11  Looking further ahead, developments in global financial markets will have a considerable impact on the GPFG. Higher inflation and signals that interest rates will be raised faster than markets expected have recently made investors uneasy. The long equities bull market may be nearing an end. In a transitional period, higher interest rates will also reduce the value of the GPFG’s fixed income portfolio. NORGES BANK ECONOMIC PERSPECTIVES 17 FEBRUARY 2022  Developments ahead may also be marked by demographic changes, tension between countries and lower global trade integration. Moreover, we are facing a necessary transition to a low-carbon economy. Whatever happens abroad will still leave its mark on the GPFG. No investment is completely safe, as history has shown. In 1904, the Norwegian government set funds aside in the State Reserve Fund to be used only “in extraordinary circumstances or in an emergency”. When it was dissolved in 1925, it was nearly empty. Creative accounting must take some of the blame. Yet it didn’t help either that it was invested in only a few assets – mainly UK, French and German government bonds – investments regarded at the time as absolutely safe. After the First World War, the value of German and French government bonds was close to zero, wiping out much of the State Reserve Fund’s assets.5 The investment strategy behind the GPFG stands in stark contrast. The fundamental principle underlying the strategy is risk diversification. This lessens the potential for an across-the-board value decline in GPFG assets.
It is difficult to completely capture a sequence of events where changes in different variables tend to reinforce one another in economic calculations. If the households have also been overly optimistic - irrational - in their expectations, it becomes particularly difficult to capture these effects. It is therefore important for forecasters to make more “qualitative” assessments in addition. Another reason for not trusting solely to formal models based on historical data is that the effects of structural changes that have taken place fairly recently can easily be underestimated. Let me give an example that to some extent captures these problems. During the years from the mid-1980s to the beginning of the 1990s, substantial changes were made in the economic structure and there was a clear correlation between the change in house prices and the change in household borrowing. The decline in house prices during the financial crisis at the beginning of the 1990s was largely due to an unfavourable combination of changes of both a structural and a cyclical nature. In connection with the deregulation of the credit markets during the second half of the 1980s, household borrowing increased substantially and the loans were largely used to buy houses. The fairly high and fluctuating inflation rate contributed to real interest costs after tax often being low, sometimes even negative, which in practice meant that one could at times make a profit from borrowing.