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Financial stability, asset prices and monetary policy Svein Gjedrem Central Bank Governor Centre for Monetary Economics 3 June 2003 Objectives • Price stability - Clear definition • The interest rate as an instrument • Financial stability - More difficult to define • Financial instability – Volatile asset prices – Failure in the functioning of financial institutions/markets 1 180 Debt in municipalities, non-financial institutions and households as a percentage of nominal GDP. 1890-2002 180 150 150 120 3) 1) 90 2) 3) 90 2) 60 60 30 30 0 1890 1) 120 0 1910 1930 1950 1970 1990 The increase in 1960 is partly due to a downward revision of GDP in connection with the transition to a new national accounting standard The marked fall in 1970 is due to an upward revision of GDP in connection with the transition to a new national accounting standard. C3 mainland Norway as a percentage of mainland GDP is used as from 1995. Sources: Norges Bank and Gerdrup (2003) Twelve-month rise in bank lending at year-end deflated by the rise in the consumer price index Per cent. 1890-2002 60 60 Commercial banks 45 45 Savings banks 30 30 15 15 0 0 -15 -30 1890 -15 -30 1910 1930 1950 1970 1990 Sources: Statistics Norway, Gerdrup (2003) and Norges Bank 2 Growth in real GDP 1) Percentage change on previous year. 1865-2001 20 20 15 15 10 10 5 5 0 0 -5 -5 -10 1865 1) -10 1885 1905 1925 1945 1965 1985 Private sector, mainland Norway, from 1970 Sources: Statistics Norway and Norges Bank Fixed investment1) Annual percentage change. 3-year moving average 1865-2000 20 20 15 15 10 10 5 5 0 0 -5 -5 -10 -10 -15 -15 -20 1865 -20 1) 1885 1905 1925 1945 1965 1985 Private sector, mainland Norway, from 1970 Sources: Statistics Norway and Norges Bank 3 Relationship between asset prices, debt and the real economy Consumer price inflation Investment Asset prices Credit Employment Output Wages and margins Consumption Household gross financial assets, housing wealth and debt. Percentage of disposable income Housing wealth 250 200 250 200 Gross fin. assets 150 Debt 150 100 Gross fin. assets excl. insurance claims 100 50 1984 50 1987 1990 1993 1996 1999 2002 Source: Norges Bank 4 The traditional view • No emphasis on asset prices and debt accumulation beyond the effect they have on price inflation • Uncertain when financial imbalances will be triggered • Identification is difficult • Can monetary policy reduce the build-up of imbalances? Low inflation not sufficient • Bubbles develop without a rise in inflation: - Credible monetary policy - Increased competition - Supply-side factors (productivity) • Financial imbalances may influence inflation in the medium term • A monetary policy that at times leans against the wind with regard to developments in credit growth and asset prices 5 Norges Bank Watch 2001 • “The first and main stage is flexible inflation targeting…..” • “The additional stage consists of monitoring credit aggregates. It requires the central bank to monitor a number of credit aggregates, and to intervene and possibly to overrule the signals given by the first stage. One would expect that this would not happen frequently. In normal times it will remain unused.” Source: Norges Bank Watch 2001 Bank of England • “An interest rate reduction seemed likely at present predominantly to affect house prices, household borrowing and consumption, which were already increasing strongly. A further reduction in the repo rate risked creating an unsustainable increase in debt which might subsequently unwind sharply. This would increase the risk of undershooting the inflation target in the medium term.” Source: Minutes of the Monetary Policy Committee Meeting, 9 and 10 October 2002, Bank of England 6 Household debt burden Loan debt as a percentage of disposable income 180 180 160 160 140 140 120 120 100 1987 100 1989 1991 1993 1995 1997 1999 2001 Source: Norges Bank Household debt as a percentage of disposable income 180 180 Denmark 160 Norway 140 120 160 140 120 UK 100 US Sweden 80 1990 1992 1994 1996 1998 2000 100 80 2002 Sources: Sweden’s Riksbank, Danmarks Nationalbank, OECD and Norges Bank 7 Household debt as a percentage of gross financial assets and housing wealth 60 60 50 50 40 Norway Sweden 30 40 30 Denmark 20 UK 20 10 US1) 10 0 1990 0 1992 1994 1996 1998 2000 2002 1) Non-financial assets are used instead of housing wealth for US Sources: Sweden’s Riksbank, Danmarks Nationalbank, Bank of England, OECD and Norges Bank House prices deflated by the building cost index and annual wage index. Index, 1987=100. 150 150 Deflated by the building cost index 125 100 125 100 Deflated by the annual wage index 75 75 50 50 25 25 0 0 1987 1989 1991 1993 1995 1997 1999 2001 Source: Norges Bank 8 Debt burden in non-financial enterprises excl. petroleum and shipping 800 As a percentage of cash surplus1) excl. interest expenses 800 700 700 600 600 500 500 400 400 300 300 200 200 1987 1) 1989 1991 1993 1995 1997 1999 2001 Cash surplus = Value added - labour costs + net capital income Sources: Statistics Norway and Norges Bank Credit gap: Debt in municipalities, non-financial institutions and households as a percentage of GDP – difference between actual observations and trend 1). Percentage points 24 24 16 16 8 8 0 0 -8 -8 -16 -16 -24 -24 -32 -32 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 1) Trend is calculated using a rolling HP filter (λ=1600), according to the method of Borio and Lowe (2002). Calculated using annual data from 1899. Mainland C3 as a percentage of mainland GDP is used as of 1995 Sources: Gerdrup (2003) and Norges Bank 9 Developments in number of bankruptcies, employment and sales value of bankrupt companies. Index 350 350 Sales 300 value1) 300 Number of bankruptcies 250 250 200 200 150 150 100 Number employed1) 50 50 1) Turnover 2) 0 1995 1996 and employment in last normal operating year Annualised figures based on Q1 2003 1997 1998 1999 2000 2001 100 0 2002 2003 2) Source: Statistics Norway Gross non-performing loans, by sector. All banks. In billions of NOK 3.5 3.5 3 3 2.5 2.5 2 2 Other sectors 1.5 1.5 1 0.5 0 1997 1 Corporate sector 0.5 Household sector 1998 1999 2000 2001 2002 0 2003 Source: Norges Bank 10 Trade-weighted exchange rate index (TWI) and three-month interest rate differential July 1999 – May 2003 5 4 90 95 Interest rate differential, (left-hand scale) 3 100 TWI, (right-hand scale1) ) 2 1 0 1999 Source: Norges Bank 105 110 115 2000 2001 2002 1) 2003 A rising curve denotes an appreciation of the krone 11