The key policy rate is set with a view to keeping inflation close to 2.5 percent over time without triggering excessive fluctuations in output and employment. Monetary policy also seeks to be robust and take into account the risk that financial imbalances in the economy build up. Even though the objectives differ, both of these instruments work through banks’ responses. The level of the countercyclical buffer may therefore affect the conduct of monetary policy. Increased buffer requirements may induce banks to increase their lending margins or restrict access to credit in other ways. Tighter lending growth curbs economic activity and inflation. This suggests, in isolation, a lower key policy rate. Other developments in the economy may amplify or dampen this effect. Although increasing lending margins in isolation point towards a lower key policy rate, a period of strong economic expansion, with prospects for high inflation and a risk of a build-up of financial imbalances, might indicate that the key policy rate should be raised while at the same time tightening capital requirements for banks. Conversely, in a sharp downturn with higher bank losses, it may be appropriate to reduce both the key policy rate and the countercyclical buffer. Chart: Credit cycles and business cycles in Norway Having more economic policy instruments available can make it easier to achieve several objectives at the same time. But the countercyclical capital buffer is not a new stabilisation policy instrument on par with monetary policy.
The level of the buffer must therefore be considered in the light of other capital requirements. Norway could be among the first countries to apply the countercyclical buffer. Growth in credit and in house prices in Norway has been high for a long period, and credit has reached a historical level relative to GDP. In view of this situation, banks must make extra allowance for the risk of an economic setback. Banks have taken due note of the requirements and are in the process of adjusting to them. Discussions with market participants suggest that an expected countercyclical buffer has been included in banks’ long-term adjustments. 3  Basel Committee on Banking Supervision, “An assessment of the long-term economic impact of stronger capital and liquidity requirements”, August 2010. http://www.bis.org/publ/bcbs173.pdf. For an updated collection of references to studies of the costs and benefits of macroprudential regulation, see Annex 1 in IMF Working Paper WP/13/167, by Arregui et al. “Evaluating the Net Benefits of Macroprudential Policy: A cookbook”, July 2013. http://www.imf.org/external/pubs/cat/longres.aspx?sk=40790.0. 4  For further detail and references, see Norges Bank Papers 1/2013. 4  BIS central bankers’ speeches  Capital requirements and monetary policy The countercyclical capital buffer and the key policy rate are two instruments serving different objectives. The objective of the countercyclical capital buffer is to increase banks’ resilience to losses in a downturn. The primary objective of monetary policy is low and stable inflation.