International Monetary Found. November 22, 2011. Norway’s economy continues to perform well amidst considerable global turbulence. Over the last two years, mainland GDP has grown steadily at an annual pace of 2-3 percent, supported by robust growth in consumer spending and favorable terms of trade developments. Output has now surpassed its pre-recession levels, and unemployment remains low. This solid recovery has been aided by supportive policies, including low interest rates and temporary fiscal stimulus employed during the recession.
2. Going forward, we expect moderately paced growth to continue. Growth in mainland GDP is projected to be around 2½ percent both in 2011 and 2012. Expansion will be driven mainly by domestic demand, given strong wage growth, continued momentum in the housing market, and sluggish growth amongst major trading partners. The closing of the output gap, along with strong wage pressures, should result in a gradual rise in inflation from its current low rates toward the 2½ percent target over the next two years. Over the medium term, growth is expected to rebalance away from domestic demand as macroeconomic policies tighten, the housing market gradually cools, and external demand slowly improves. Under this central scenario, mainland growth over the medium term is projected to be close to its trend rate of 2¾ percent.
3. This relatively benign central scenario is subject to significant risks, including:
• Eurozone economic turmoil. Norway’s economy is better placed than many in Europe to weather an intensification of eurozone stress, given its low sovereign risk and the limited direct exposure of Norway’s banks to the most vulnerable eurozone countries. Nonetheless, severe stress would undoubtedly affect Norway via shaken consumer confidence, lower exports to Europe, lower oil prices, and strains in international interbank markets—a key funding source for Norway’s largest banks.
• Elevated house prices and high household debt. House prices have soared over the last decade and continue to climb at a rapid pace. Although this may partly reflect supply constraints and solid population growth, standard metrics suggest a risk of overvaluation: Norway has the highest house price-to-rent ratio relative to its historical average amongst all OECD economies, and the house price-to-income ratio exceeds levels reached prior to the late 1980s house price crash. A fall in house prices poses a major macroeconomic risk, as it would dampen consumption via wealth effects and reduce residential investment. Moreover, Norway has one of the highest ratios of household debt to disposable income amongst OECD economies. Very high household debt levels imply that a house price drop could also push up default rates and stress banks’ balance sheets.
Near-Term Macroeconomic Policies: A careful policy mix will help reduce risks while supporting growth
4. Macroprudential policies should gradually tighten to reduce risks associated with high household debt and elevated house prices:
• Guidelines introduced by the Financial Supervisory Authority (FSA) in 2010 establishing recommended limits on loan-to-value (LTV) and loan-to-income (LTI) ratios on mortgages, as well as the recent FSA proposal to tighten these limits further, are welcome. However, these limits are not hard caps. As a result, the percentage of loans exceeding the recommended limits continues to rise. More binding limits are thus necessary to achieve the desired reduction in high-risk loans and household indebtedness.
• Minimum risk weights on mortgages should be raised, in coordination with other Nordic countries to limit the risk that such tightening will be undermined by cross-border regulatory arbitrage.
• Banks should also be encouraged to restrain dividends and remuneration, given heightened risks both domestically and abroad and to ensure steady progress toward raising core tier 1 equity to Basel III levels.
5. The broadly neutral fiscal stance for 2012 envisaged in the budget is appropriate, given heightened global risks and conditional on macroprudential tightening. Norway has been well served by its fiscal guidelines, which call for gradual phasing in of petroleum revenues. Within these guidelines and given the closing output gap, fiscal adjustment is needed over the medium term to rebuild precautionary fiscal buffers and to ensure that the guidelines are met on average over the cycle. Medium-term adjustment will also help reduce the large long-run fiscal gap (see below). However, macroprudential and fiscal tightening should be sequenced carefully to avoid excessively contractionary policy, especially given heightened global risks. Of the two, macroprudential tightening is the more pressing near-term priority and should proceed first. Fiscal tightening would be appropriate starting in 2013 under the central scenario.
6. Tighter macroprudential and medium-term fiscal policies should allow monetary policy to stay loose for longer. The contractionary effects from macroprudential and fiscal tightening can be offset by keeping monetary policy looser than it would be otherwise, thereby ensuring that inflation rises to the target by the end of the policy horizon and that the output gap stays closed. Such a mix of relatively tight fiscal and loose monetary policy would also contain risks of excessive exchange rate appreciation and associated competitiveness problems.
