderate a tendency toward appreciation of the exchange rate. Between October 1996 and January 1997 the Norges Bank lowered official short-term interest rates by 125 basis points. Subsequently, in July, the Norges Bank raised its official short-term interest rate by 25 basis points in response to downward pressure on the exchange rate while, in October, the Norges Bank maintained its official rate unchanged in the wake of the Bundesbank’s 30 basis point interest rate hike. The Norway-German short-term interest rate differential is presently about 50 basis points, leaving Norwegian interest rates well below the EU average.

Executive Board Assessment

Executive Directors welcomed Norway’s impressive economic performance, marked by five consecutive years of rapid growth, a sharp fall in unemployment, significant gains in real wages, low inflation, and strong fiscal and external positions. They considered Norway’s macroeconomic strategy—the so-called Solidarity Alternative—and structural reforms to have been instrumental in these achievements.

Directors underscored, however, the fact that the authorities now faced important challenges in preserving and extending these gains. For the immediate future, the priority must be to prevent further overheating of the economy, as evidenced by the emergence of capacity constraints in a number of sectors, the gradual but continuous upturn in underlying inflation, and the sharp increases in asset prices and associated bank lending. For the longer run, the primary challenge will be to promote sustainable growth and stable financial conditions in the face of fluctuations in oil income and demographic change. In pursuing these objectives, Directors noted that Norway’s macroeconomic strategy, which relies upon monetary policy to stabilize the exchange rate and incomes policy to attain moderate wage settlements, places a heavy burden on fiscal policy.

Directors considered that the marginally contractionary fiscal stance adopted in the 1998 budget was likely to be insufficient to avoid an intensification of inflationary pressures. They urged the Norwegian authorities to take additional measures as soon as possible to reduce the non-oil budget deficit further. In light of the high tax burden on the mainland economy, Directors suggested that fiscal adjustment should focus mainly on expenditure restraint, with particular emphasis on reducing subsidies, tax preferences, and public sector employment. They noted that a strengthening of fiscal policy along these lines would help safeguard the ability of the State Petroleum Fund to insulate the mainland economy from fluctuations in oil earnings—a goal the importance of which had been highlighted by the recent downturn in world oil prices—and to cover the increase in pension-related expenditures as the population ages.

Against this background, many Directors indicated that, if fiscal policy were unable to play a sufficiently restraining role in 1998, it would be important to help alleviate demand pressures through more active use of monetary policy. A key element in this judgment was the concern that the present policy mix would be unable to forestall a significant increase in wages in the face of excess demand and tight labor markets. Some Directors suggested, however, that it would be preferable for the Norwegian authorities not to deviate from the current exchange rate targeting framework, judging that there was a risk that significant appreciation of the exchange rate would undermine support for the incomes policy. In general, Directors felt that it would be desirable to preserve the transparent and consensual approach to economic policy that had contributed to the success of the Solidarity Alternative strategy. In that context, Directors considered that wage and price developments during the coming year, and the fiscal policy response, would shed important light on the sustainability of the strategy and the appropriate framework for monetary policy.

Directors welcomed recent structural measures, including those taken in the context of Norway’s participation in the European Economic Area, but noted that there was a substantial agenda of unfinished business. They encouraged the authorities to reduce Norway’s protection of the agricultural sector and noted that there was scope for further measures to increase labor market flexibility. Directors also supported the proposals to promote greater neutrality in the tax system.

Directors emphasized the importance of further steps to strengthen the banking system, through continued strong supervision, higher capitalization in some institutions, and further gains in bank efficiency. To that end, they encouraged the authorities to reduce legal impediments to consolidation in the banking sector and to consider phasing out more rapidly the government’s remaining ownership stake in Norway’s largest commercial banks.

Finally, Directors welcomed Norway’s continued commitment to a high level of official development assistance.