In a different situation such a policy could have undermined confidence, leading to a depreciation of the krone and higher interest rates. Owing to high oil prices, however, the krone was very strong in 1996 and 1997. It may be that the foreign exchange market accepted that Norway was in a situation – with large government budget and current account surpluses – where the country both could and should have transferred resources from the business sector to the public sector. It could be that market participants believed that this transfer of resources would occur with the help of a strong krone exchange rate, which reduces profitability in the business sector. Appreciation pressures mounted and culminated in a reduction in interest rates by Norges Bank in January 1997 in order to counter the sharp strengthening of the krone. If the central bank had not acted, the krone might have appreciated by an even greater margin. This could have given a strong signal to the business sector to move out of Norway. However, in a situation where fiscal policy was not sufficiently tight, the reduction in interest rates increased the risk of an acceleration in price and cost inflation. Then came the fall in oil prices, with an associated erosion of the external account. Income growth for liberal professions had been substantial, wage growth for salaried employees accelerated and the wage and income settlement in 1998 was very generous. This eliminated the basis for the strong krone.
The crisis in Asia spread to Russia, where the decline in commodity prices led to an even further deterioration in government finances. The announcement that Russia could no longer service its debt was met with strong reactions in global financial markets in August and September. There were growing fears that the world economy would be caught in a financial crash. Many investors withdrew from small and risky markets, particularly in Latin America. The Brazilian currency came under pressure. It was difficult to raise loan capital even in the most advanced markets. As financial institutions throughout the world experienced growing losses, fears of a world economic depression intensified. Reductions in interest rates in the US and Europe facilitated access to credit and prevented a market collapse. Measures perceived as credible were finally implemented to resolve the Japanese banking crisis. Additional capital was allocated to the International Monetary Fund. There are still many challenges ahead. Brazil and Russia are running government budget deficits and are having problems establishing a credible monetary policy. China is bearing substantial costs as a result of the crisis in surrounding countries and may experience difficulties of its own. Other countries may also feel the contagion effect. However, even though the outlook points to lower growth in the global economy this year than forecast earlier, fears of a worldwide depression have receded. This is by no means the first time we have experienced an international financial crisis.