7. However, policies should adjust if shocks cause major deviations from the central scenario. Monetary policy should be the first line of defense, as it can react more nimbly. In particular, a sharper-than-expected deterioration of external conditions could necessitate monetary easing. Conversely, if macroprudential tightening does not occur or is ineffective in arresting risks associated with high house price and household debt levels, monetary policy would need to tighten.
Structural Reforms: Promoting economic stability and growth over the longer run
8. Norway faces large long-run fiscal challenges. Oil revenue, as well as non-oil revenue that is indirectly dependent on oil production, is projected to decline over time as a percent of mainland GDP. At the same time, spending on healthcare and age and disability pensions will steadily increase—even after the cost-saving effects of recent pension reforms—due to population aging and the trend increase in demand for healthcare services as a percent of income. In addition, the large drop in real long-term interest rates in major economies over the last decade suggests that the real return on the oil fund may well fall short of the assumed 4 percent for an extended period. Although official long-run budget projections also contain elements of conservatism (e.g., a conservative oil price), on balance these factors indicate that Norway faces a large long-run fiscal gap—likely in excess of 10 percent of mainland GDP by 2060.
9. Addressing this challenge requires continued reform on multiple fronts. To help smooth out the required adjustment, consideration should be given to gradually spending less than 4 percent of the oil fund’s capital. In addition, it will be crucial to build broad public consensus for further entitlement reforms aimed at reducing costs, increasing efficiency, and bolstering employment, while maintaining a strong safety net for those in need. In this regard, recent reforms to enhance monitoring of sick leave benefits, for which enrollment rates are very high by international standards, are welcome. Options for further reform include the following:
• Requiring employers to contribute to longer-term sick leave benefits (currently they contribute only for the first 16 days) to improve their incentives to accept returning workers and to monitor use of longer-term sick leave; this would need to be offset by cuts in employer payroll taxes or a reduction in the days for which employers pay 100 percent of benefits in order to keep overall employment costs unchanged.
• Increasing the use of social security physicians in assessing eligibility for disability benefits in order to promote more uniform assessments and limit abuse.
• Reforming public sector pensions in line with recent reforms of the National Insurance Scheme in order to increase incentives to remain in the labor force.
• Changing the annual increase in pensions from wage growth minus 0.75 percent to the more internationally common practice of CPI inflation. This would yield fiscal savings while preserving the real value of pensions during an individual’s retirement.
10. Tax reforms could bolster financial stability, economic efficiency, and equity:
• The very large implicit subsidies for owner-occupied housing in Norway’s tax code encourage households to accumulate excessive mortgage debt while disproportionately benefiting high-income households. Reducing these subsidies—with offsetting tax cuts elsewhere—would strengthen financial stability while increasing progressivity and economic efficiency. As with macroprudential measures, such reforms would need to be phased in gradually to avoid excessive disruptions to housing markets.
• Tax reforms could also promote financial stability by reducing incentives for excessive leverage in both the financial and nonfinancial corporate sectors. In this regard, one option worth consideration is the introduction of a tax allowance for increases in equity of the non-oil corporate sector. Fiscal space for such a reform could be created by offsetting changes elsewhere in the income tax code.
11. Financial stability may also benefit from establishing a more formal framework for countercyclical macroprudential policy. The key objective of such policy is to mitigate the build-up of systemic risk via the use of targeted instruments, such as time-varying adjustments in capital ratios, LTV limits, LTI limits, and risk weights on assets. In the wake of the global financial crisis, many countries—including Norway— are considering strengthening their institutional set-up for macroprudential policymaking. Good guiding principles for such reforms include to promote operational independence in order to shield macroprudential policy from political cycles, as with monetary policy; to establish clear lines of accountability; to facilitate information-sharing across policymaking institutions; and to bolster the role of the central bank in order to harness its macroeconomic expertise and promote coordination with liquidity management, payment systems oversight, and monetary policy. A number of institutional arrangements could achieve these objectives, including the one recently proposed by Norway’s Financial Crisis Commission, especially if mechanisms are included to ensure robust collaboration between the FSA and the central bank in regard to risk identification and information sharing.
