Time‐Varying Dynamics of the Norwegian Economy

• Published date: 01 January 2019
• Date: 01 January 2019
• DOI: http://doi.org/10.1111/sjoe.12270
• Author: Q. Farooq Akram,Haroon Mumtaz

Scand. J. of Economics 121(1), 407–434, 2019

DOI: 10.1111/sjoe.12270

Time-Varying Dynamics of the Norwegian

Economy*

Q. FarooqAkram

Norges Bank, Oslo NO-0107, Norway

farooq.akram@norges-bank.no

Haroon Mumtaz

Queen Mary College, London E1 4NS, UK

h.mumtaz@qmul.ac.uk

Abstract

We use time-varying parameter vector autoregressive models to investigate possible changes in

the time-series properties of key Norwegian macroeconomic variablessince the 1980s. Notably,

we find that inflation persistence falls during the inflation targeting period,while the volatility of

inflation and nominal exchange rates increases. The observed time-variation in the correlations

between the interest rates and the macro variableslargely reflects the prevailing monetary policy

regimes.An increase in the cor relations betweenoil prices and other macro variables over time is

alsodocumented. Using a counterf actual analysis,we discuss the observed time-varying dynamics

of the Norwegian economy in the light of monetary policy and oil price shocks.

Keywords: Great Moderation; inflation targeting; persistence; stochastic volatility; time-varying

coefficients

JEL classification:C51; E31; E32; E52; E58

I. Introduction

The Norwegian economy has experienced substantial structural and policy

changes over the past decades. From 1990 to 2014, the share of imports

of goods and services from emerging economies increased steadily from

below 5 percent to 24 percent. The economy also became more open to the

inflow of foreign labour; the total number of immigrants more than doubled

over the last ten years mostly due to the process of European labour-market

integration. Over the same period, the share of crude petroleum exports of

total exports increased from around 25 percent to more than 50 percent

while the share of the Norwegian petroleum sector increased from around

*Thispaper should not be reported as representing the views of Norges Bank. The views expressed

are those of the authors and do not necessarily reflect those of Norges Bank. In particular, the

authors would like to thank twoanonymous referees and seminar participants at Norges Bank for

very useful comments.

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The editors of The Scandinavian Journal of Economics 2017.

408 Time-varying dynamics of the Norwegian economy

10 percent to around 30 percent of mainland gross domestic product (GDP).

Regarding government policies, public petroleum revenues have been

accumulated in an oil fund since 1996 and its size is currently more than

double Norwegian mainland GDP. To partly manage the flow of oil revenues

into the mainland economy, the government has mostly followed a fiscal

policy rule since March 2001 that limits annual petroleum revenue spending

to around 4 percent of the fund’s market value. Simultaneously, Norwegian

monetary policy switched formally from exchange rate to inflation targeting.

This has been practised as flexible inflation targeting where the central

bank’s interest rate setting has aimed to achieve the inflation target of

2.5 percent in the medium run while attenuating fluctuations of aggregate

output around its trend level (see Svensson,2005;Olsen,2016).1The

structural developments in combination with shifts in government policies

over time might have altered the dynamics of Norwegian macroeconomic

variables.

In this paper, we examine the dynamic properties of key Norwegian

macroeconomic variables and their co-movements over the last three

decades. Our aim is to investigate whether trends, volatility, persistence,

and cross-correlations of these variables have changed over time and

whether the changes have coincided with the structural or policy changes

experienced. To estimate these time-varying statistics, we employ a time-

varying parameter vector autoregressive (TVP-VAR) model with stochastic

volatility to describe the behaviour of macroeconomic variables over the

period 1983Q4–2014Q4. The variables modelled are: real Norwegian GDP

relative to its trend, consumer price inflation rates, nominal effective

exchange rate (NEER) changes, short-term money market rates, and trend-

adjusted real crude oil prices.

The analysis in this paper is closely related to Cogley and Sargent

(2005), Primiceri (2005), and Benati (2008) (amongst others), who use

similar models to explore the time-varying dynamic properties of the

US and the UK data offering evidence on the Great Moderation. Our

investigation adds to this body of literature by providing results for

an economy that has several unique characteristics. Norway is a major

petroleum-producing country with well-regulated spending of petroleum

1The inflation target in Norway was set half a percentage point higher than in most of its main

trading partners, including many European union countries, in anticipation of a real exchange

rate appreciation of half a percentage point because of Norway’s substantial petroleum revenues

(see Olsen and Skjæveland,2002). A gap of half a percentage point betweenthe inflation targets

in Norway and its main trading partners was expected to maintain a stable nominal exchange

rate. In contrast, an inflation target equal to that of the trading partners was expected to lead to

a systematic nominal exchange appreciation to bring about the real exchange rate appreciation

implied by the petroleum revenues.

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The editors of The Scandinavian Journal of Economics 2017.