Norway's Approach to Monetary Policy
Olivei, Giovanni P., New England Economic Review
The goal of monetary policy as conducted by Norges Bank is to maintain low and stable inflation. The operational target of monetary policy is explicitly defined in a consumer price inflation rate of approximately 2.5 percent over time. Norges Bank sets its interest rate instrument with a view to achieving the inflation target over a two-year horizon, and it will normally tolerate deviations of actual inflation from target that are not in excess of plus or minus 1 percentage point. In general, the direct effects on consumer prices resulting from changes in interest rates, taxes, excise duties, and extraordinary temporary circumstances shall not be taken into account.
The inflation target was introduced in March 2001, after a long tradition of exchange rate targeting. After abandoning a fixed-rate regime in 1992, Norges Bank conducted a managed float of the krone, with no explicit stipulation of a central rate and fluctuation margins. Norges Bank had no obligation to intervene in the foreign exchange market, but, in the event of significant changes in the exchange rate, the Bank would orient its instruments with a view to returning the exchange rate over time to its initial range. In practice, this meant that Norges Bank conducted monetary policy with the aim of bringing inflation toward the level of other European trading partners. Thus, the move to an explicit inflation target did not bring significant changes in the conduct of monetary policy.
Norges Bank's Main Monetary Policy Instruments
While in many other countries the central bank sets the interest rate on liquidity supplied through open market operations and thereby signals the market rate it deems appropriate, Norges Bank has decided not to signal interest rates in this way. The policy rates are in fact the rates on Norges Bank's standing facilities, that is, banks' interest rate on sight deposits in Norges Bank (deposit rate) and the interest rate on overnight loans to banks (overnight lending rate). The deposit rate and the overnight lending rate form a corridor for the shortest money market rates.
The difference between the overnight lending rate and the sight deposit rate is kept at 2 percentage points on an annual basis. In recent years Norges Bank has supplied liquidity in a way such that the banking system as a whole has sight deposits with the central bank. (1) Thus, the sight deposit rate is the banking system's marginal rate and the key policy rate in the Bank's conduct of monetary policy. In normal times, money market rates will be close to the prevailing sight deposit rate.
It is, as mentioned, the inflation outlook two years ahead that determines the sight deposit rate set by Norges Bank. In normal times, the Bank takes a gradualist approach when changing the policy rate.
Banks can automatically deposit any available liquidity within Norges Bank, which is remunerated at the posted sight deposit rate. Banks can also borrow liquidity during the day and overnight from Norges Bank. No interest or fees are charged on intraday loans, while overnight loans carry an interest rate (the overnight lending rate) which is, as mentioned, 2 percentage points above the posted sight deposit rate. Access to the intraday and overnight lending facility is automatic, and since June 2001 Norges Bank has ceased to set semi-monthly total drawing limits for overnight loans.
For both intraday and overnight loans, usually referred to as D-loans, banks must post collateral in an amount equivalent to 100 percent of the loan. The eligible collateral for D-loans is identical to the collateral Norges Bank requires for loans the Bank issues in open market operations (F-loans), described below.
Norges Bank also has an extraordinary intraday borrowing facility, introduced to provide for the execution of special payment settlements specified by Norges Bank. …