## 1. Risk Assessment Matrix

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### Context: an oil economy in transition
- Oil prices dropped by roughly 60 percent from their peak in June 2014 to less than US$40 per barrel, taking a toll on mainland output.
- Mainland GDP growth fell to 1 percent last year—the lowest rate since the 2008–09 crisis; mainland economy expanded by 0.3 percent (q/q) in the first quarter of this year.
- Labor market:
  - Seasonally-adjusted LFS unemployment rate reached 4.7 percent in March—the highest level in ten years.
  - Rising unemployment mainly driven by strong labor force growth; employment began to falter in the fourth quarter.
  - Unemployment increasingly concentrated in oil-dependent parts of the country (e.g., Rogaland).
- Inflation and wages:
  - Core inflation (CPI-ATE) was 2.7 percent on average last year; reached 3.3 percent in April after peaking at 3.4 percent in February.
  - Wage growth was 2.8 percent last year.
- Exchange rate and external sector:
  - The import-weighted nominal exchange rate has depreciated by about 25 percent since early 2013.
  - The krone is assessed to be moderately undervalued relative to fundamentals and policies (Annex I).
  - Current account surplus narrowed in 2015, almost entirely due to the fall in the value of oil and gas exports.
- Housing and household balance sheets:
  - House prices increased by 6.1 percent last year; significant regional variation (robust in Oslo area, declining in Stavanger).
  - Household debt as a share of disposable income about 220 percent in mid-2015.
- Migration:
  - Norway received over 27,000 first-time asylum applicants between June and December last year; total over 31,000 for the year (0.6 percent of the population), a third from Syria.
  - Government expects about 25,000 inflows in 2016 and proposed a broadly budget-neutral increase in spending of about 0.4 percent of mainland GDP to handle extra inflows.

### Outlook: projections and drivers
- Staff projections:
  - Mainland economy growth: about 1 percent this year and close to 1¾ percent in 2017.
  - Unemployment projected to rise to 4.7 percent this year, declining to 4.5 percent in 2017.
  - Headline inflation expected at 2¾ percent this year and to return to the 2.5 percent target next year.
- Drivers of recovery:
  - Expansionary fiscal and monetary policy, lagged impact of weak krone, gradual upturn in oil prices, slowing pace of decline in oil investment.
- Medium-term challenge:
  - Transition away from oil dependence; about one in ten jobs is oil-related.

### Risks (skewed to the downside)
- External and oil-price risks:
  - A sharper-than-expected global growth slowdown or persistently lower oil prices could derail recovery; persistently lower-than-projected oil prices could intensify fall in oil investment and reduce oil-related demand for mainland goods and services.
- Housing market correction:
  - A substantial correction in property prices could depress private demand and reduce output.
  - Staff analysis: a 10 percent decline in real house prices could reduce private consumption by 0.9 percent.
  - Probability of sharp increase in mortgage default rate is low; risks to financial stability are contained (2015 FSAP Update).
- Financial conditions:
  - Tighter or more volatile global financial conditions could lead to liquidity strains and raise costs for Norwegian banks relying on wholesale funding (possible triggers include a bumpy QE exit in the United States, a British exit from the EU, or Euro Area turbulence).
- Slow transition risk:
  - A hesitant or stalled transition to a less oil-dependent growth model could lead to higher unemployment for a longer period if wages fail to adjust or resources fail to move efficiently to non-oil tradable sectors.
- Refugee integration risk:
  - Increased number of refugees, if not effectively integrated into the labor market, could weigh on public finances and raise structural unemployment.
- Interaction of risks:
  - Persistently low oil prices could trigger a sharp correction in house prices, producing negative wealth effects, reduced consumption and investment, and possible banking sector implications.
  - Protracted global weakness could dampen external demand for traditional goods exports, depressing investment and job creation.

### Scenarios: slow transition impacts (staff estimates)
- Scenario assumptions:
  - Out of 40,000 likely lost oil jobs, only a third would be replaced in 2016, and it would take the next five years to replace all lost jobs.
- Projected impacts under slow transition scenario (Fund staff estimates):
  - Unemployment: higher path relative to baseline (chart data span 2015–2021 showing unemployment rising above baseline through 2021).
  - Mainland growth: lower vs. baseline (chart data span 2015–2021 showing persistent drag on mainland growth).
  - Growth impact assumption: higher unemployment subtracts 1ppt from household consumption and private investment growth in 2016 and 0.5ppt for each year during 2017–21; mainland exports also affected.

