Monetary policy

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Monetary policy unemploymentEcon 4325 -
Monetary policy and business fluctuationsGuest
lectureUiO, February 26 2007

• Harald Magnus Andreassen
• hma_at_first.no

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Some good advices

• Read history
• Read economic financial history
• Read history on economic theory (development)
• Dont trust old truths nor old people, and even
  less new truths and not mine

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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!

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The real proof of the pudding
This should not have been possible!
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The business cycle markets

• The stock market
• The bond market

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Long term Real fundamentals decide
A Tobins q, calculated from the balance sheet
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The Oslo Stock exchange is volatile, it must be
oil
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But wait a bit OSE is even more dependent on
aluminiumor India??
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In the end The OSE is dependent on the cycle
abroad!
India (China)
Global growth
Raw. Mat alum.
Oil
Shipping
OSE
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A big swinger
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A quite close connection
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The stock market vs. actual earnings
Not only a long term connection!!
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Interest rates vs the cycle. Not that difficult??
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For investors The long end vs. the short end
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Asset allocation The cycle is important!
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What am I looking at?

• Demand cycles (Keynes)
• C, I, G-T, X-M
• Supply cycles (Real business cycle)
• Whats 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?

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Whats driving the cycle
1 Bad times 2 Soft landing 3 Happy days
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G-T, quite important with the right sign!

• Keynes is of course dead, but

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Not only in the US
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Not only in the US
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The supply side
Short term cycles Capacity utilisation Long term
cycels Technology
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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)

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A global fall in the unemployment rate

• Growht has beem well above trend everywhere

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The world is new!
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But how new is the world??
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A new world? The short term Phillips curve
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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

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Still not any disaster!!
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.. And the Fed is not that preoccupied with the
CPI
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its the economy, stupid!
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The cycle, business surveys are more important
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By the way What drives earnings expectations?
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EMU Falling unemployment but still low wage
inflation
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EMU Low wage inflation, low cost inflation, low
inflation
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Inntjeningsforventingene ikke så utsatt i EMU?
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Interest rates are on their way up but still low?
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More liquidity in the system
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Some asset inflation
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What if?
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Somewhat interconnected?

• However Inflation is not a common problem, not
  imbalances
• China, India much more important than before

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Some others are still saving!
Husholdningens finansinvesteringer, anslag
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A special case?

• Hvilken strek er et snitt av 30 OECD-land
• Hvilken strek er en liten åpen, oljeavhengig.
  økonomi?

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A special case?
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The economy is firing on all cylinders
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Fiscal policy Slightly expansionary
And will remain so
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G not that important vs. the private sector
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Savings The flip side of spendings
The credit market important? Liberalised credit
in the 80ies, ultra low rates now?
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Strong credit growth, house price boom
Fuelled by historically low interest rates!
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Seen it before?
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It might be a new world. But it might bee too low
rates too.
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Some asset inflation
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Housing starts at 23 year high
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Capacity utilisation is record high!
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Remarkable improvement in the labour market
Labour market is tight, despite dynamic labour
immigration
Open unemployment rate at 18 year low
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Consequently Wage growth is definitely picking up
Quarterly statistics, National accounts tax
payments indicates wage growth on the rise
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Productivity might be slowing down, unit labour
cost no doubt increasing
Less reason to woory about too low inflation
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We know Norges Banks reaction function
Norges Bank behind the curve? Mind the gap!
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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?

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The problem Inflation is too low
Is inflation too low? Really?

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Bom, falleri, falleri, bom, bom
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Inflation expectations on the rise
High capacity utilisation, higher inflation
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Norges Bank is trying!
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Even so, Norge Bank is speeding up
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but the bank is way behind the curve?
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Norges Bank policy rate at relatively low levels
Low relative to other countries
and relative to normal levels
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A stable connection?
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But what about the exchange rate?

• We dont 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

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In December 2002 Norway at the top
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Now Norway is close to the bottom
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What is important for the NOK exchange rate now?
2 år swap rate differanse 1pp diff 2 on NOK
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(No Transcript)
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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!