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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! 72