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Monetary policy & unemployment
Econ 4325 - Monetary policy and business fluctuations
Guest lecture
UiO, February 26 2007
Harald Magnus Andreassen
[email protected]
Some good advices
Read history
Read economic & financial history
Read history on economic theory (development)
Don’t trust old truths nor old people,
and even less new truths – and not mine
2
First Securities ASA
 Brokerage/investment bank/merchant bank
 Equities, corporate
 Merchant bank – with Swedbank, trading all sorts of int. rate/fixed income
instruments
 160 employees
 22 analysts (the best &…)
 7- 8% + af revenues on Oslo Stock Exchange
 We are better bean counters, than dreamers
 We give goods advices
 Our clients appreciates us
 We hire business economists all the time, and economists from time
to time. Our trainee-program works!
3
The real proof of the pudding:
First portfolios
1,600
1,400
Weekly Port.
This should not have been possible!
1,200
1,000
Buy
800
600
400
Monthly port.
200
OSEBX
Sell
Jan-99
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
Firsts anbefalinger
Oslo Børs
(OSEBX)
1999
2000
2001
2002
2003
2004
2005
2006
Samlet siden 99
Siden 2001
4
Mndport.
Kjøp
Salg
18%
-2%
-15%
-31%
49%
35%
42%
31%
26%
6%
-1%
-23%
43%
36%
52%
37%
46%
40%
6%
-9%
54%
47%
105%
44%
-1%
-9%
-51%
-52%
26%
21%
8%
8%
156%
307% 1223%
-62%
121%
205% 543% -58%
Ukeport.
30%
1%
32%
88%
103%
59%
949%
The business cycle & markets
 The stock market
 The bond market
5
Long term: Real fundamentals decide
A Tobins q, calculated from the balance sheet
6
The Oslo Stock exchange is volatile, it must be oil…
500
90
450
80
400
70
350
60
Brent
50
Index
300
250
40
200
30
150
20
USD/Barrel
OSEBX and the oil price
S&P 500 and OSEBX Sector Distribution, July 2006
S&P 500
Financials
OSEBX
100
10
OSEBX/Synthetic Index
IT
Industrials/Other
Cons Disc
50
0
96
97
98
99
00
01
02
03
04
05
06
07 08
Source: Reuters EcoWin
Healthcare
Energy
Cons Staples
Utilities
Telecom
Materials
0%
7
10 %
20 %
30 %
40 %
50 %
But wait a bit: OSE is even more dependent on aluminium
or India??
OSEBX and Aluminum
400
Aluminium
OSEBX and Bombay SE Index
USD/tonne
Index
200
15000
500
450
12500
400
Bombay SE Index
350
10000
Index
OSEBX
7500
Index
300
250
100
1200
97
98
99
00
01
02
03
04
05
06
07 08
200
5000
Source: Reuters EcoWin
150
2500
100
50
0
97
98
99
00
01
02
03
04
05
06
07 08
Source: Reuters EcoWin
8
In the end: The OSE is dependent on the cycle abroad!
India (China)
Global
growth
Oil
Raw. Mat
alum.
OSE
9
Shipping
A big swinger
Oslo Børs Pris/Bok
108
2.75
106
2.50
2.25
104
2.00
102
1.75
100
1.50
98
1.25
96
1.00
94
0.75
86
88
90
92
94
96
98
00
02
04
06
Source: EcoWin, First Securities
10
A quite close connection
11
The stock market vs. actual earnings
Oslo Børs: Indeks vs. inntjening pr aksje
320
EPS
11.2
160
Indeks
5.6
80
2.8
40
1.4
20
0.7
10
84
86
88
90
92
94
96
98
00
02
04
OSEBX
Recurring EPS
22.4
06
Source: EcoWin, First Sec.
Not only a long term connection!!
12
Interest rates vs the cycle. Not that difficult??
13
For investors: The long end vs. the short end
14
Asset allocation: The cycle is important!
15
What am I looking at?
 Demand cycles (”Keynes”)
 C, I, G-T, X-M
 Supply cycles (Real business cycle)
 What’s most important?
 Markets are mostly “Keynesian” (animal spirit, risk appetite, financial
condition, monetary/fiscal policy impulses/responses)
 Late followers of fashion? Or realistic, what works?