2. Going forward, we expect moderately paced growth to continue. Growth in mainland GDP is projected to be around 2½ percent both in 2011 and 2012. Expansion will be driven mainly by domestic demand, given strong wage growth, continued momentum in the housing market, and sluggish growth amongst major trading partners. The closing of the output gap, along with strong wage pressures, should result in a gradual rise in inflation from its current low rates toward the 2½ percent target over the next two years. Over the medium term, growth is expected to rebalance away from domestic demand as macroeconomic policies tighten, the housing market gradually cools, and external demand slowly improves. Under this central scenario, mainland growth over the medium term is projected to be close to its trend rate of 2¾ percent.
3. This relatively benign central scenario is subject to significant risks, including:
• Eurozone economic turmoil. Norway’s economy is better placed than many in Europe to weather an intensification of eurozone stress, given its low sovereign risk and the limited direct exposure of Norway’s banks to the most vulnerable eurozone countries. Nonetheless, severe stress would undoubtedly affect Norway via shaken consumer confidence, lower exports to Europe, lower oil prices, and strains in international interbank markets—a key funding source for Norway’s largest banks.
• Elevated house prices and high household debt. House prices have soared over the last decade and continue to climb at a rapid pace. Although this may partly reflect supply constraints and solid population growth, standard metrics suggest a risk of overvaluation: Norway has the highest house price-to-rent ratio relative to its historical average amongst all OECD economies, and the house price-to-income ratio exceeds levels reached prior to the late 1980s house price crash. A fall in house prices poses a major macroeconomic risk, as it would dampen consumption via wealth effects and reduce residential investment. Moreover, Norway has one of the highest ratios of household debt to disposable income amongst OECD economies. Very high household debt levels imply that a house price drop could also push up default rates and stress banks’ balance sheets.
Near-Term Macroeconomic Policies: A careful policy mix will help reduce risks while supporting growth
4. Macroprudential policies should gradually tighten to reduce risks associated with high household debt and elevated house prices:
• Guidelines introduced by the Financial Supervisory Authority (FSA) in 2010 establishing recommended limits on loan-to-value (LTV) and loan-to-income (LTI) ratios on mortgages, as well as the recent FSA proposal to tighten these limits further, are welcome. However, these limits are not hard caps. As a result, the percentage of loans exceeding the recommended limits continues to rise. More binding limits are thus necessary to achieve the desired reduction in high-risk loans and household indebtedness.
• Minimum risk weights on mortgages should be raised, in coordination with other Nordic countries to limit the risk that such tightening will be undermined by cross-border regulatory arbitrage.
• Banks should also be encouraged to restrain dividends and remuneration, given heightened risks both domestically and abroad and to ensure steady progress toward raising core tier 1 equity to Basel III levels.
5. The broadly neutral fiscal stance for 2012 envisaged in the budget is appropriate, given heightened global risks and conditional on macroprudential tightening. Norway has been well served by its fiscal guidelines, which call for gradual phasing in of petroleum revenues. Within these guidelines and given the closing output gap, fiscal adjustment is needed over the medium term to rebuild precautionary fiscal buffers and to ensure that the guidelines are met on average over the cycle. Medium-term adjustment will also help reduce the large long-run fiscal gap (see below). However, macroprudential and fiscal tightening should be sequenced carefully to avoid excessively contractionary policy, especially given heightened global risks. Of the two, macroprudential tightening is the more pressing near-term priority and should proceed first. Fiscal tightening would be appropriate starting in 2013 under the central scenario.
6. Tighter macroprudential and medium-term fiscal policies should allow monetary policy to stay loose for longer. The contractionary effects from macroprudential and fiscal tightening can be offset by keeping monetary policy looser than it would be otherwise, thereby ensuring that inflation rises to the target by the end of the policy horizon and that the output gap stays closed. Such a mix of relatively tight fiscal and loose monetary policy would also contain risks of excessive exchange rate appreciation and associated competitiveness problems.