### Authorities’ views
- Authorities broadly agreed with staff assessment of outlook and risks, noting large regional variation in labor and housing markets.
- Authorities cited shock absorbers: supportive macroeconomic policies, sound fiscal framework, weaker exchange rate, flexible labor force, and solid financial positions of banks and households.
- On a British exit from the EU, authorities saw small direct impact on Norway if a bilateral trade agreement is quickly put in place and major financial market disruptions are avoided.

### Policy discussions — overarching objectives
- Overarching objective:
  - Policies should mitigate the downturn, facilitate transition to a less oil-dependent growth model, strengthen productive capacity, and enhance resilience.
  - Macroeconomic policies should support growth and employment while smoothing structural adjustment; labor market policies are key for competitiveness and refugee integration; further measures needed to mitigate financial sector risks.

A. Fiscal policy: promoting employment and structural adjustment
- 2015 fiscal stance and GPFG:
  - Fiscal impulse last year was ½ percent of mainland trend GDP.
  - Structural non-oil budget deficit about 6¼ percent of mainland trend GDP — equivalent to 2.6 percent of GPFG assets at year-end — well below the 4 percent “target” of the fiscal rule.
  - GPFG assets have grown rapidly in recent years, in part due to currency depreciation increasing the krone value of foreign-currency-denominated assets.
- 2016 fiscal stance:
  - Authorities expecting a 1.1 percent fiscal impulse this year.
  - Revised 2016 budget forecasts a structural non-oil deficit of about 7½ percent of mainland trend GDP, or 2.8 percent of staff’s projected GPFG assets at year end.
  - An additional 0.4 percent of mainland GDP included to cover asylum seeker-related expenses (broadly budget-neutral).
- Employment and tax measures in 2016 budget:
  - Special employment-enhancing measures amounting to NOK 4 billion (nearly 0.2 percent of mainland GDP).
  - New targeted measures worth NOK 900 million (0.04 percent of mainland GDP) to support employment in southern and western Norway.
  - Net tax reductions worth NOK 8.3 billion (0.3 percent of mainland GDP) in 2016 as part of 2016–18 tax reform proposal, including:
    - Reduction of statutory corporate income tax (CIT) rate from 27 to 25 percent in 2016.
    - Reduction of top marginal tax rate on personal income by 0.3 percentage points in 2016.
    - CIT rate to be reduced further to 23 percent by 2018.
- Staff assessment of fiscal stance:
  - Expansionary fiscal stance in 2016 is justifiable given a widening output gap (staff estimate -1.4 percent), rising unemployment, ample fiscal space, and low debt sustainability risk (Annex II).
  - Fiscal support would complement monetary policy as the key policy rate approaches zero.
- Composition guidance:
  - Fiscal policy should balance countercyclical support and structural adjustment: tax reductions promote private saving and investment and align tax system with international practice; public expenditure should focus on boosting productive capacity and external competitiveness.
  - Public spending should avoid interrupting resource shift to non-oil tradable production by increasing public employment or domestic-goods-and-services demand.

### Fiscal policy: Gradual shift to neutral to relieve Dutch Disease pressures
- Recent practice:
  - Fiscal policy has been prudent, with spending of oil revenues "well below 4 percent of GPFG assets" in recent years.
  - As the GPFG has grown much faster than mainland GDP, the fiscal rule’s "4 percent target is no longer appropriate as a short-term operational guidance."
- Recommendation:
  - Target a transfer more like "the current transfer to the budget as a share of GPFG assets (2.5–3.0 percent)".
  - Rationale: closer to likely returns for the next decade and helps conserve GPFG resources to address long-run aging-related costs.
- Supplementary rule:
  - Fiscal impulse should be neutral when the economy is at capacity and negative when the economy is above capacity to help prevent crowding out of tradable goods and services.
- Authorities’ views:
  - Agreed fiscal policy should support employment and growth without inhibiting adjustment to a non-oil growth model.
  - Noted planned fiscal expansion this year can be justified given the shock and available fiscal space and contains targeted measures for hardest hit regions.
  - Agreed it would be undesirable if the public sector absorbed a large part of labor released from oil-related sectors or if fiscal expansion became a new norm.

