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Monetary policy framework in Norway Øistein Røisland Norges Bank

Monetary policy framework in Norway Øistein Røisland Norges Bank. Agenda. What do we do? Why do we do it? How do we do it?. What do we do?. Monetary policy in Norway. Objective: Low and stable inflation - close to 2.5 per cent over time Implementation:

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Monetary policy framework in Norway Øistein Røisland Norges Bank

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  1. Monetary policy frameworkin NorwayØistein RøislandNorges Bank

  2. Agenda • What do we do? • Why do we do it? • How do we do it?

  3. What do we do?

  4. 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)

  5. Baseline scenario in Monetary Policy Report 1/07 30% 50% 70% 90% Output gap Key interest rate CPI CPI adjusted for taxes and energy

  6. Alternative scenarios in Monetary Policy Report 1/07 Output gap CPI-ATE Higher capacity utilisation Lower inflation Higher capacity utilisation Lower inflation Key interest rate Higher capacity utilisation Lower inflation

  7. Decomposing changes in the interest rate path IR 3/06 MPR 1/07 IR 1/06 IR 2/06

  8. Decomposing changes in the interest rate path 30% 50% 70% 90% Isolated effect on the interest rate of lower inflation (red line). Isolated effect on the interest rate of higher output gap and weaker exchange rate (red line).

  9. Why interest rate forecasts?

  10. 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

  11. 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)

  12. 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

  13. Market reactions after publication of Monetary Policy Reports a. March 2006 b. July 2006 Implied forward rates day after report (black) NB forecast (red) NB forecast (red) Implied forward rates day after report (black) Implied forward rates before report (shaded) Implied forward rates before report (shaded)

  14. Market reactions after publication of Monetary Policy Reports Implied forward rates day after report (black) NB forecast (red) NB forecast (red) Implied forward rates day after report (black) Implied forward rates before report (shaded) Implied forward rates before report (shaded) NB forecast (red) NB forecast (red) Implied forward rates day after report (black) Implied forward rates day after report (black) Implied forward rates before report (shaded) Implied forward rates before report (shaded) Implied forward rates month after report (green) a. March 2006 b. July 2006 d. March 2007 c. November 2006

  15. How do we do it?

  16. 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

  17. Core model • Currently • Simple 4 equation ”new-keynesian” model • Implementing • NEMO, a modern DSGE model • Down-scaled version of GEM

  18. 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

  19. 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)

  20. Inflation and output gaps in the baseline scenario Output gap Inflation gap

  21. ”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!

  22. Inflation and output gaps in the baseline scenario Output gap Inflation gap

  23. Inflation and output gaps in the baseline scenario Output gap Inflation gap

  24. Inflation and output gaps in the baseline scenario Output gap Inflation gap

  25. Inflation and output gaps in the baseline scenario Output gap Inflation gap 2011

  26. Inflation and output gaps in the baseline scenario Output gap Inflation gap

  27. Discretion, Commitment andTimeless Perspective

  28. 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)

  29. 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

  30. The interest rate path in MPR 1/07 only consistent with commitment

  31. Inflation and output gaps in the baseline scenario Output gap Inflation gap 2011

  32. Ramsey and Timeless (baseline scenario) Key policy rate Ramsey Timeless and Ramsey: - λ=0.30 - Weight change in interest rate=0.2 Timeless CPI-ATE Output gap Timeless Timeless Ramsey Ramsey Sources: Statistics Norway and Norges Bank

  33. Timeless with different λ’s Key policy rate λ=0.40 Timeless and Ramsey: - λ=0.30 - Weight change in interest rate=0.2 λ=0.20 Baseline scenario CPI-ATE Output gap λ=0.20 λ=0.20 Baseline scenario λ=0.40 λ=0.40 Baseline scenario Sources: Statistics Norway and Norges Bank

  34. Finalremarks • 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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