15 - Inflation Targeting: Overcoming the Fear of Floating, 1998–2016

Summary

Introduction

By the end of the 1990s, Norway had entered the arguably most prosperous period in its recorded history. The catchphrase ‘richest country in the world’ gained ground and Norway frequently topped international indices of human development. The prosperity or, to be quite precise, the part of its newfound prosperity that made it depart from the northwest European mean originated in the development of the global economy. The rise of China and other Asian tigers rendered Norway with, on one hand, declining import prices for many manufactured items and, on the other hand, a fabulous increase in oil prices, the country's most important export. Between 1998 and 2013, terms of trade improved by 101 per cent.

Only once before had Norway been exposed to a positive terms of trade shock of this magnitude. The sharp improvement in the first years of World War I, however, had soon been arrested. The novelty of 1998–2013 was both its strength and its durability over time. Norway ran a double-digit trade balance surplus (in relation to GDP) for more than a decade. Only in the last half of 2014 did a marked weakening of terms of trade set in as a result of plummeting oil prices. For fifteen years, Norwegians experienced substantial, but rather effortless, real welfare gains in a time when the Western Hemisphere suffered the worst economic backslash since the interwar period.

Windfall prosperity coincided with important changes in the monetary policy framework. In 1986, as discussed in the previous chapter, Norway had restored the monetary anchor and adopted a fixed exchange rate regime. In the following years it had taken part in the great moderation, which brought inflation rates down at home and abroad. Under the managed float following the end of the ERM peg in 1992, price stability had gradually come to the forefront of policy. By the autumn of 1998 the fixed exchange rate regime had run its course and in January 1999, Norway de facto moved to inflation targeting. Two years later Norges Bank was officially given an inflation target mandate.