Norges Bank to introduce 2.5% inflation target

The Norges Bank welcomed the move, saying in a press statement on its website "that the communication of Norwegian monetary policy may be facilitated with the government now quantifying an inflation target, in line with international practice."

Analysts said the decision would give Norway's central bank more leeway to cut interest rates, which was considered good news for the currency against a backdrop of global economic slowdown.

However, central bank governor Svein Gjedrem said the move would not result in "significant changes in the conduct of monetary policy" both in terms of the executive board's monetary policy decisions and day-to-day liquidity management.

Gjedrem said the likelihood of an increase or a decrease in interest rates was about the same. In the bank's March Inflation Report, price inflation was projected to fall below 2.5 per cent towards the end of 2002 and into 2003. But he said that the bank "must assess the effects of the inflation target on inflation expectations," indicating that inflation expectation may be raised by the implementation of a 2.5% target.

INCREASE GOVERNMENT SPENDING

The Norges Bank governor noted that the increases in government spending which are being funded by running down the country's large Petroleum Fund might also have an impact on inflation not previously considered by the bank. "Our projections are based on a technical assumption of a neutral fiscal stance", he said. However, on balance, the evidence at hand does not support a change in Norges Bank's monetary policy stance, he said.

At the same time as annoncing the adoption of the new inflation target, the Norwegian government proposed a fiscal policy strategy involving a modest and gradual increase in the use of the country's substantial petroleum revenues. The proposal is part of a 2002-2005 macroeconomic plan.

The government said the fiscal strategy would be implemented in a measured fashion. "With a large and rapidly growing petroleum fund, a clear long-term strategy for the use of petroleum revenues is needed... The use of petroleum revenues in the government budget is to be moderate and gradual, approximately in line with an estimated 4% real return on the capital of the petroleum fund," the government said in a statement.

The central bank oversees the petroleum fund on the government's behalf. The Norwegian government petroleum fund takes surpluses generated from the country's oil and gas revenues and invests them to bolster the country's long-term public finances. Typically, 30%-50% of the fund is invested in equities, while the remainder is in government-backed securities.

At the end of the year, the total market value of the fund was NOK386.4 billion. The new fiscal policy rule implies a modest increase in the use of petroleum revenues, as fiscal balances and economic developments are sustainable, the government said.

Based on this rule, the central government structural non-oil budget deficit is presently estimated to rise from nearly 2% of mainland GDP in 2001 to around 5.5% in 2010, according to the government.This translates into an increase of around 0.4% of mainland GDP, or around 4 billion kroner ($1=NOK9.1195), compared with a scenario of neutral fiscal policy, and suggests a government budget surplus of around 6% of GDP in 2010, as well as the capital in the petroleum fund rising to nearly 130% of GDP.

The government said actual implementation of fiscal policy will take into account business cycle fluctuations. It will remain focused on stabilizing output and employment and insuring that overall growth in demand for goods and services is consistent with balanced growth in the Norwegian economy.

The government also said that the new policy is aimed at enhancing growth potential in line with its belief that the performance of the mainland economy, not revenues from the petroleum sector, is the determining factor in the country's long-term prosperity.

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The following is a brief summary of main changes in Norway's monetary policy since 1990

* 1990 - Norway becomes the first nation outside the European Community to peg the crown to the European currency unit (Ecu). Other Nordic nations follow suit.

* December 10, 1992 - Norway abandons the peg and devalues after waves of selling of the crown also battering other non-core Ecu currencies. The central bank had briefly jacked up key interest rates to 25 percent in a vain bid to defend the crown.

* 1992-94 - Crown in a "dirty float" against the Ecu. The government said it would re-establish a fixed rate as soon as practical.

* May 6, 1994 - Norway drops goal of pegging crown to Ecu and says it will merely keep it "around the current value" against European currencies without setting formal rates. The rate was about 3-5 percent weaker than the former central rate versus the Ecu.

* November 28, 1994 - Norway votes "No" to EU membership in a referendum.

* January 1999 - New central bank governor Svein Gjedrem says that the central bank should take more account of inflation and of economic growth in setting interest rates, while sticking to the overriding goal of currency stability. He later says Norway should aim over time to get Norwegian inflation down to euro zone levels of 2.0 percent.

* March 29, 2001 - Norway, dropping the target of currency stability, says it will set an inflation target of 2.5 percent and increase use of oil cash in the economy.