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Economic perspectives: annual address by Governor Svein Gjedrem at the meeting of the Supervisory Council of Norges Bank on 19 February 2004.

Article Excerpt
Introduction

There is now growth in the Norwegian economy. Oil prices are high. Capacity utilisation in the mainland economy is at the level prevailing in the mid-1990s. Wage growth is slowing. White-collar workers have lowered their wage demands, and there are prospects of a moderate main settlement this spring--the first in eight years. The value of the krone is on a par with the mid-1990 level. The interest rate level is in line with the level among our trading partners.

In that respect, there is equilibrium in the Norwegian economy at present. But it is fragile.

The international division of labour is shifting, and when faced with major changes it is a disadvantage for Norwegian business and industry that costs are high. Inflation is very low.

Short-term interest rates abroad have been unusually low over the past 2 1/2 years, and there are no prospects of a considerable increase in the near term even if the world economy is expanding. Last year, interest rates abroad acted as a magnet on Norwegian interest rates. We now have the lowest nominal interest rate level recorded in decades.

Norwegian households are optimistic and are borrowing and investing in housing and property.

This stands in contrast to corporate behaviour. Businesses are rationalising and earnings are on the rise, but they are still investing and borrowing on a limited scale.

The upturn is still not entirely self-sustained.

A global financial market

Cross-border capital flows have increased considerably in recent decades. Bond markets have moved more in tandem, particularly since the mid-1990s (see Chart 1). This also applies to equity markets.

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Investors are increasingly spreading their investments across countries. They are diversifying risk, and seeking high returns. In parallel, governments, banks and companies are issuing more debt externally.

Currency trading has increased markedly since the 1980s (see Chart 2). This trend was reversed when the number of currencies was reduced owing to the introduction of the euro. Large trading volumes enhance market liquidity. The growth in currency trading is ascribable to an increase in portfolio investment, higher foreign direct investment and growth in world trade.

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The forward exchange and options market have expanded in recent years. A deeper market reduces transaction costs, and it is easier to find counterparties. This has provided companies with greater scope for hedging against foreign exchange risk. The use of instruments that reduce the risk associated with a floating krone is also increasing in Norway.

A considerably larger portion of credit in other countries is now channelled via the bond market. Less risk is being accumulated in banking systems. The development of new markets and instruments, for example credit derivatives, has also led to a broader risk spread than earlier.

The improved diversification of risk is probably one of the reasons that world financial markets have coped with the stock market decline and the accounting scandals with limited damage to the wider economy. This is probably one reason why the downturn following the stock market decline in 2000 was considerably less pronounced than earlier downturns.

The new instruments spread risk, but do not eliminate it. Financial markets have become highly complex. This alone entails an operational risk, which is a challenge to participants and the supervisory authorities.

A shift in the international division of labour

Increased trade promotes growth and lays a basis for prosperity. A number of Asian countries have experienced strong, export-led growth--Japan from the 1950s and several countries in Southeast Asia from the 1960s. In recent years, China has become an important player in international trade, and the country is now probably the world's fourth largest trade nation (see Chart 3). The Asian economies and the rest of the world have become more integrated.

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Technological advances and a sharp fall in prices in the IT and telecommunications sectors have exposed a number of services that were previously sheltered to competition from low-cost countries. Indian companies service three million customer telephones for companies in the US and the UK--daily. European airlines are transferring ticket settlement to India. US companies are outsourcing accounting services to India. Analytical activity in investment banks and development divisions in ITC companies are also being moved to India. Norwegian engineering companies are buying cheap engineering services in India and China. EU enlargement this spring, with ten new members, is also influencing the division of labour in Europe.

The advances in Asian economies have generally relied on an abundant supply of cheap labour, but wages have gradually increased in step with productivity gains (see Chart 4). A higher income level paves the way for higher imports.

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Today's globalisation has a historical parallel (see Chart 5). In the period preceding World War I, the world experienced a period of strong growth in trade and cross-border capital flows. There were few political barriers and major technological advances fostered growth in trade. Prosperity increased. But this period was interrupted, and in the interwar period protectionism gained ground, with trade barriers and a contraction in international trade. This was combined with an economic recession. In the post-war period, trade barriers have gradually been scaled back. Trade picked up already in the 1950s, and since the 1980s...

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