We review developments in monetary policy and exchange rate regimes in Norway since the Bretton Woods system collapsed. Norway has traditionally had a monetary policy regime geared towards exchange rate stability. The long history with fixed exchange rates as "normalcy" may be one factor which explains the rather late transition to inflation targeting in Norway. This "fear of floating" may seem hard to explain today. We look at five episodes, in 1992, 1998, 2008, 2014 and 2020, respectively, through the lens of the prevailing monetary regime in real-time. What if we had reacted "as if" under the opposite regime?

The paper reports on counterfactual model simulations used to analyse the potential effects of alternative monetary policy rules, such as standard Taylor rule reaction functions for the short-run interest rate. When applied to the period 1990-1996, this creates a temporary downward shift in nominal interest rates when compared to the historical path. Given the considerable uncertainty about the effects on exchange rates of such a counterfactual policy, we have considered four sets of different assumptions, ranging from no effect at all to a strong immediate currency depreciation followed by a gradual strengthening of the currency back to its reference level. The analysis has been made within the framework of Norges Bank’s macroeconometric model RIMINI. For the purpose of the paper, the model has been extended to include a submodel for financial sector losses assumed to be explained by key macroeconomic indicators of financial fragility, such as the debt service to income ratio, real housing prices and the level of unemployment.

An abstract is not available for this content so a preview has been provided. As you have access to this content, a full PDF is available via the ‘Save PDF’ action button.

In the introduction to Part II, we sketched the broad lines of economic and monetary change in the second half of the long nineteenth century. In particular, we stressed the importance of the middle of the century as the beginning of a shift along a far-reaching front that, in the course of two to three generations, transformed the country. In Chapter 4 the focal point is how the first stage of this transformation influenced monetary growth, the expansion of a financial sector and the conduct of the bank of issue.

The first half of the nineteenth century was a period of political upheaval and formative nation-building in Norway. At the dawn of the century, Norwegians could look back on more than four hundred years of attachment to the Danish king's dynastic conglomerate state. Within this conglomerate Norway had played a subordinated political role, governed from Copenhagen more like a set of Danish provinces than as a partner in the dual monarchy of Denmark-Norway. Following the endgame of the Napoleonic Wars all this changed. In the Kiel peace treaty of January 1814, the king of Denmark was forced to cede Norway to the king of Sweden.

The outbreak of World War I marks the beginning of a troubled period for Norway as a nation and for the Norwegian economy. The overriding objective of foreign policy during the war was to preserve Norway's neutrality. The government did succeed in manoeuvering between the belligerent nations in such a way that Norway was not directly drawn into the military conflict. This was a great relief to the nation, although it could be achieved only by giving some financial concessions to Britain and Germany in connection with the export of fish to these countries. This seems to be a low price for achieving neutrality, but as will emerge from the narrative of this chapter, this policy greatly exacerbated the liquidity problems that Norges Bank had to struggle with in the final years of the war.

The quest for monetary stability had been an uphill struggle for the new nation. However, by the early 1850s, despite the severe challenges of the crisis years of 1847–1848, the commitment to currency convertibility appeared firm. In retrospect, the middle of the century represented the start of an unprecedented period of stable monetary values spanning more than six decades. Until the international monetary order fell apart with the outbreak of World War I, Norges Bank honoured its notes in specie without exception. Its commitment to monetary stability was never in question.

Throughout their long history, the primary concern of central banks has oscillated between price stability in normal times and financial stability in extraordinary times. In the wake of the recent global financial crisis, central banks have been given additional responsibilities to ensure financial stability, which has sparked intense debate over the nature of their role. Bankers and policy makers face an enormous challenge finding the right balance of power between the central bank and the state. This volume is the result of an international conference held at Norges Bank (the central bank of Norway). International experts and policy makers present research and historical analysis on the evolution of the central bank. They specifically focus on four key aspects: its role as an institution, the part it plays within the international monetary system, how to delineate and limit its functions, and how to apply the lessons of the past two centuries.

This book provides a broad overview of monetary developments in Norway over the past 200 years, using a rich variety of graphical illustrations based on a unique data set of historical monetary statistics, which will be documented and made available on the Norges Bank website (in English) at http://www.norges-bank.no/en. Throughout the book, Norway's monetary developments are anchored in a historical context and in the development of monetary thinking. Through their analysis of the historical data, the authors provide new insights and comparisons to other Scandinavian countries, along with an excellent examination of the development and character of the banking and financial system in Norway.

This chapter analyses in broad terms how the monetary restoration was carried out and eventually materialised in the form of a stable currency and an embryonic monetary system that served the needs of the economy. The centre stage of the chapter is occupied with the thorny road to resumption. The legislation introduced in 1816 laid down a principle, that the note issue should be backed by specie and that notes should be freely convertible into silver. From the beginning this was a weak pledge, a commitment for the future. The year set for the resumption of specie payments, 1819, passed without Norges Bank being anywhere near the objective. In 1822, a course was adopted where Norges Bank started paying out in silver, but at a discount for the note holders. Gradually the premium commanded by silver was reduced, bringing the value of notes closer and closer to their promised par value in silver. Although far from their ultimate target, this change of course in effect promoted monetary stability by securing a lower limit below which the exchange rate, i.e. the silver value of the bank notes, would not depreciate. Resumption took time. Not until 1842 did the weak pledge finally materialise in the tangible conversion of one speciedaler note into one speciedaler silver coin.