16
What’s driving the cycle
1 Bad times
2 Soft landing
3 ’Happy’ days
17
G-T, quite important – with the ‘right’ sign!
 Keynes is of course dead, but…
18
Not only in the US
19
Not only in the US…
20
The supply side
Short term cycles: Capacity utilisation
Long term cycels: Technology ++
21
When does the cycle turn down?
1) Shortage of labour – wage inflation, price inflation
 Central banks are forced to hike (too much)
 Corporate profits squeezed
2) Private or public sector spending cuts (also without higher rates)
 Corporate over investments, on borrowed funds
 Inventory cycles
 Too low household savings
 Public deficits
3) Bad luck (wars, terror, plague or cholera, or an oil chock)
22
A global fall in the unemployment rate
 Growht has beem well above trend everywhere
23
The world is new!
World GDP
Developed vs. emerging markets
7.0
Contribution from rich countries and poor,of which China
6.0
5.0
4.0
3.0
2.0
1.0
0.0
-1.0
65
24
70
75
80
85
90
95
00
05
10
But how new is the world??
25
A new world? The short term Phillips curve
26
A new world?
Normal/low productivity growth
High wage inflation
High growth in unit labour cost
High GDP inflation
.. and core CPI inflation well above
normal
USA Productivity, nonfarm business sector
12.5
12.5
q/q, annual rate
10.0
10.0
7.5
5.0
7.5
y/y
5.0
2.5
2.5
0.0
0.0
-2.5
-2.5
-5.0
-5.0
-7.5
-7.5
78 80 82 84 86 88 90 92 94 96 98 00 02 04 06
Source: EcoWin, First Securities
27
Still not any disaster!!
USA KPI Energipriser vs. andre priser
15.0
50
KPI samlet
40
12.5
KPI eks energi
Energi
10.0
30
20
7.5
10
5.0
0
2.5
-10
0.0
65
-20
70
75
80
85
90
95
00
05
Source: EcoWin, First Securities
28
.. And the Fed is not that preoccupied with the CPI
29
… it’s the economy, stupid!
30
The cycle, business surveys are more important
US - ISM vs. Fed funds
When does the Fed start cutting?
65.0
65.0
ISM
62.5
62.5
60.0
60.0
57.5
57.5
55.0
55.0
52.5
52.5
50.0
50.0
o
47.5
o
o
45.0
47.5
45.0
o
42.5
42.5
40.0
40.0
Fed cutting shaded
37.5 FIRST
37.5
7
7
Fed funds - 5y CPI
4
4
1
1
-2
-2
85
87
89
91
93
95
97
99
01
03
05
07
Source: EcoWin, First Securities
31
By the way: What drives earnings expectations?
32
EMU: Falling unemployment but still low wage inflation
33
EMU: Low wage inflation, low cost inflation, low inflation
34
Interest rates are on their way up but still low?
36
More liquidity in the system
37
Some asset inflation
38
What if?
39
Somewhat interconnected?
 However: Inflation is not a common problem, not imbalances
 China, India much more important than before
40
Some others are still saving!
Household net financial investment
Husholdningens
finansinvesteringer,
anslag
Estimates based on saving
ratios, housing investments
15.0
15.0
12.5
12.5
Japan
10.0
10.0
Germany
7.5
7.5
5.0
5.0
2.5
2.5
0.0
0.0
-2.5
-5.0
First
USA
-2.5
-5.0
80 82 84 86 88 90 92 94 96 98 00 02 04
Source: EcoWin, First Securities
41
A special case?
BNP OECD vs. Fastlands-Norge
6
6
Vekst år/år
5
5
4
4
3
3
2
2
1
1
0
0
-1
-1
-2
-2
-3
FIRST
-3
78 80 82 84 86 88 90 92 94 96 98 00 02 04 06
Source: EcoWin, First Securities
 Hvilken strek er et snitt av 30 OECD-land
 Hvilken strek er en liten åpen, oljeavhengig…. økonomi?
42
A special case?
