Twenty years of low and stable inflation had provided confidence in central banks’ ability to control inflation, which in turn had paved the way for a sharp reduction in real interest rates without compromising the overall monetary policy target. This contrasts with the downturn in the late 80s, as illustrated in the case of Norway, as well as during the Depression, when real interest rates were kept high due to faltering credibility. Fiscal policy has also been used everywhere, and has prevented an even sharper fall in output. After two years of extensive fiscal measures, many governments are facing the wall. They are unable to finance further deficit spending and have to cut spending and increase taxes now. The graph shows the increasing government deficit in the UK. The government has no choice but to tighten policy. The Swedish government, on the other hand, in spite of expansionary policies in the aftermath of the crisis, had maintained a surplus in the years before, and the Swedish economy has thus fared well. Although countries were hit by the crisis in a fairly similar way, they emerged from it very differently. Some countries have experienced good growth rates and falling unemployment. Others are struggling to keep their head above water. Production is still far below the precrisis level, with unemployment hovering at record levels. Are these differences predictable? As a participant in OECD meetings for many years, I have sometimes been among the backbenchers, trying to check the pulse of the economy in various countries.
According to Kenneth Rogoff and Carmen Reinhart, the Norwegian banking crisis is in the top five list of the most severe banking crises in history, which also includes Spain 1977, Finland 1991, Sweden 1991 and Japan 1992. Three of Norway’s four biggest banks received capital injections from the government, after writing off the entire equity capital. The banks were fully nationalised. Two of them were later sold 100 per cent to private owners, while the government retained a large share (34 per cent) in DnB Nor. The banks had too little capital, as much of it was unable to bear losses. Therefore, the Norwegian definitions of Tier 1 capital were stricter than most countries. Like many resource-rich economies, Norway expanded its welfare state rapidly after the discovery of oil. During the latter half of the 1970s, the government increased its ambitions in many key areas of the economy: the pension age was cut, agricultural subsidies increased, industrial policy widened and the government reduced taxes to bring wages under control. The consequences were galloping inflation, a depreciating currency and worst, meager productivity development in the Norwegian economy. BIS central bankers’ speeches  3  After 1986, steps were taken to get back on track. Interest rates were increased to subdue lending and the fiscal deficit was reduced. By 1990, Norwegian government believed a potentially upcoming crisis had been averted. But Norway, like most European countries, was hit by the high interest rates following the German unification.