Svein Gjedrem: Monetary policy and the labour market Speech by Mr Svein Gjedrem, Governor of Norges Bank (Central Bank of Norway), at the conference to mark the 10th anniversary of the Federation of Norwegian Professional Associations, Oslo, 24 October 2007. The text below may differ slightly from the actual presentation. The speech does not contain assessments of the economic situation or the monetary stance. *  *  *  The Norwegian economy is expanding sharply after the strong upturn began in summer 2003. The upturn followed a period of slow growth from 1998 and a mild slowdown in 2002 and into 2003. Growth has been stronger than in the cyclical upturn in the mid-1990s. The high rate of growth has only to a limited extent fed through to a higher rise in prices for consumer goods and services. Electricity prices have fallen sharply this year, contributing to low inflation and high real wage growth. But even excluding energy, inflation is still low, even though it has gradually picked up since late summer 2006. In recent years, the Norwegian economy has been influenced by a number of positive supply-side factors. First, high export prices and low import prices have resulted in a substantial improvement in Norway’s terms of trade. We can now import considerably more for a given quantity of export goods. Second, productivity growth has been unusually strong, both for companies competing on international markets and those supplying goods and services to the domestic market.
The "leader" – the social partners – can internalise the monetary policy response and take the "follower’s" – Norges Bank’s – response to their actions into account. This approach is most relevant when wage setting is centralised. A number of studies2 have shown that countries with a relatively high degree of centralisation and coordination, such as Norway, can achieve relatively low unemployment. When wage-setting is decentralised, monetary policy will instead influence wage growth via market mechanisms, by stabilising aggregate demand for goods, services and labour. Monetary policy that is flexibly oriented towards low and stable inflation will function well whether wages are set at the central, local or individual level. 2 In the initial period after the introduction of the inflation target in 2001, it appeared that the social partners had not yet internalised the response pattern ensuing from the monetary policy mandate. We are now well into a cyclical phase with very high capacity utilisation and low unemployment. In this situation, there may be a risk that wage growth will again accelerate. On the other hand, the experience gained by the social partners that large pay rises push up interest rates may have the effect of curbing pay increases. In local wage negotiations at enterprise level, competition, the supply of foreign labour and the possibility of outsourcing or relocating activities may dampen the impact. Low and stable inflation should not be taken for granted. Norway’s and other countries’ economic history shows that inflation and inflation expectations can become unhinged.