BNP OECD vs. Fastlands-Norge
6
6
Vekst år/år Fastlands-Norge
5
5
4
4
3
3
2
2
OECD
1
1
0
0
-1
-1
-2
-2
-3 FIRST
80 82
-3
84
86
88
90
92
94
96
98
00
02
04
06
Source: EcoWin, First Securities
43
The economy is firing on all cylinders
Private demand
6%
Deviation from trend, % of Mainland GDP
Mainland business
4%
Households
2%
0%
-2%
Petroleum inv.
-4%
-6%
1979 1982 1985 1988 1991 1994 1997 2000 2003 2006
44
Fiscal policy: Slightly expansionary
7.0
Structural budget deficit ex. oil
vs spedning rule
And will remain so
In per cent of GDP
6.0
5.0
Actual deficit
4.0
3.0
2.0
Oil revenue spending rule
1.0
0.0
1995
1997
1999
2001
2003
2005
2007
2009
Sources: Ministry of Finance, First
Norway - Fiscal policy
vs. GDP (Mainland)
Per cent
4
Change in deficit in
per cent of GDP *)
2
0
-2
-4
Output gap (OECD/FIRST)
-6
1980
1985
1990
*) Change in ex. oil structural deficit
Sources: Ministry of Finance, OECD
45
1995
2000
2005
2010
’G’ not that important vs. the private sector
Privat og offentlig etterspørsel
10%
Avvik fra trend, % av Fastlands-BNP
8%
10%
Forbruk + investeringer, inkl olje
8%
6%
6%
4%
2%
46
4%
Offentlig
etterspørsel
2%
0%
0%
-2%
-2%
-4%
-4%
-6%
-6%
First
-8%
1980 1984
-8%
1988
1992
1996
2000
2004
2008
Savings: The flip side of spendings
The credit market important?
Liberalised credit in the 80’ies, ultra low rates now?
47
Strong credit growth, house price boom
Fuelled by historically low
interest rates!
House prices vs. Norges Bank's forecasts
20
20
yoy growth %
15
15
10
10
5
5
NB's forecasts
0
0
-5
-5
01
02
03
04
05
06
07
08
09
Source: EcoWin, First Securities
48
Seen it before?
49
It might be a new world. But it might bee too low rates too.
Household debt, Norges Bank's f'casts
260
Debt in % of disp. income ex. insurance int. income
Forecasts from Financial Stability Reports
FS 06/2
240
220
FS 06/1
200
FS 05/2
FS 04/2
180
FS 03/2 - high
FS 03/2
160
140
120
First/Norges Bank
100
1980
50
1985
1990
1995
2000
2005
2010
Some asset inflation
51
Housing starts at 23 year high
Housing starts vs. order book
175
37.5
Real orders: Adjusted for cost of building
35.0
150
32.5
30.0
125
27.5
Orders, volume
100
25.0
22.5
75
20.0
17.5
50
15.0
Housing starts
25
12.5
88
90
92
94
96
98
00
02
04
06
Source: EcoWin, First Securities
52
Capacity utilisation is record high!
Norway Resource shortages in manufacturing
55
55
Indicator & trend, seas. adj
50
50
45
45
40
40
35
35
30
30
25
25
20
20
15
15
SSB/First
10
84
Output gap
Deviation between actual and potential production
4 % of potential GDP
3
2
1
0
-1
-2
-3
-4
-5
-6
70
75
80
4
3
2
1
0
-1
-2
-3
-4
-5
-6
Norges Bank
Ministry of Finance
90
95
00
05
10
Source: EcoWin, First Securities
53
10
88
90
92
94
96
98
00
02
04
06
Source: EcoWin, First Securities
OECD
85
86
Remarkable improvement in the labour market
Norway Employment
2.39
In millions
2.32
2.25
2.18
2.11
2.04
1.97
4
2
0
-2
-4
2.39
2.32
2.25
2.18
2.11
2.04
1.97
Labour market is tight, despite
dynamic labour immigration
4
2
0
-2
-4
Change % y/y
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06
Source: EcoWin, First Securities
Norway - Labour market
9
1.1
In %
Unemployment, incl. measures
8
0.9
7
Open unemployment rate at 18
year low
1.0
0.8
6
0.7
5
0.6
4
0.5
0.4
3
0.3
2
0.2
Vacancies
1
0.1
84
86
88
90
92
94
96
98
00
02
04
06
Source: EcoWin, First Securities
54
% y/y
Consequently: Wage growth is definitely picking up
Norway: Wages vs. the labour market
Vacancies/unemployed vs. wage growth
Quarterly statistics, National
accounts & tax payments
indicates wage growth on
the rise
12
11
10
9
8
7
6
5
4
3
2 no\v-u-lonn
80 82 84
0.8
0.7
0.6
0.5
V/U ratio
Wages "TRC"
0.4
0.3
0.2
Est.
