| dc.description.abstract | Following the relatively high levels of inflation in the 1970’s and early 1980’s, lowering the rate of inflation became a stated goal of many central banks from the first part of the 1980’s and onwards. Even so, having an explicit target for the level of
inflation as a monetary policy has a more recent history, and when Norway adopted an explicit inflation target on the 29. Mars 2001, it was only about ten years after the first country (New Zealand).
However, during the 1990’s several countries, with both developed and developing economies, and high and low rates of inflation, adopted explicit inflation targets.
Therefore a lot of experience and knowledge was gained, which undoubtedly helped Norway designing their specific inflation targeting monetary policy. Norway chose a long-term annul rate of inflation of 2.5%, which balances the trade-off of making the zero boundary limit for the nominal interest rate binding, and the cost of having a too high rate of inflation. But more importantly it was in line with what their major trading partners that had already adopted an explicit inflation. The target horizon Norway chose, which later has been revised twice, was too reach the inflation target rate around two years, which the prevailing literature at the
time though to be enough time for the central banks short term interest rate to work on the economy, and also give the central bank enough time to make small adjustments in their short term interest rate, thereby not jeopardizing financial stability. The latter point was, besides achieving a stable rate of inflation, the mandate given to Norges Bank by the Norwegian Government.
Even though inflation targeting has become increasingly popular over the last 15 years, there is no general consensus as to the effect inflation targeting has had on the countries that have implemented it. Mishkin and Schmidt-Hebbel (2001) conducts a comparison of countries that have an explicit inflation target on one hand, and
industrial countries that do not have an explicit target on the other hand, and concludes that although the adoption of an inflation target has been a success at lowering the rate of inflation, either prior to the adoption, or after, these countries have not been able to out-perform the control group of non-inflation targeting countries. Bernanke et al. (1999) and Corbo and Schmidt-Hebbel (2000) on the other hand argue that countries that have adopted an inflation target have been able to lower the sacrifice ratio between output and inflation, and also lower the output volatility.
Although there is no general consensus to the effect inflation targeting has had on the countries that have adopted it, there is broader agreement of what elements that need to be in place an inflation target to work properly. Mishkin (2004) outlines the
following five elements as being the key characteristic of inflation targeting:
Forward-looking medium-term target for the rate of inflation, price stability as the ultimate long-term goal for monetary policy, increased commitment for transparency by publishing plans and objectives, a strategy that emphasises information, and increased accountability for the monetary authorities.
As mentioned, since the early 1980’s lowering the rate of inflation had received high priority from Norges Bank, and following the Governmental decree that was issued on the 5. Of May 1992, which stated that Norges Bank should aim at keeping the exchange rates stable and at about the current levels vis-à-vis major European
currencies, they implicitly also got a target for the rate of inflation.
The main objective of this thesis has been to analyse whether adopting an explicit inflation target has been an improvement in Norwegian monetary policy, or if it has just made the policies already in place, and clearly understood by the public, explicit,
with no effects on the rate and volatility of inflation or people’s expectations.
The main empirical findings have been that adopting an inflation target by the Norwegian Government have had very limited effects, when measured in terms of variances, on inflation, ambiguous effects on the exchange rates, and a slight reduction in output volatility, although there are several elements of uncertainty associated with the last result.
However, by making the monetary policy more explicit the Norwegian
Government has made Norges Bank more accountable for its actions, as it has been easier to measure their performance ex-post, and it has also improved the communication between Norges Bank and the market through publications and a more understandable target.
This can be seen from the correlations between the sight deposit rate and the 3-, 5- and 10-year Government bonds, and between the sight deposit rate and bank deposits and loans, which have increased quite considerably, arguably meaning that market expectations have become more in line with those of Norges Bank.
The above results show that adopting an inflation target, as mentioned, has not caused Norges Bank to focus too strongly on reaching the explicit rate of inflation causing excessive fluctuations in other key variables, which have been argued by
several economists to be a major disadvantage of having an explicit target for the rate of inflation. This can probably be contributed to the fact that Norges Bank has a flexible approach to inflation targeting, implying that they pay attention to other variables when setting their monetary instrument, although reaching the inflation
target is the overriding goal in the case of a conflict.
So, even though we have developed the perspective that adopting an explicit inflation target by the Norwegian Government has not been a large revolution compared to the way monetary policy was previously conducted in Norway, it has certainly improved the communication between Norges Bank and the market, making market expectations more in line with those of Norges Bank, and it has also made it easier to judge the performance of Norges Bank and thus making them more
responsible for their actions.
All the calculations are done using MS Excel and the statistical software. | eng |