Real-time Data for Norway: Challenges for Monetary Policy

National accounts data are always revised. Not only recent data, but also figures dating many years back can be revised substantially. This means that there is a danger that an important part of the central bank's information set is flawed for a long period of time. In this paper we present a data base consisting of various vintages of real-time data from 1993Q1 to 2003Q4. We describe the nature of the data revisions, the causes of the revisions, and investigate whether the revisions are true martingale differences, or whether they can be forecasted. In the spirit of Orphanides and van Norden (2002), we analyze how data revisions and model uncertainty affect the reliability of output gap estimates. We also compare Taylor type interest rate rules based on real-time data versus final data and assess the consequences for monetary policy if policy was conducted using this type of interest rate rules. Finally, we analyze the implications of output gap uncertainty for monetary policy using a small New Keynesian macroeconomic model. --Monetary policy,output gap,real-time data,interest rate rules

Simple Cross-Check Models for the Krone Exchange Rate

In this paper we discuss simple cross-check models for the krone exchange rate. Such models may give information as to whether the exchange rate is in line with basic macroeconomic fundamentals. Norges Bank publishes forecasts for several variables, e.g. the interest rate, inflation, the output gap and the exchange rate. General equilibrium models are important tools in the forecasting process. However, as stated by Deputy Governor Jarle Bergo, “…There is no mechanical relationship between the models the Bank uses and its forecasts…Central to this process is the use of judgement…” (Bergo, 2006). Cross-checks are useful tools in the forecasting process as they may provide additional information not necessarily captured by the bank’s macro models. First, we look at the evolution of the real exchange rate since the beginning of the 1970s. If the real exchange rate is stationary, the future exchange rate can be predicted on the basis of deviation from Purchasing Power Parity (PPP). Second, we discuss some simple econometric models where the exchange rate is determined by variables like the price and interest rate differential relative to Norway’s trading partners and the oil price

The Relationship Between the Key Policy Rate and Macroeconomic Variables : A Simple Cross-Check for Norway

In this paper we discuss simple relationships between the key policy rate and macroeconomic variables in Norway. Such models may be useful tools in monetary policy analysis as they provide a cross-check for the interest rate. This study is an update of Bernhardsen and Bårdsen (2004), who estimate similar models for the period 1999-2004. An estimated relationship between the policy rate and macroeconomic variables can be interpreted as reflecting the central bank’s average reaction pattern in monetary policy given the development of macroeconomic variables in the past. However, an estimated equation of this kind can not be interpreted as “the reaction function of the central bank”. The actual interest rate setting is based on a vast amount of information about economic developments, macroeconomic equilibrium models and – not least – experience and judgment. No central bank follows simple cross-checks when setting the interest rate. Still, simple cross-checks may give guidance in the process of interest rate setting and if the actual interest rate deviates considerably from simple cross-checks, one should be able to explain why. Moreover, we should recall that econometrics is not an exact science. In the estimation process emphasis is put on economic theory, experience about the Norwegian economy, judgement and econometric evidence

A Test of Uncovered Interest Rate Parity for Ten European Countries Based on Bottstrapping and Panel Data Models

Based on both single country models and panel data models uncovered interest rate parity is tested for ten European countries relative to Germany by regressing exchange rate changes on interest rate differentials. The period is from March 1979 to February 1996 at one month, three, six and twelve months maturity. Since exchange rate changes follow a non-normal distribution, the distribution of the test-statistic is bootstrapped from the sample. The bootstrapped confidence intervals are wider with larger upper limits than the confidence intervals based on the normal distribution. The regression coefficients, all estimated to be less than one, are considerably lower for long term maturities than for short term maturities, and lower for countries outside the ERM than for ERM countries. This is explained by differences in the variance of exchange rate changes and thereby by the risk premium between long and short term maturities and the risk premium between these two groups of countries.publishedVersio