### Monetary policy: supporting demand while maintaining price stability
- Recent actions:
  - Norges Bank reduced its key policy rate to "½ percent in March 2016" in view of weakened growth prospects and subdued inflation outlook.
- Inflation and wages:
  - Wage growth in 2016 expected to be "about 2½ percent"—down from "2.8 percent in 2015".
  - This implies social partners assume "approximately unchanged real wages in 2016".
  - Inflation should stay slightly above target this year but return to target next year as low capacity utilization weighs on domestic inflation and exchange rate effects unwind.
- Policy stance and risks:
  - Monetary policy can stay accommodative for now; further easing could be considered if growth is significantly weaker, provided inflation expectations remain well anchored.
  - Negative rates should not be ruled out in a more adverse scenario.
  - Monitor wage developments and spillover risk from imported inflation to domestic inflation.
  - Financial stability concerns argue for caution as policy rate is lowered given risks of acceleration in property prices and household debt growth.
- Longer-run normalization:
  - A gradual return from current negative real rates to Norges Bank’s estimated normal real interest rate of "about 1½ percent"—corresponding to a normal nominal interest rate of "about 4 percent" given the inflation target—will be needed over time.
- Authorities’ views:
  - Monetary policy can facilitate the transition by easing credit and avoiding appreciation, provided confidence in stable inflation remains firm.
  - Possibility of a negative key policy rate cannot be ruled out for new major shocks, but further easing will be considered with greater caution.
  - Macroprudential policy is the first line of defense in maintaining financial stability.

### Financial sector policy: strengthening resilience and reducing vulnerabilities
- Banking sector performance:
  - Banks are profitable compared with peers; NPL ratio trended down to "1.1 percent of total loans".
  - FSAP 2015 stress tests suggest banks’ buffers position them to withstand severe shocks such as persistently low oil prices plus a contraction in house prices.
- Key vulnerabilities:
  - Elevated household debt, overvalued house prices, and heavy reliance on external wholesale funding.
  - Persistently low oil prices could deteriorate household and corporate balance sheets and build up banks’ credit risks.
  - Specific figures:
    - Banks’ direct exposure to the oil sector is "1 percent of banks’ corporate lending portfolios".
    - Measured by percentage of banks’ equity returns attributable to oil-related firms, banks’ total exposure to the oil sector could be "as high as 30 percent".
- Recent and planned policy actions:
  - Countercyclical capital buffer to be increased to "1½ percent from July 1, 2016".
  - New liquidity rules set minimum total "all currency" LCR requirement at "100 percent", effective from 2016 for the three systemically important banks and gradually phased in for other credit institutions.
  - Housing sector measures:
    - Lending guidelines on new mortgages introduced in 2010 and converted into regulations in mid-2015 that are set to expire at "end-2016".
    - FSA tightened parameters for IRB model estimation of residential mortgage risk in 2014–15.
    - Staff analysis suggests these measures impacted mortgage growth but "may not be enough to contain housing market vulnerabilities."
- Further recommended actions (key FSAP recommendations):
  - Consider additional targeted measures to contain systemic risks from house price and household indebtedness growth, including:
    - Higher mortgage risk weights.
    - Tighter LTV limits (current LTV cap "85 percent" described as relatively high).
    - Supplementing affordability tests by adding LTI or DSTI ratio limits.
    - Tailoring measures regionally given divergent housing market developments.
  - Enhance stress tests to account for funding risks and monitor/limit banks’ wholesale funding including maturity mismatch between currency swaps and underlying exposures.
  - Strengthen crisis management, safety nets, and bank resolution: finalize recovery plans, initiate resolution planning, and conduct resolvability assessments for the largest banks.
  - Strengthen regional cooperation on financial stability issues, notably in light of Nordea’s planned conversion of Nordic subsidiaries into branches and negotiations on a new Memorandum of Understanding.
- Authorities’ views:
  - Broad agreement scope exists to strengthen the policy framework.
  - Authorities monitor housing market and household debt closely and assess macroprudential measures’ impact.
  - On broadening macroprudential instruments, authorities view the current affordability test as serving similar purpose to DTI/DSTI limits and being more "granular."
  - Further proposals on individual currency LCR requirements and BRRD implementation expected in the second half of 2016.

