November 27, 2022

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The Bank of Norway wants to get the economy out of the fog

The Bank of Norway wants to get the economy out of the fog

In economics: high price growth is like sudden fog on a mountain trip. Everyone becomes unsure, the scene fades and decisions become bad. Norges Bank aims for low price growth and clear weather in the Norwegian economy.

Central Bank Governor Ida Waldenbach experienced rain and gray weather in Arendal Week in August.

High interest rates have a strong impact on the finances of anyone with a loan. This burden is placed on people’s shoulders to bring down high inflation.

But why is low price growth so important?

Isn’t it just an increase in wages by the same amount so that everything is as before?

Central Bank Governor Ida Walden Bach tries to answer. I increasingly took on the role of a teacher. At press conferences and lectures, you spend a lot of time explaining why low interest rates are in the public good above To get a price increase lowest.

The last explanation came in lecture Thursday at BI Business School. The advantage of low price growth (inflation) is summarized as follows:

The best contribution monetary policy can make to high and stable employment over time is to ensure low and stable inflation.

In other words, turn around: high price growth “over time” will lead to high unemployment.

More room for variety

Bache goes through a series of unseen mechanisms that lead to the conclusion that low price growth is a good thing.

History shows that price increases go hand in hand with uneven price growth. Given that prices do not usually fall, there is more room for change when price growth is 10 percent than when it is 2 percent.

The variability of price growth makes it difficult to predict future price growth. Uncertain decisions become more uncertain. Financial planning becomes more difficult.

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– For example, bidding would be more risky, says Bach.

A contractor has an easier job of bidding for a construction project when they are reasonably certain that the price increase will be about 2 percent in the next two to three years, compared to 5-10 percent.

Uncertainty breeds short term

The companies invested around NOK 350 billion last year. Investments can last for several decades. These are some of the most important boardroom decisions.

Bash fears that high volatile price growth will influence decisions in the direction of short-term decisions. A hotel owner can easily estimate the cost of a 50-room expansion next year.

But if the increase in the prices of accommodation, labor and purchases is likely to be between 5 and 10 per cent in the coming years, it becomes difficult to determine whether the investment will provide the return that the owner demands. The calculation is safer and easier if price inflation remains stable at around 2 percent for a long time.

A high and variable rate increase could result in a hotel owner agreeing to expand by 10 rooms so it doesn’t collapse.

It can reduce the level of investment and, over time, give less productive potential in the economy, says Bach about the consequences of high and uneven price growth.

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out in the store

Prices carry important information for consumers and producers in a market economy.

Strong price growth for a product or service can indicate higher demand, which is a signal to producers that it may be worthwhile to increase production. But it can also be a signal to consumers that the item is becoming more expensive to produce. It may be time to reduce consumption.

descending Prices on a single item can be a signal to producers to cut back on production. Or a message to consumers that something is getting cheaper here.

These signals are important for a business to use its resources in the best possible way and for consumers to make the right choices.

Fog seeps into the economy

Bash distinguishes between:

  • Growth in the general level of prices: the increase in the prices of all goods and services combined. It is measured each month by the Consumer Price Index (CPI).
  • Changes in relative prices: the relationship between the increase in the prices of individual commodities. For example, the increase in the price of visits to restaurants in connection with an increase in food prices.

Relative prices are what are initially calculated. Bache refers to it as “reasonably priced”.

Right prices contribute to the production and distribution of different goods in a socially efficient manner, she says.

Then labor and capital are distributed to the places where it is spent the most. The consumer makes choices that increase the pleasure of consumption.

But high and variable price growth (ie more than 2 percent per year over time) creates a haze about changes in relative prices. Important signals become difficult to see.

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High inflation (…) makes it difficult to assess whether an increase in the price of a commodity is an increase in the relative price or an increase in the general price level, says Bach.

Its function is to clarify the fog.

Unpleasant surprises

High and variable price growth leads to unexpected changes in purchasing power. Just ask the parties in this year’s salary settlement. The industry negotiated a salary framework of 3.7 per cent based on an expected price increase of 3.3 per cent. Social Security settlement basically follows wage settlement.

In the past Forecasting The Norges Bank expects price growth to be 5.4 percent this year. Off-field salary adjustment has been eliminated. The agreed increase in purchasing power unexpectedly turned into a decrease in purchasing power.

This does not affect equally, this is the message from Norges Bank.

Thus, an unexpected increase in price inflation will reduce the purchasing power of most households. It especially affects those who cannot use the money that has been saved. Perhaps in this group we find many on lower incomes, Bach says.

Much of the debate about low and stable price growth revolves around unseen mechanisms. It can seem distant, theoretical and weak. But in short, it weakens jobs and economic growth, central bank education says.

This is the basis for interest rate changes that everyone cares about.

The annual price increase in September approached 7 per cent. Our job is to make sure it comes back again, says Bach in a Thursday lecture.

She takes her job very seriously and quotes former Central Bank Governor Sven Gederim: “Price stability does not come on a whim.”

If it were that simple.