Norges Bank
Monetary policy framework
in Norway
Øistein Røisland
Norges Bank
1
Norges Bank
Agenda
• What do we do?
• Why do we do it?
• How do we do it?
2
Norges Bank
What do we do?
3
Norges Bank
Monetary policy in Norway
Objective:
• Low and stable inflation
- close to 2.5 per cent over time
Implementation:
• A flexible inflation targeting regime
• Stabilise inflation in the medium term
Decision structure:
• Consensus seeking committee
(Governor, Dep. governor + 5 external members)
4
Baseline scenario in Monetary Policy Report 1/07
9
Key interest rate
8
7
6
5
4
3
30% 50% 70% 90%
2
1
0
2005 2006 2007 2008 2009 2010
4
CPI
9
8
7
6
5
4
3
2
1
0
2
2
1
1
0
0
-1
4
3
2
2
1
1
0
0
-1
-1
-2
2005 2006 2007 2008 2009 2010
-2
4
3
Output gap
3
4
3
-1
2005 2006 2007 2008 2009 2010
4
Norges Bank
3
CPI adjusted for
taxes and energy
4
3
2
2
1
1
0
2005 2006 2007 2008 2009 2010
0
5
Alternative scenarios in Monetary Policy Report 1/07
4
CPI-ATE
4
3
2
1
0
3
Higher capacity
utilisation
2
1
Lower
inflation
0
Output gap
4
Higher capacity utilisation
3
Lower inflation
4
3
2
2
1
1
0
0
-1
-1
-2
-2
2005 2006 2007 2008 2009 2010
2005 2006 2007 2008 2009 2010
9
8
7
6
5
4
3
2
1
0
Norges Bank
Key interest rate
Higher capacity
utilisation
Lower
inflation
9
8
7
6
5
4
3
2
1
0
2005 2006 2007 2008 2009 2010
6
Decomposing changes in the interest rate path
Norges Bank
8
8
7
7
6
5
5
MPR 1/07
4
3
6
IR 3/06
IR 1/06
IR 2/06
4
3
2
2
1
1
0
2004 2005 2006 2007 2008 2009
0
7
Decomposing changes in the interest rate path
Isolated effect on the interest rate of
higher output gap and weaker
exchange rate (red line).
Isolated effect on the interest
rate of lower inflation (red line).
8
Norges Bank
8 8
8
7 7
7
6
6 6
6
5
5 5
5
4
4 4
4
3
3 3
3
2
2 2
2
1
1 1
1
0
2004 2005 2006 2007 2008 2009
0 0
2004 2005 2006 2007 2008 2009
0
7
30% 50% 70% 90%
8
Norges Bank
Why interest rate forecasts?
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Norges Bank
Changes in Norges Bank’s interest rate assumption
• 2001 - 2002 Constant interest rate
• 2003 - 2005 Markets’ interest rate expectations
…with comments
• 2005
Our own interest rate forecast
10
Norges Bank
Talking about the future…
– “In these circumstances, the Committee believes that policy
accommodation can be maintained for a considerable
period"
(FED, 2003-2004)
– ” the prospect of continued low inflation in Norway also
implies that we should lag behind other countries in setting
interest rates at a more normal level”
(Norges Bank, 2004-2005)
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Norges Bank
Experiences
• Communication
– More precise than verbal deliberations alone
• Market participants
– Well understood
• Internal organisation
– Close link between analysis and policy makers
• Competence
– New analytical challenges
12
Market reactions after publication of Monetary Policy Reports
a. March 2006
8
b. July 2006
8
8
7
7
7
6
6
6
5
5
4
4
3
3
2
2
1
1
1
1
0
2006
0
0
2006
0
5
4
Implied forward rates day
after report (black)
3
NB forecast (red)
Implied forward rates
before report (shaded)
2
2007
2008
2009
8
7
Implied forward
rates day after
report (black)
NB forecast (red)
Implied
forward rates
before report
(shaded)
2007
2008
6
5
4
3
2
2009
13
Market reactions after publication of Monetary Policy Reports
a. March 2006
8
b. July 2006
8
8
7
7
7
6
6
6
5
5
4
4
3
3
2
2
1
1
1
1
0
2006
0
0
2006
0
5
4
NB forecast (red)
Implied forward rates day
after report (black)
3
Implied forward rates
before report (shaded)
2
2007
2008
2009
c. November 2006
8
7
6
5
Implied forward rates day
after report (black)
4
Implied forward rates
before report (shaded)
3
2
1
0
2006
NB forecast (red)
Implied forward rates
month after report (green)
2007
2008
2009
8
7
Implied forward
rates day after
report (black)
NB forecast (red)
Implied
forward rates
before report
(shaded)
2007
2008
6
5
4
3
2
2009
d. March 2007
8
8
8
7
7
6
6
5
5
4
4
3
3
2
2
2
1
1
1
0
0
2006
0
7
Implied forward rates day
after report (black)
NB forecast (red)
5
Implied forward rates
before report (shaded)
2007
2008
6
2009
4
3
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Norges Bank
How do we do it?
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Norges Bank
Criteria for choosing a good interest rate path
1. Inflation close to the target in the medium term.
2. Reasonable balance between the path for inflation and
the path for capacity utilisation.