### Supporting transition and improving efficiency — structural priorities
- Competitiveness and wages:
  - Between 1995 and 2013, Norway’s ULC measured in common currency has "appreciated by over 70 percent relative to trading partners," driven by high wage growth—particularly in oil- and gas-related sectors—and subdued productivity gains.
  - Recent exchange rate weakening has reversed some lost ground, boosting traditional goods exports.
  - Curbing future real wage increases is important. Centrally-negotiated pay in this year’s bargaining round: "0.3 percent" nominal increase (similar to last year).
  - Economy-wide nominal wage growth for 2016 estimated at "about 2.4 percent", implying flat real wages.
  - Continued restraint in wage settlements critical to deliver sustained downward adjustment in ULC relative to trading partners.
- Productivity:
  - Productivity growth in mainland Norway has fallen considerably since the mid-2000s for cyclical and structural reasons (e.g., rising labor immigration, resource reallocation from booming oil prices).
  - Productivity Commission recommendations include reforms in education, research and innovation, workforce mobilization, public sector efficiency, cooperation between higher education and industry, softer regulation of working hours, making social security benefits more activity-oriented and enforcing activity requirements, and reforming local government organization.
  - Authorities should continue ongoing reforms and prioritize measures likely to generate large productivity payoffs.
- Labor market and social protection reforms:
  - 2011 pension reforms increased labor force participation among older workers in the private sector; public sector pension reforms need completion along similar lines.
  - Disability and sickness claims account for a large fraction of lost labor; recent changes to disability benefits and pilot programs to enforce activity requirements for sickness benefits show encouraging results.
  - Further reforms to sickness and disability benefits would help maintain labor force participation amid aging and support reallocation during the transition.
  - Active labor market policies can improve search and matching efficiency.
- Tax and structural reforms:
  - Tax reforms should shift taxation from labor and corporate income to property and consumption.
  - Reducing tax preferences for housing would channel investment to more productive uses, including non-oil tradable sectors.
  - Recent tax reform reduced corporate tax rate and marginal personal income tax rate, but a shift to higher taxes on property has not been implemented.
  - Recent political agreement for additional reductions in personal and corporate income tax rates would, if implemented, be positive.
  - Relaxing constraints on new property construction, including at municipal level, could boost housing supply and reduce housing price pressure.
  - Reducing protection and subsidy to agriculture would have positive distributional effects and free up resources for more effective rural policies.
- Authorities’ views:
  - Agreed on need to restore competitiveness and continue structural reforms.
  - Noted substantial downward adjustment in unit labor costs due to weak currency and forecast low wage growth for next year.
  - Ongoing reforms in higher education, research and innovation, and local government organization noted.
  - Discount on taxable values of second dwellings and commercial property reduced from "50 to 20 percent over the last three years."

### Accommodating and integrating refugees
- Short- and medium-run challenges:
  - Surge of asylum seekers strains reception and asylum processing systems, raising fiscal cost in short run.
  - Medium-run concern: capacity to integrate refugees into economy and society, partly depending on labor market success.
  - Employment stats: "Just over half of non-Western immigrants, which includes most refugees, are employed, a rate that is 15 percentage points lower than that for natives."
  - Recent slowdown and lower labor demand may make absorption of refugees more difficult.
- Potential macroeconomic impact of successful integration:
  - Increasing refugees’ employment rate to the level of natives could temporarily increase labor force growth rate by "as much as 0.3 percentage points", which would in turn add "as much as 0.1–0.2 percentage points to potential growth for a couple years."
- Policy recommendations to improve integration:
  - Combine language lessons and other training with work where appropriate to ensure stronger and more rapid labor force attachment.
  - Improve assessment of refugees’ formal and informal qualifications to better match refugees with jobs and training.
  - Spread successful municipal approaches more widely, as the likelihood of refugees being in work or education one year after the introduction course varies substantially across municipalities.
  - Consider greater wage flexibility in a temporary and targeted manner to incentivize hiring of refugees, given compressed wage distribution and high effective minimum wage in Norway.
  - The White Paper introduced to Parliament in May 2016 takes several steps toward improving the introduction program and refugee integration into the labor market.
- Authorities’ views:
  - The authorities emphasized the need to quickly integrate refugees into the labor market and support the White Paper measures to accelerate integration of high-skilled refugees and speed up processing of asylum seekers more likely to obtain refugee status.
  - STAFF APPRAISAL: Timely integration of the newly arrived refugees into productive employment is crucial for reducing fiscal costs.
  - Specific suggestions include making the two-year introduction program more personalized and work-oriented and learning from more successful municipalities.