0.1
FIR
0.0
86
88
90
92
94
96
98
00
02
04
06
08
Source: EcoWin, First Securities
Norway - Wage inflation, private sector
9
9
Wage cost per hour (Nat. acc)
8
7
8
7
Annual wage (TRC)
6
6
5
5
Est
4
4
Wage index, average
3
3
2
2
98
99
00
01
02
03
04
05
06
07
08
Source: EcoWin, First Securities
55
Norway Unemployment
vs. wage inflation 1994 - 2007
10
Change y/y
Wage inflation (TBU)
10
6.5
6.0
5.5
First est
est.
5.0
4.5
4.0
3.5
2007
2006
Norges Bank est
(incl. pensions).
3.0
2.5
2.0
2005
1994
1.0
2.0
3.0
4.0
Unemployment (Aetat)
5.0
6.0
Productivity might be slowing down,
unit labour cost no doubt increasing
Norway Mainland GDP, productivity
8 y/y, smoothed
7
6
5
4
3
2
1
0
-1
-2
-3
80 82 84 86 88
Mainland GDP, business ex energy
Productivity (GDP/hours worked)
90
92
94
96
98
00
02
04
06
8
7
6
5
4
3
2
1
0
-1
-2
-3
08
Source: EcoWin, First Securities
Norway - Unit labour cost vs. CPI
15.0
Less reason to woory about
’too low’ inflation
12.5
10.0
CPI/CPI-ATE
Growth y/y
15.0
12.5
10.0
Unit lab. cost business x energy
7.5
7.5
5.0
5.0
2.5
2.5
0.0
0.0
-2.5
78 80 82 84 86 88 90 92 94 96 98 00 02 04 06
-2.5
Source: EcoWin, First Securities
56
We know Norges Bank’s reaction function
Norges Bank rate vs. unemployment
4.5
1
Norges Bank deposit rate, scale inverted
2
4.0
3
3.5
4
5
3.0
6
7
2.5
8
Unemployment, NAV %
2.0
97
98
99
00
01
02
03
04
05
06
9
07
08
Source: EcoWin, First Securities
57
Norges Bank behind the curve?
Mind the gap!
The monetary policy dilemma
 High GDP growth, the supply side has turned out to be more flexible
than assumed
 Strong growht in credit and house prices
 … but inflation has been low, and well below target
 An now, pressure on capacity is no doubt strengthening
 Lower unemployment, increasing wage growth
 … but inflation remains far below target
What should Norges Bank then do?
58
”The problem”: Inflation is too low
Norway Inflation measures
Change y/y
Mainland GDP deflator ex energy
Headline CPI
5
5
Is inflation too low?
4
4
Really?
3
3
2
2
1
1
0
0
CPI-AT
-1
-2
-1
Sources: SSB, First
96
97
98
99
-2
00
01
02
03
04
05
06
07
Source: EcoWin, First Securities
59
Bom, falleri, falleri, bom, bom
Norges Bank CPI-ATE estimates
3.0
IR 2/02
2.5
IR 3/02
IR 3/03
IR 1/04
IR 2/04 IR 1/05
IR 3/05
IR 1/03
2.0
IR 2/05
IR 2/03
1.5
IR 1/06
IR 2/06
1.0
IR 3/06
0.5
Outcome
IR 3/04
IR = Inflation Report
-0.5
jan.02
60
jan.03
jan.04
jan.05
jan.06
jan.07
jan.08
Inflation expectations on the rise
Expected inflation 2 - 5 years ahead
3.00
Average economists, businesses and employer's org
2.75
2.50
Kilde: tns Gallup/Norges Bank
2.25
Companies pricing plans
1 kv 02
1 kv 03
1 kv 04
1 kv 05
1 kv 06
35
30
Net share of companies that report prices will rise faster
25
20
15
10
5
0
-5
Source: tns Gallup/Norges
Bank
-10
1 kv 02
61
1 kv 03
1 kv 04
1 kv 05
1 kv 06
High capacity utilisation, higher
inflation
Norges Bank is trying!
