Given the large deviation from the "4% rule" in 2009 and 2010, sizeable subsequent tightening of the fiscal stance is desirable for both macroeconomic management and medium-term fiscal sustainability. Monetary policy tightening has already started and should continue for some time, as the economy recovers, the labour market tightens and inflation expectations edge up. Policies to improve public spending efficiency should be pursued further, helping fiscal consolidation for the years to come.
A relatively mild recession
The recession was short-lived in Norway and much less severe than in most other OECD countries. Mainland activity was boosted by the sizable fiscal stimulus and dramatic reduction of interest rates. The authorities also took important measures to provide liquidity and equity capital in the banking system, thus easing credit conditions. Private consumption growth resumed in the second quarter of 2009, while government investment supported activity in the construction sector. Unemployment has barely increased, partly thanks to specific government measures, but also because of a reversal of migration flows, though the size of the latter is not known with certainty. This, together with relatively high wage growth and an increase in transfers to households, has supported private demand. The rebound in off prices has led to sustained investment in the petroleum sector, boosting both mainland activity and the prospects for recovery. The inflation picture was quite mixed during the first half of the year, with a positive impulse coming from growing labour costs and the lagged effects of the krone depreciation. More recently inflation pressures eased as the exchange rate appreciated.
Saving is failing again
Norwegian households are highly indebted and nearly all their borrowing is at a floating interest rate. The transmission of monetary policy to consumer spending is thus particularly rapid. Against a backdrop of an unchanged or even declining supply of dwellings, house prices have increased rapidly since December 2008, and have now surpassed the peak reached in 2007. Growth in household debt has slowed substantially but borrowing has not fallen, despite the deterioration of the economy. Credit conditions for the business sector are somewhat less favourable; the global recovery under way is still sluggish and access to credit has not improved as strongly as for households.
Policy tightening is highly desirable
Overall the financial system was quite resilient to the crisis. Both banks' losses and the need to raise new capital have been quite small by the standards of many OECD countries. This, together with the projected swift recovery of the economy, justifies an early and ambitious exit strategy for both fiscal and monetary authorities. Following strong fiscal expansion in 2009 and a further budgetary stimulus in 2010, the medium-term prospects for public finances are well out of line with the fiscal framework (the "4% rule"). Strong fiscal consolidation is therefore required. Given the prospects for recovery, and since fiscal policy will remain expansionary in 2010, monetary tightening has already begun and will continue for some time, unless downside risks to growth materialise. Such tightening should head off an increase in inflation expectations as unemployment stops rising and import prices stop falling. Finally, the implications for activity of the strong in crease in house prices, in a context where the prices-to-rent and prices-to-income ratios are well above long-run averages, should also be carefully taken into account by the central bank. Containing what may be excessive price increases argues for tighter policy. The winding down of special short-term and long-term liquidity measures has started, as markets are returning to normal and the increase in structural liquidity demand will be met by government's deposits at the central bank.
There is still downside risk in shipping and commercial property
The recovery of global trade, oil and commodity prices will shape the prospects for the Norwegian economy. Downside risks have diminished, but possible negative shocks to the shipping sector's activity may further depress banks' profitability, given their large exposure to this business. Similarly, defaults on loans to the commercial property sector may increase. Given the large sustained fiscal stimulus amid an output gap which is closing fast, inflation pressures could be stronger than projected here and require more and faster monetary tightening.
Norway: Demand, output and prices 2008 2007 2008 2009 2010 2011 Current Percentage changes, volume prices (2006 prices) NOK billion Private consumption 881.8 6.0 1.4 0.0 4.4 4.5 Government consumption 413.0 3.4 3.8 5.9 3.2 2.3 Gross fixed capital 424.2 8.4 3.9 -3.9 0.4 5.3 formation Final domestic demand 1 718.9 6.0 2.6 0.4 3.1 4.1 Stockbuilding (1) 5.1 -0.7 0.7 -1.6 0.0 0.0 Total domestic demand 0.2 5.0 3.3 -1.7 3.0 4.2 Exports of goods and 0.1 2.5 1.4 -7.8 -0.4 2.6 services Imports of goods and 612.8 7.5 4.4 -11.5 4.3 5.4 services Net exports (1) 389.7 -0.9 -0.7 -0.5 1.3 -0.3 GDP at market prices 2 159.6 3.1 2.1 -1.4 1.3 3.2 GDP deflator 2.2 9.6 -3.3 3.7 2.9 Memorandum items Mainland GDP at market -- 6.1 2.6 -1.2 2.8 3.2 prices (2) Consumer price index -- 0.7 3.8 2.3 1.6 2.2 Private consumption -- 0.7 3.9 2.9 1.7 2.2 deflator Unemployment rate -- 2.5 2.6 3.3 3.7 3.5 Household saving -- 0.4 2.0 3.3 2.0 2.0 ratio (3) General government 17.7 18.8 9.6 9.9 10.8 financial balance (4) Current account -- 15.9 19.4 17.4 18.6 18.1 balance (4) Note: National accounts are based on official main-linked data. This introduces a discrepancy in the identity between real demand components and GDP For further details see OECD Economic Outlook Sources and Methods (http://www.oecd. org/eco/sources-and-methods). (1.) Contributions to changes in real GDP (percentage of real GDP in previous year), actual amount in the first column. (2.) GDP excluding oil and shipping (3.) As a percentage of disposable income (4.) As a percentage of GDP. Source: OECD Economic Outlook 86 database. StatLink http://dx.doi.org/10.1787/753825125401