14 - A Decade of Crises and Reforms, 1986–1998

Summary

Introduction

The year 1986 can easily be singled out as one of the most important defining moments in the newer monetary history of Norway. The year witnessed the inglorious end of the devaluation decade followed by decisive steps taken to restore a credible monetary anchor. By the end of the year, bank rate setting had returned to Norges Bank and had been defined as a monetary instrument to be used to maintain the renewed commitment to fixed exchange rates. For the first time since 1945, the central bank had a clear monetary stability mandate and was entrusted with the means to achieve that end.

The perception of 1986 as defining is a product of hindsight, a consequence of how the monetary authorities managed to stick to the course set out that year. Such an outcome was not inevitable. Following the fall in oil prices, the years 1987–1993 turned out to be the bleakest since the interwar period with sluggish growth, falling investments and substantial unemployment. On top of this, the reckless credit expansion and bad banking following the partial deregulation of financial markets in the first half of the 1980s turned sour. Property prices, inflated by the earlier lending boom, fell sharply.

In the banking crisis of 1988–1993, following substantial losses, the major commercial banks were taken over and recapitalised by the government. In such a macroeconomic landscape, maintaining a fixed exchange rate necessarily brought hardship to many. A distinctive procyclical policy was made even worse after 1990 as the leading economy of Europe, Germany, increased interest rates in the aftermath of its reunification. Moreover, a tax reform effective from 1992 reduced the effect of interest rate deductions. Consequently, this increased real interest rates after taxes even further to their peak level, which was reached in 1993.

Staying the course undoubtedly carried a high cost. In the face of substantial opposition from both within own ranks and the trade union movement, the social democratic government showed resoluteness. There was no turning back and the government came to spearhead the move towards more liberal, market-oriented policies. By 1990 the last remnants of the postwar policy model, including capital controls, had been removed.