BIS Review 37/2008  9  Strong growth in real income has contributed to the long period of high housing investment and rising house prices. House price inflation peaked amid the housing market euphoria of about a year ago. The housing market is now cooling. In parallel with rising house prices, households have been borrowing more and saving less. Household financial saving was negative in 2006 and 2007. At the same time, Norway has a substantial current account surplus. Most of the current account surplus is matched by government financial and oil sector surpluses – which are redeployed abroad. Adjusted for these outflows, Norway recorded a basic balance of an estimated minus NOK 150 billion in 2007, or close to 10 per cent of mainland GDP. 10  BIS Review 37/2008  The corollary to the deficit on the basic balance is that Norwegian businesses, as well as Norwegian banks, borrow in foreign markets. The recent turbulence in international money markets has affected the price and supply of funding in these markets. Monetary policy assessments Monetary policy in Norway is oriented towards keeping inflation low and stable. The operational target is annual consumer price inflation of close to 2.5 per cent over time. Norges Bank operates a flexible inflation targeting regime. Both variability in inflation and variability in output and employment are given weight in interest-rate setting. Inflation has been expected to pick up for some time.
Whether an economy functions smoothly and efficiently or not depends much on the manner in which the financial system performs this task. A strong banking sector with highly disciplined risk management helps to mitigate the risks of financial imbalances while the existence of a deep and liquid financial market that offers a breadth of financial instruments helps improve the ability of the economy to absorb shocks. More generally, the level of development of an economy’s financial sector has a fundamental bearing on social welfare insofar as it determines the ability of agents to smooth out their consumption profile in the face of fluctuations in income. As such, a substantial part of the observed differences in macroeconomic outcomes between emerging market economies and developed economies can be attributable to the disparate levels of financial sector development in these two groups of countries. Indeed, a number of empirical studies indicate that financial development, especially greater financial access, is associated with lower macroeconomic volatility. 2 Next, the institutional framework of monetary and financial supervision policy also has an important influence on the extent to which various shocks make their way through the economy. Importantly, in a setting where the central bank lacks independence, its performance is likely to be more easily influenced for short-term political ends with adverse macroeconomic consequences.