### Box 1. Risk Assessment Matrix — identified risks, likelihood, impact, and policy responses (summary)
- Persistently lower energy prices:
  - Relative likelihood: High
  - Expected impact if realized: High
  - Policy response: Use ample fiscal space and scope for monetary easing to facilitate transition.
- Sharper-than-expected global growth slowdown:
  - Relative likelihood: High
  - Expected impact if realized: High
  - Policy response: Automatic stabilizers and discretionary fiscal support as needed.
- Widespread and large reduction in house prices:
  - Relative likelihood: Medium
  - Expected impact if realized: High
  - Policy response: Extend temporary regulations on new mortgages beyond end-2016 and take additional macroprudential measures.
- Tighter or more volatile global financial conditions:
  - Relative likelihood: Medium
  - Expected impact if realized: Medium
  - Policy response: Introduce NSFR requirements and strengthen liquidity monitoring.
- Failure of non-oil mainland economy to pick up slack:
  - Relative likelihood: Medium
  - Expected impact if realized: Medium
  - Policy response: Avoid public employment crowding-out; pursue competitiveness and productivity reforms.
- Dislocation in capital and labor flows (large migrant flows):
  - Relative likelihood: High
  - Expected impact if realized: High
  - Policy response: Strengthen refugees’ access to ALMPs and accelerate settlement processes.
- British exit from the EU (June 23rd referendum):
  - Relative likelihood: Low
  - Expected impact if realized: High
  - Policy response: Prepare liquidity provision and negotiate new cooperation/trade agreements to minimize disruptions.

### Annex I — External sector assessment (key statistics and staff evaluation)
- Key developments:
  - CA balance fell from 14.9 percent of (mainland) GDP in 2014 to 10.8 percent of GDP in 2015.
  - Fall driven by 36 percent decline in value of oil exports.
  - Terms of trade shock led to 27 percent depreciation in the nominal effective exchange rate (import weighted) since early 2013.
  - NIIP rose 30 percentage points to 239 percent of GDP.
  - Banks’ net external liabilities around 57 percent of GDP.
  - Reserve assets just over 19 percent of GDP.
- EBA results (range of exchange rate misalignment estimates):
  - EBA CA Analysis-1.33.7
  - EBA REER (Index) Analysis---9.3
  - EBA REER (Level) Analysis---29.7
  - EBA External Sustainability Approach-10.529.6
- Staff assessment:
  - Staff considers the CA and REER index analyses more reliable and concludes the exchange rate is not significantly undervalued.
  - REER level and ES approaches give large and opposing indications, raising questions about suitability for Norway.

### Annex IX — Housing boom and macroprudential policy (key findings)
- Real house prices risen more than 80 percent since 2000; prices estimated 40 percent overvalued (averaged across three measures).
- Household indebtedness exceeded 220 percent of disposable income by end-2015.
- Empirical effects:
  - A 10 percentage point increase in mortgage risk weights reduces mortgage credit growth by 2.4 percentage points (estimated).
  - A ten point change in the net balance measure of banks’ tightening of LTV limits over the next 3 months would reduce mortgage credit growth by 0.6 percentage points.
- DSGE model illustrative results:
  - Reduction in tax deductibility: almost all steady state impact in 5 years; reduces steady state DTI by just over 11 percentage points.
  - Tightening the LTV cap: about half the impact on debt ratio after 5 years; new steady state DTI about 20 percentage points lower.
  - Strengthening amortization requirement: about 20 percentage point reduction in DTI in new steady state; about one third of reduction after 5 years.
  - In all simulated cases, impact on consumption is minimum and even slightly positive for most.
- Policy implication:
  - Macroprudential measures could be tightened further; addressing structural contributors such as mortgage interest tax deductibility would reinforce policy effects.

### Annex V — Authorities’ response to past IMF recommendations (highlights)
- Fiscal policy:
  - Authorities’ 2016 budget: positive fiscal impulse of 1.1 percent of trend mainland GDP (compared to 0.5 percent in 2015).
  - GPFG at 286 percent of mainland GDP at end-2015.
  - Structural non-oil deficits kept well below 4 percent of GPFG capital; structural deficits remain below 3 percent of GPFG value.
  - Authorities committed to respond to Commission on the Fiscal Rule in Spring 2017 White Paper on Long-Term Perspective.
- Macroprudential policy:
  - Countercyclical capital buffer to be increased to 1½ percent from July 1, 2016.
  - Minimum total “all currency” LCR requirement set at 100 percent effective from 2016 for three systemically important banks.
  - Mortgage regulations effective 1 July 2015 to end-2016; to be continuously assessed.
- Structural reforms:
  - Discount on taxable values for secondary dwellings and commercial property reduced from 30 to 20 percent.
  - Negotiations on public sector occupational pension scheme ongoing but delayed.
  - Changes to disability benefits and pilot programs for sickness benefit activity requirements underway and showing encouraging results.

