JT: Norges Bank has a monetary policy mission to reach "annual consumer price inflation of close to 2% over time", but the policy also stipulates that "…inflationtargeting shall be forward-looking and flexible so that it can contribute to high and stable output and employment and to counteracting the buildup of financial imbalances". How would you describe Norges Bank's thinking and approach to balancing reaching the CPI target with maintaining stability and robust economic activity?
OCBM: In the long run, there is no conflict between low and stable inflation and high and stable employment – on the contrary. The best contribution monetary policy can make to high and stable employment over time is to keep inflation low and stable.
In the short run, however, a conflict may arise between how quickly one should seek to return inflation to target and the aim of high and stable employment. In the day-to-day conduct of monetary policy, Norges Bank’s Monetary Policy and Financial Stability Committee must therefore weigh these two considerations against each other.
The greater the weight the central bank puts on high and stable employment, the longer it will normally take to bring inflation back to the target after a deviation. In its deliberations, the Committee is concerned with balancing the risk of tightening too much against the risk of tightening too little. If it does not tighten monetary policy enough, there is a risk that inflation will be entrenched, and that it will be necessary to raise the policy rate even higher at a later stage to reduce inflation. On the other hand, the Committee wants to avoid a situation where the economy contracts more than what is necessary to bring down inflation. According to our latest forecast, published in December, inflation will fall and approach the target further out. If the Committee’s sole concern had been to rapidly return inflation to the target, it would have set the policy rate higher.
JT: Very generally, how is Norges Bank’s approach to monetary policy (or indeed the overall mandate for the central bank) different from those of the other Nordic central banks? Are there significant differences to the approach of the ECB or the Fed?
OCBM: There are some differences in how the mandates are formulated. We have an inflation target and are also mandated to help keep employment as high as possible and to counter the buildup of financial imbalances. Norges Bank practises flexible inflation-targeting, and the time horizon for seeking to bring inflation back to the target after a deviation is flexible, depending on the shocks to which the economy is exposed.
Comparing monetary policy in Norway with those of central banks such as the Fed, with a dual mandate there is hardly any basis for claiming that Norges Bank places less emphasis on high and stable employment than these central banks do.
Approaches may also differ among central banks according to differences in the transmission of monetary policy into the economy. For instance, in Norway households are highly indebted, which means that interest rate hikes have a large and direct effect. At the same time, almost all mortgages have adjustable-rate mortgages, which means that changes in the policy rate affect mortgage rates with only a few weeks' lag. This makes the policy rate an effective instrument.
JT: Inflation is markedly higher than the target and expectations have increased. How do you assess the risk of a wage-price spiral?
OCBM: We do not believe that there is an imminent danger of a wage-price spiral in Norway. We have a solid tradition whereby the social partners take into consideration firms’ profitability and employment developments in wage negotiations. There may therefore be a reduced need to tighten monetary policy in response to a cost shock than would otherwise have been the case. Last year, prices rose much faster than wages, but we do not assume that this will be compensated for in this year’s wage settlement.
At the same time, in today’s situation we must guard against a rise in inflation expectations with the risk of inflation being entrenched at a high level. That would make it more demanding to bring it down.