Assuming the criteria above have been satisfied, the following
additional criteria are useful:
3. Robustness
4. Consistence
5. Cross-checks
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Norges Bank
Core model
• Currently
– Simple 4 equation ”new-keynesian” model
• Implementing
– NEMO, a modern DSGE model
– Down-scaled version of GEM
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Norges Bank
Modelling monetary policy: two approaches
• Simple interest rate rule
rt = art-1 + (1-a)[b1(Etpt+k -p*)+b2yt +b3Dyt]
• Optimal policy
– Minimizing a loss function
L = (π - π*)2 + λy2 + δ(r - r-1)2
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Norges Bank
Simple rule
rt = art-1 + (1-a)[b1(Etpt+k -p*)+b2yt +b3Dyt]
• Iterate towards optimal policy through choices
of coefficients
• No unambiguous relationship between
coefficients and preferences (loss function)
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Norges Bank
Inflation and output gaps in the baseline scenario
3
2
3
Output gap
2
1
1
0
0
-1
-1
Inflation gap
-2
-2
-3
2005
-3
2006
2007
2008
2009
2010
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Norges Bank
”Lambda”-consistency
• Preferences should be consistent over different
strategy rounds
• Used to apply an indirect method to estimate
”lambda”
– ”Revealed preferences”
– Compare loss with higher and lower interest rate than
reference path
– Gives an interval for ”lambda” in Norges Bank’s loss
function
– However: This method is only valid under a discretionary
policy!
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Norges Bank
Inflation and output gaps in the baseline scenario
3
2
3
Output gap
2
1
1
0
0
-1
-1
Inflation gap
-2
-2
-3
2005
-3
2006
2007
2008
2009
2010
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Norges Bank
Inflation and output gaps in the baseline scenario
3
2
3
Output gap
2
1
1
0
0
Inflation gap
-1
-1
-2
-2
-3
2008
-3
2009
2010
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Norges Bank
Inflation and output gaps in the baseline scenario
3
2
3
Output gap
2
1
1
0
0
-1
Inflation gap
-1
-2
-2
-3
2009
-3
2010
24
Norges Bank
Inflation and output gaps in the baseline scenario
3
2
3
Output gap
2
1
1
0
0
-1
-2
-3
2010
Inflation gap
-1
-2
-3
2011
25
Norges Bank
Inflation and output gaps in the baseline scenario
3
2
3
Output gap
2
1
1
0
0
-1
-1
Inflation gap
-2
-2
-3
2005
-3
2006
2007
2008
2009
2010
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Norges Bank
Discretion,
Commitment and
Timeless Perspective
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Norges Bank
Discretion vs commitment
• Discretion
– Re-optimize each period
– Take expectations as given
• Commitment
– Commit oneself to a specific reaction pattern
– Seek to affect private expectations
– Not time-consistent (incentive-consistent)
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Norges Bank
Commitment
Two main types:
• Ramsey rule
– Re-optimize today, but commit in all future periods
– Exploit the initial conditions
• Timeless perspective
– As Ramsey, but act as if you committed long time
ago
– Does not exploit the initial conditions
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Norges Bank
• The interest rate path in MPR 1/07 only
consistent with commitment
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Norges Bank
Inflation and output gaps in the baseline scenario
3
2
3
Output gap
2
1
1
0
0
-1
-2
-3
2010
Inflation gap
-1
-2
-3
2011
31
Ramsey and Timeless (baseline scenario)
Norges Bank
Key policy rate
7
7
Ramsey
Timeless and Ramsey:
- λ=0.30
- Weight change in
interest rate=0.2
6
6
5
5
Timeless
4
4
3
3
2
2
1
1
0
2006
0
2007
2008
2009
2010
CPI-ATE
Output gap
3
3
Timeless
3
3
Timeless
2
2
2
2
1
1
Ramsey
Ramsey
0
1
0
2006
0
1
0
2007
2008
2009
2010
-1
-1
-2
2006
-2
2007
2008
2009
2010
Sources: Statistics Norway and Norges Bank 32
Timeless with different λ’s
Norges Bank
Key policy rate
7
7
λ=0.40
6
Timeless and Ramsey:
- λ=0.30
- Weight change in
interest rate=0.2
6
5
5
4
4
λ=0.20
3
3
Baseline
scenario
2
2
1
1
0
2006
0
2007
2008
2009
2010
CPI-ATE
Output gap
3
3
λ=0.20
2
1
λ=0.40
1
1
Baseline
scenario
0
2007
2008
3
λ=0.20
2
2
0
2006
3
2009
2010
Baseline
scenario
2
1
λ=0.40
0
0
-1
-1
-2
2006
-2
2007
2008
2009
2010
Sources: Statistics Norway and Norges Bank 33
Norges Bank
Final remarks
• Publishing an interest rate forecast requires modelling
monetary policy
• Simple rules and optimal policy both useful approaches for
internal analysis
• Moved towards optimal policy in a timeless perspective as the
benchmark
• Judgment will always be needed
• However, not obvious
– what the loss function looks like
– what to assume about the degree of commitment.
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