Prior to the crisis, the lack of an institutional mechanism to translate the financial stability analysis made by central banks and the ECB into policy actions was a major lacuna. In response, the European Systemic Risk Board (ESRB) has been set up to monitor and assess macro-prudential risks. Given that the new framework began operating in January this year, it is difficult to assess its effectiveness comprehensively. However, it could be instructive to review ex ante the robustness of the analytical toolbox assigned to the ESRB, and consider ex post whether such a toolbox would have enhanced policymakers understanding of systemic risk prior to the crisis. Before doing so, I should make clear that the purpose of the ESRB is not to predict crises. The academic literature on early warning signal models, developed over the years, suggests that, for a number of reasons, the scope for error in predicting crises is substantial. Either the eruption of a crisis is missed or a period is wrongly identified by the start of a crisis. For this reason, the ESRB’s analytical toolbox is based on early warning models and indicators designed to identify emerging vulnerabilities or imbalances that could lead to financial instability. These models aim to perform three functions in particular. First, to identify the variables which are associated with financial instability.
In spite of the objective of a fixed exchange rate, several adjustments of the international value of kroner were made in the 1970s and 1980s to compensate for the loss of cost competitiveness due to price and wage inflation. From the mid-1980s the focus of monetary policy was increasingly shifted to the role of a stable exchange rate as a nominal anchor – against the backdrop of very high price and wage inflation and relatively high domestic interest rates following the devaluation in 1986. The EU countries’ lowinflation track record was used as an argument for pegging the krone rate to the ECU in 1990. The currency turmoil in Europe in 1992-93 prompted Norway to abandon the fixed rate against the ECU in favour of a sort of “managed float”, now aiming at keeping the exchange rate “stable” against European currencies, but with no fluctuation margins. This regime is still in force. In this context it is important to note that the small and very open Norwegian economy is highly vulnerable to fluctuations in the international economy. Furthermore, the petroleum sector is of substantial importance to our economy, and mainland industries are largely commodity-based. Whatever the choice of exchange rate or monetary policy regime may be, there will be considerable challenges associated with stabilising an economy which is that heavily exposed to cyclical fluctuations. This has been amply illustrated by recent events.