The chartering of Norges Bank in 1816 heralded what became a new era in Norwegian monetary and financial history. For the first time since the Middle Ages Norway gained a viable domestic currency separate from that of its union partner. This step was important. Not only as a political demarcation vis-à-vis Sweden but maybe even more important in terms of the economic and financial structures that monetary stabilisation on Norway's own keel brought about. Without entering deeply into the counterfactual, a common currency in the years after 1814 would have altered the monetary history of both countries and arguably also enhanced the sustainability of the institutions that bound them together. Instead 1816 became year 1 in the modern monetary history of Norway.

In simplistic language monetary history deals with money, its different forms and uses over the course of history and the different institutions involved in producing it. The concept of money is, however, intrinsically connected with a society's payment system and its institutions. Irrespective of whether money predominantly circulates among the general public in the form of coins and bank notes, as was the case in the eighteenth and early nineteenth century, or, as is the case in modern societies of the twentieth and twenty-first century, of money mainly appearing in the form of bank deposits, a well-functioning payment system is always built on trust. Historically, the general public had to trust the issuer of coins, typically the sovereign, to preserve the value of his coins and restrain himself from debasement or clipping. Likewise the issuers of bank notes had to be trusted that they would restrain themselves from the temptation of letting the printing works run, such that the overissuing of bank notes led to the undermining of their value. Finally, as deposits in private banks gradually evolved to become the main component of modern societies’ money stock, the general public would need to have a similar faith in the banks with whom they entrusted their funds, believing that the banks could be trusted as custodians of their deposits. We will in the following denote the sum of the general public holdings of coins, bank notes and bank deposits as ‘broad money’, and we will often refer to this as M2 or ‘the money stock’, as is common in the literature on monetary aggregates.

Annual house price indices for four Norwegian cities were compiled using observations from Norwegian administrative data on housing transactions. The house price indices were constructed using the weighted repeat sales method. Real house prices are constructed by deflating the house price indices with a consumer price index taken from the Norges Bank Historical Monetary Statistics (HMS) database, producing reasonably valid and reliable real house price indices for a period covering near two centuries. As part of the preparations of the book projects in connection with Norges Bank’s bicentennial in 2016, a substantial amount of new and/or improved historical data have been compiled. These data will be made available at Norges Bank’s web-site and documented in a third volume (HMS III), which will appear in Norges Bank’s series occasional papers. Preliminary results from applying tests for house price bubbles show evidence of bubble-behaviour in Norwegian house prices on 1895-1899 and 1985-1988.

Monetary development in the years after 1945 necessarily reflected the financial and economic challenges created by war. The monetary overhang still loomed over the country and there was an urgent need for restoring broken trading links and production capacity. In a sense, the challenges arising from the war, although substantial, were all short term in nature. Subsequent development showed that they were fairly soon overcome. Already by 1947, output in per capita terms had surpassed 1939. By 1950, the export volume had regained the prewar level. At the beginning of the new decade, the monetary overhang had been more or less eliminated.

Norway was, like many small open economies, adversely affected by the recession that followed the global financial crisis. But in an international perspective, the Norwegian economy and institutions were less affected by the crisis than many other countries. Norway's approach to monetary policy, flexible inflation targeting, was already in place when the crisis hit, and it benefitted from having established a credible and transparent framework for communication of Norges Bank's policy intentions. One lesson was that monetary policy is more than setting the policy rate. Appropriate and adequate liquidity measures were required to improve the functioning of the financial markets. The international experience shows that inflation targeting per se is not sufficient, neither for price stability nor for financial stability. Although Norway benefited from lessons from the Nordic financial crisis in the 1990s, the recent crisis revealed weaknesses in the policy framework for financial stability, suggesting a need to look creatively for macroprudential instruments, and improvements in the resolution regime for troubled banks. Flexible inflation targeting proved to be a robust framework for monetary policy during the crisis, and successfully provided the necessary room for maneuver for Norges Bank in its pursuit of price stability and financial stability.

There is now a remarkably strong consensus among academics and professional economists that central banks should adopt explicit inflation targets and that all key monetary policy decisions, especially those concerning interest rates, should be made with a view to ensuring that these targets are achieved. This book provides a comprehensive review of the experience of inflation targeting since its introduction in New Zealand in 1989 and looks in detail at what we can learn from the past twenty years and what challenges we may face in the future. Written by a distinguished team of academics and professional economists from central banks around the world, the book covers a wide range of issues including many that have arisen as a result of the recent financial crisis. It should be read by anyone concerned with better understanding inflation targeting and its past, present and future role within monetary policy.