Norwegian interest rate(s)
16
Average
12
8
4
Kilde: Norges Bank/First
0
1820
62
1840
1860
1880
1900
1920
1940
1960
1980
2000
Even so, Norge Bank is speeding up
Norges Banks rate projections
Inflation reports in 2006
5.50
5.50
IR 3 2006
5.00
5.00
IR 2 2006
4.50
4.50
4.00
4.00
IR 1 2006
3.50
3.50
3.00
3.00
2.50
2.50
2.00
2.00
1.50
1.50
04
05
06
Norges Bank rate
07
08
09
Source: EcoWin, First Securities
63
… but the bank is way behind the curve?
Interest rates and growth
11
10
9
8
7
6
5
4
3
2
1
Nominal GDP-growth (Mainland)
Nov 06
Mar 06
3 m. money market rate
Norges B's paths
11
10
9
8
7
6
5
4
3
2
1
94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09
Source: EcoWin, First Securities
64
Norges Bank policy rate at relatively low levels
Central bank rates
8
7
Low relative to other countries…
8
New Zealand
Norway
7
6
6
AUS
5
5
UK
4
4
USA
3
3
EMU
2
2
Sweden
1
0
Norges Bank policy rate
8.0
7.0
7.0
Neutral rate estimat
5.0
4.0
4.0
3.0
3.0
2.0
2.0
NB projection IR 3/2006
FIRST
95
96
97
98
99
00
01
02
03
04
05 06
07
08
1.0
09
Source: EcoWin, First Securities
65
01
02
03
04
05
06
07
Source: EcoWin, First Securities
6.0
5.0
1.0
0
00
8.0
6.0
1
…and relative to “normal” levels
A stable connection?
NOK TWI vs. interest rate diff.
94
0.8
95
NOK TWI
96
0.6
97
0.4
98
99
0.2
100
0.0
101
-0.4
Jan
66
102
2 y swap vs. trading partners
-0.2
103
104
Apr
Jul
05
Oct
Jan
Apr
Jul
06
Oct
Jan
07
Source: EcoWin, First Securities
But what about the exchange rate?
 We don’t need 4 pp more than the others this time
 The NOK is not strong; the world, the corp sector & the stock
market is
 The oil prce is higher, we ‘need’ a stronger currency
67
In December 2002: Norway at the top
Pengemarkedsrente
12
11
10
9
8
7
6
5
4
3
2
1
0
12
11
10
9
8
7
6
5
4
3
2
1
0
Desember 2002
SVE
NOR
EMU
CAN
UK
USA
AUST NEW Z ISL
Source: EcoWin, First Securities
68
Now: Norway is close to the bottom
Pengemarkedsrente
12
11
10
9
8
7
6
5
4
3
2
1
0
12
11
10
9
8
7
6
5
4
3
2
1
0
SVE
NOR EMU CAN
UK
USA AUST NEW Z ISL
Source: EcoWin, First Securities
69
What is important for the NOK exchange rate now?
NOK vs. oil, interest rates
90.0
90.0
Model, est from 2005
95.0
95.0
100.0
100.0
105.0
105.0
110.0
NOK actual (TWI)
FIRST
-15.0
110.0
-15.0
Oil price contribution
-10.0
-10.0
-5.0
-5.0
0.0
0.0
Interest rate contribution
5.0
02
03
04
05
06
5.0
07
Source: EcoWin, First Securities
2 år swap rate differanse: 1pp diff + 2% on NOK
70
71
Conclusions – monetary policy
 The Norwegian economy is over stimulated by the strongest world
ec. growth in 40 years and the lowest interest rate in 200/60 years
+ an oil boom
 The labour market is tightening rapidly, wage inflation in the rise
 Even if immigration is record high
 Unusual rapid increase in credit & house prices show that
borrowing cost is low
 A substantial fall in private sector savings
 Inflation is low, and might remain low (we expect it up)
 But is low inflation enought to keep rates well below a neutral rate?
NO! Risk analysis is important!
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