7. However, policies should adjust if shocks cause major deviations from the central scenario. Monetary policy should be the first line of defense, as it can react more nimbly. In particular, a sharper-than-expected deterioration of external conditions could necessitate monetary easing. Conversely, if macroprudential tightening does not occur or is ineffective in arresting risks associated with high house price and household debt levels, monetary policy would need to tighten.
Structural Reforms: Promoting economic stability and growth over the longer run
8. Norway faces large long-run fiscal challenges. Oil revenue, as well as non-oil revenue that is indirectly dependent on oil production, is projected to decline over time as a percent of mainland GDP. At the same time, spending on healthcare and age and disability pensions will steadily increase—even after the cost-saving effects of recent pension reforms—due to population aging and the trend increase in demand for healthcare services as a percent of income. In addition, the large drop in real long-term interest rates in major economies over the last decade suggests that the real return on the oil fund may well fall short of the assumed 4 percent for an extended period. Although official long-run budget projections also contain elements of conservatism (e.g., a conservative oil price), on balance these factors indicate that Norway faces a large long-run fiscal gap—likely in excess of 10 percent of mainland GDP by 2060.
9. Addressing this challenge requires continued reform on multiple fronts. To help smooth out the required adjustment, consideration should be given to gradually spending less than 4 percent of the oil fund’s capital. In addition, it will be crucial to build broad public consensus for further entitlement reforms aimed at reducing costs, increasing efficiency, and bolstering employment, while maintaining a strong safety net for those in need. In this regard, recent reforms to enhance monitoring of sick leave benefits, for which enrollment rates are very high by international standards, are welcome. Options for further reform include the following:
• Requiring employers to contribute to longer-term sick leave benefits (currently they contribute only for the first 16 days) to improve their incentives to accept returning workers and to monitor use of longer-term sick leave; this would need to be offset by cuts in employer payroll taxes or a reduction in the days for which employers pay 100 percent of benefits in order to keep overall employment costs unchanged.
• Increasing the use of social security physicians in assessing eligibility for disability benefits in order to promote more uniform assessments and limit abuse.
• Reforming public sector pensions in line with recent reforms of the National Insurance Scheme in order to increase incentives to remain in the labor force.
• Changing the annual increase in pensions from wage growth minus 0.75 percent to the more internationally common practice of CPI inflation. This would yield fiscal savings while preserving the real value of pensions during an individual’s retirement.
10. Tax reforms could bolster financial stability, economic efficiency, and equity:
• The very large implicit subsidies for owner-occupied housing in Norway’s tax code encourage households to accumulate excessive mortgage debt while disproportionately benefiting high-income households. Reducing these subsidies—with offsetting tax cuts elsewhere—would strengthen financial stability while increasing progressivity and economic efficiency. As with macroprudential measures, such reforms would need to be phased in gradually to avoid excessive disruptions to housing markets.
• Tax reforms could also promote financial stability by reducing incentives for excessive leverage in both the financial and nonfinancial corporate sectors. In this regard, one option worth consideration is the introduction of a tax allowance for increases in equity of the non-oil corporate sector. Fiscal space for such a reform could be created by offsetting changes elsewhere in the income tax code.
11. Financial stability may also benefit from establishing a more formal framework for countercyclical macroprudential policy. The key objective of such policy is to mitigate the build-up of systemic risk via the use of targeted instruments, such as time-varying adjustments in capital ratios, LTV limits, LTI limits, and risk weights on assets. In the wake of the global financial crisis, many countries—including Norway— are considering strengthening their institutional set-up for macroprudential policymaking. Good guiding principles for such reforms include to promote operational independence in order to shield macroprudential policy from political cycles, as with monetary policy; to establish clear lines of accountability; to facilitate information-sharing across policymaking institutions; and to bolster the role of the central bank in order to harness its macroeconomic expertise and promote coordination with liquidity management, payment systems oversight, and monetary policy. A number of institutional arrangements could achieve these objectives, including the one recently proposed by Norway’s Financial Crisis Commission, especially if mechanisms are included to ensure robust collaboration between the FSA and the central bank in regard to risk identification and information sharing.
Describes the preliminary findings of IMF staff at the conclusion of certain missions (official staff visits, in most cases to member countries). Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, and as part of other staff reviews of economic developments.
