MNI INTERVIEW: Norges' Forecast Rate Shifts Too Predictable
MNI (LONDON) - Changes to Norges Bank's in-house projected rate path are too slow, overly predictable and fail to fully incorporate the latest information, a co-author of the finance ministry backed annual review of the central bank told MNI.
While the next rate-path revision is likely to be downwards in line with the Bank’s easing cycle, the underweighting of international shocks and excessive rate-smoothing have limited its usefulness, BI Norwegian Business School Professor Leif Anders Thorsrud said in an interview.
"The whole point is that forecast errors should not be predictable ... you should use all the information you have at the current point in time, and if you use it efficiently, it will be impossible to predict the errors you're going to do in the future," Thorsrud said, adding that "With the information I have today I can predict the revisions, or forecast errors, in the interest rate path published by Norges Bank."
The Norges Bank Watch 2025 report called on Norway’s central bank to place more weight on international developments when shocks occur, but this suggestion was rejected in an official response by Deputy Governor Pal Longva.
"It's almost like they don't fully understand how, or they are very uncertain about how, international developments or shocks transmit into the Norwegian economy,” said Thorsrud, adding that the Bank also errs in assuming that the impact of global shocks will be in line with historic averages.
"This would potentially be too low a weight, because it doesn't really matter most of the time, but when it matters, it matters a lot," he said.
Norges Bank is also overly wary of being seen to make sudden changes, he said, so the rate path lags economic developments.
"They have a lot of interest rate smoothing ... they don't want to do large changes, abrupt changes, they would rather do small steps at a time," Thorsrud said.
OUTPUT GAP
In another section, the Watch report highlighted the recent weight Norges Bank has assigned to the output gap in its policy decisions, rather than purely focussing on deviations of inflation from target.
"In simple terms, you could say that in 2024 they should have set a much higher interest rate to decrease the inflation gap, which was really high ... but they didn't do it. They implicitly put more weight on not hurting the real economy too much," Thorsrud said.
Placing the highest weight on the output gap in 20 years, Norges Bank instead kept the policy rate flat at 4.5% throughout 2024. It has now signalled that its first cut will come this March, with another later in the year.
In Norges Bank Watch 2024, Thorsrud and his co-authors had highlighted the central bank's systematic tendency to overestimate the strength of the krone, and called for it instead to look at scenario and risk analysis, along the lines proposed by former Fed chief Ben Bernanke. (See MNI INTERVIEW: Norges Bank Needs Scenarios For Krone Weakness).
Norges Bank, whose currency forecast last year eventually proved fairly accurate, while still missing with its inflation forecast, does now seem to be moving towards developing scenario analysis, with the central bank talking about using option prices to look at alternative asset prices.
"I will not be surprised if they actually start doing it," Thorsrud said.