Factors That Influence the Krone Exchange Rate

Expectations about future interest rates and inflation influence economic developments. For example, market expectations of higher inflation may themselves result in higher inflation, for instance through higher pay increases. Households’ choice between consumption and saving is influenced by their expectations concerning future interest rates. A high level of short-term interest rates will probably have less of a contractionary effect on economic activity if the market believes this to be a transitory phenomenon than if it is expected to persist. Inflation expectations also reflect whether market participants are confident that economic policy will result in low inflation over time. One important source of information about these expectations is the market’s pricing of interest-bearing securities with different maturities. This article describes the method used by Norges Bank for estimating interest rate expectations, and discusses how these estimates may be interpreted. In addition, the importance of various premia will be considered, and some alternative approaches for estimating interest rate expectations will be discussed

Misunderstood Central Bank Reserves

Recently, the media in Norway and other countries have reported that euro area banks have sharply increased their deposits with the ECB. That is correct. Some commentators attribute the high level of deposits with the ECB to banks’ unwillingness to lend to one another or to their customers, preferring to keep their funds on deposit with the central bank. This conclusion is misleading. It may be that banks are unwilling to lend, but the volume of deposits with the ECB reveals nothing about this.publishedVersio

Higher Risk Premiums on Government Debt

In this commentary we examine liquidity and credit premiums in euro-area government securities markets. For countries with a common currency and monetary policy, differences in government bond yields largely reflect different risk premiums across countries. The tendency is that higher government debt, higher government budget deficits, weaker current account balances, lower credit ratings and higher credit premiums have resulted in higher government bond yields in the euro area.publishedVersio

What Is the Normal Interest Rate Level?

The normal real interest rate level in Norway is estimated to be in the interval of 2-3 per cent. With an inflation target of 2.5 per cent, the interval for the normal nominal interest rate is 4½-5½ per cent (three-month money market rate). This is a downward revision of half a percentage point from the previously estimated interval. The downward revision is in line with the market’s interest rate expectations and estimates of potential growth. Norges Bank’s Monetary Policy Report 1/2010 assumes a normal real interest rate of 2½ per cent and hence a normal nominal interest rate of 5 per cent. This is the same estimate used in the Bank’s analyses in recent years, but the estimate is now the midpoint of the interval. In both Norway and other countries, it appears that market participants expect roughly the same long-term level of nominal interest rates that prevailed prior to the financial crisis, as measured by implied forward rates.publishedVersio

Liquidity Management System : Floor or Corridor?

Developments during the financial crisis of 2008 and 2009 have, at least temporarily, changed the way monetary policy is implemented in many countries. Before the crisis, most countries implemented policy through some form of a corridor system. The key feature of a corridor system is that it is costly for banks to use the central bank’s standing facilities for deposits and lending. Provided that this cost is sufficiently large, the system will encourage interbank trading. However, for given values of the central bank’s rate, the system also implies a tight link between the quantity of central bank reserves and the overnight interest rate: The central bank cannot control the two independently. In contrast, a floor system has almost the opposite features: there are limited incentives for interbank trading, but the central bank can control the overnight rate and the level of excess reserve balances independently. During the crisis, the need to supply more reserve balances meant that many central banks found it necessary to move towards a floor system, in order to break the link between reserves and the overnight interest rate

The Relationship Between the Key Policy Rate and Macroeconomic Variables : A Simple Cross-Check for Norway

In this paper we discuss simple relationships between the key policy rate and macroeconomic variables in Norway. Such models may be useful tools in monetary policy analysis as they provide a cross-check for the interest rate. This study is an update of Bernhardsen and Bårdsen (2004), who estimate similar models for the period 1999-2004. An estimated relationship between the policy rate and macroeconomic variables can be interpreted as reflecting the central bank’s average reaction pattern in monetary policy given the development of macroeconomic variables in the past. However, an estimated equation of this kind can not be interpreted as “the reaction function of the central bank”. The actual interest rate setting is based on a vast amount of information about economic developments, macroeconomic equilibrium models and – not least – experience and judgment. No central bank follows simple cross-checks when setting the interest rate. Still, simple cross-checks may give guidance in the process of interest rate setting and if the actual interest rate deviates considerably from simple cross-checks, one should be able to explain why. Moreover, we should recall that econometrics is not an exact science. In the estimation process emphasis is put on economic theory, experience about the Norwegian economy, judgement and econometric evidence