Debt as a share of household income has increased by 12 percentage points since Norges Bank last raised the key policy rate. Measured as a share of household income, debt is approaching double its level in 2000. Bank deposits have risen considerably less than loan debt. The negative effect of an interest rate increase on household income thereby carries relatively greater weight than previously. Chart: Greater impact of interest rate increase on disposable income In other words, an interest rate increase will curtail household purchasing power more than previously. In 2000, a one percentage point rise in the key policy rate would have resulted in an increase in net interest expenses equivalent to less than ½ percent of household disposable income. In 2017, this share increased to one percent of disposable income. An interest rate increase therefore probably has a stronger effect on private consumption than previously. How much stronger the impact of the interest rate is depends on how debt is distributed across household groups. Changes in the distribution of debt can thereby have consequences for the effect of monetary policy. Analyses based on microdata for the household sector can provide useful insight. International studies have shown that households with limited financial buffers tend to allow temporary income changes, for example as a result of changes in interest expenses, to impact fully on consumption. This is supported by a study recently conducted on Norwegian data (Fagereng et al (2018)).
Here, the role of central banks as liquidity provider is essential to ensure the proper functioning of the financial system, and this is one of the main lessons we learned from the mistakes made during the Great Depression that wrecked havoc in the real sector, which could have been substantially reduced. We have also learned that sound regulations designed for normal times and as crisis preventing mechanisms are not necessarily the best for moments of great stress or turmoil, including mark-to-market practices in some segments of the financial industry. It would be premature to draw definitive lessons from the present crisis that is still in the making and going through the damage-control phase. A new wave of discussions on the international financial architecture will come. And although this happens every time there is a world crisis, progress to date has been rather timid. Nonetheless, the potential liquidity constraints that economies outside the epicenter of the crises may suffer, may add an unnecessary burden to countries that had little or nothing to do with today’s events and at the same time are the basis to sustain growth in the world. In synchrony with this, the new liquidity swap facility that is being offered by the IMF is very appropriate. It should be disbursed quickly as current conditions require. In the present circumstances, countries that have saved their terms-of-trade windfalls and enjoy a solid international liquidity position, as is the case of our country, should not have the need to apply for these facilities.