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  II. Developments in individual OECD countries: Norway

The recovery has gained momentum, fuelled by historically low real interest rates and the acceleration of world demand. Growth for mainland Norway is expected to rebound to around 3 3/4 per cent during 2004, before falling back toward trend in 2005. Unemployment is likely to decline, albeit slowly, while inflation should eventually rise in response to the weaker exchange rate and the closing of the output gap.

Fiscal credibility would be improved via stricter adherence to the fiscal guidelines. The latter would be aided by the planned pension reform and by efforts to control rapidly rising expenditures for sick leave and disability. Along with reforms to strengthen competition in sheltered sectors, such steps would also enhance long-run potential growth.
Growth was robust during the latter half of 2003

Mainland GDP expanded at an annual rate of 4 per cent in the second half of 2003, bringing growth for the year to 3/4 per cent. Demand indicators for the early months of 2004 suggest continued strong growth, though employment growth has remained weak. Private consumption has accelerated in response to lower interest rates and exports began to recover toward end-year, in line with rising world demand and currency depreciation. An upswing in oil investment (nearly 40 per cent of business investment) has provided further support to the economy. Non-oil investment, on the other hand, has declined sharply in response to falling profitability in the exposed sector and overcapacity in the office market. Business employment and the participation rate have fallen, reflecting the traditional labour market response to the cycle, and the unemployment rate rose to 4 1/2 per cent.

Monetary policy is very accommodating

Policy interest rates have been reduced by a total of 5 1/4 percentage points since end-2002, and the real exchange rate has depreciated back to its historical average level. Nevertheless, core inflation was near zero in the early months of 2004, well under the 1 1/2 per cent lower band of the 2 1/2 per cent inflation target. This reflects strong price declines in recently liberalised sectors (e.g. airlines and communications), declining house rents, a shift in demand to low price countries (notably China), as well as an evidently slow pass-through of exchange rate depreciation into import prices. Hence, policy interest rates may remain low for some time and be raised only slowly.

Fiscal policy is also supportive

The non-oil structural budget deficit has expanded by over 1/2 per cent of GDP per year in both 2003 and 2004, providing further support to the recovery, although also implying that the fiscal policy guidelines (that the non-oil structural deficit should over time not exceed the real return on the Petroleum Fund) have been overshot by some 1 percentage point of GDP in each year. The government's objective to move back within the guidelines will require a modest fiscal tightening over the coming years. However, in the absence of specific measures, the OECD projections foresee further overshooting in 2005.

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A strong continuing recovery is projected ...

Mainland GDP growth is expected to continue at a rate of 3 3/4 per cent in 2004, slowing to around 3 per cent in 2005. With consumer confidence steadily rising and purchasing power bolstered by historically low inflation, private consumption should remain a main motor of the recovery. Since a very high proportion of mortgage loans are in floating rate terms, lower interest rates raise disposable income. Business confidence is strengthening in response to recovering demand and easy monetary conditions. However, the profitability of business is weak because of high labour costs, so that a period of cost cutting may be needed before fixed investment demand responds more vigorously. Employment growth is thus likely to be modest going forward, but productivity growth will be strong. The external sector should continue to recover, although export market share losses may remain significant because of the cumulative deterioration in international competitiveness. The negative output gap is expected to disappear and turn positive by the end of this year. Together with the effect of a weaker exchange rate, this should allow inflation to rise, and eventually reach its target range by the end of the projection period.

... with risks of overheating

Overheating could arise in 2005 if consumption and housing investment were to grow significantly more rapidly than projected, given low real interest rates and booming house prices. If wages were then to respond monetary policy would need to tighten, perhaps sharply, exposing indebted households and jeopardising the ongoing recovery of investment. Another risk is of greater than assumed fiscal slippage, especially in light of the 2005 elections, which could put renewed upward pressure on the exchange rate, again harming business prospects.


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