*Source: _cr16214 - IMF staff report content.*

### 1. Risk Assessment Matrix _______________________________________________________________________ 20

### 1. Risk Assessment Matrix

### Context: an oil economy in transition
- Oil prices dropped by roughly 60 percent from their peak in June 2014 to less than US$40 per barrel, taking a toll on mainland output.
- Mainland GDP growth fell to 1 percent last year—the lowest rate since the 2008–09 crisis; mainland economy expanded by 0.3 percent (q/q) in the first quarter of this year.
- Labor market:
  - Seasonally-adjusted LFS unemployment rate reached 4.7 percent in March—the highest level in ten years.
  - Rising unemployment mainly driven by strong labor force growth; employment began to falter in the fourth quarter.
  - Unemployment increasingly concentrated in oil-dependent parts of the country (e.g., Rogaland).
- Inflation and wages:
  - Core inflation (CPI-ATE) was 2.7 percent on average last year; reached 3.3 percent in April after peaking at 3.4 percent in February.
  - Wage growth was 2.8 percent last year.
- Exchange rate and external sector:
  - The import-weighted nominal exchange rate has depreciated by about 25 percent since early 2013.
  - The krone is assessed to be moderately undervalued relative to fundamentals and policies (Annex I).
  - Current account surplus narrowed in 2015, almost entirely due to the fall in the value of oil and gas exports.
- Housing and household balance sheets:
  - House prices increased by 6.1 percent last year; significant regional variation (robust in Oslo area, declining in Stavanger).
  - Household debt as a share of disposable income about 220 percent in mid-2015.
- Migration:
  - Norway received over 27,000 first-time asylum applicants between June and December last year; total over 31,000 for the year (0.6 percent of the population), a third from Syria.
  - Government expects about 25,000 inflows in 2016 and proposed a broadly budget-neutral increase in spending of about 0.4 percent of mainland GDP to handle extra inflows.

### Outlook: gradual recovery clouded by risks
- Staff projections:
  - Mainland economy growth: about 1 percent this year and close to 1¾ percent in 2017.
  - Unemployment projected to rise to 4.7 percent this year, declining to 4.5 percent in 2017.
  - Headline inflation expected at 2¾ percent this year and to return to the 2.5 percent target next year.
- Drivers of recovery: expansionary fiscal and monetary policy, lagged impact of weak krone, gradual upturn in oil prices, slowing pace of decline in oil investment.
- Medium-term challenge: transition away from oil dependence; about one in ten jobs is oil-related.

### Risks (skewed to the downside)
- External and oil-price risks:
  - A sharper-than-expected global growth slowdown or persistently lower oil prices could derail recovery; persistently lower-than-projected oil prices could intensify fall in oil investment and reduce oil-related demand for mainland goods and services.
- Housing market correction:
  - A substantial correction in property prices could depress private demand and reduce output.
  - Staff analysis: a 10 percent decline in real house prices could reduce private consumption by 0.9 percent.
  - Probability of sharp increase in mortgage default rate is low; risks to financial stability are contained (2015 FSAP Update).
- Financial conditions:
  - Tighter or more volatile global financial conditions could lead to liquidity strains and raise costs for Norwegian banks relying on wholesale funding (possible triggers include a bumpy QE exit in the United States, a British exit from the EU, or Euro Area turbulence).
- Slow transition risk:
  - A hesitant or stalled transition to a less oil-dependent growth model could lead to higher unemployment for a longer period if wages fail to adjust or resources fail to move efficiently to non-oil tradable sectors.
- Refugee integration risk:
  - Increased number of refugees, if not effectively integrated into the labor market, could weigh on public finances and raise structural unemployment.
- Interaction of risks:
  - Persistently low oil prices could trigger a sharp correction in house prices, producing negative wealth effects, reduced consumption and investment, and possible banking sector implications.
  - Protracted global weakness could dampen external demand for traditional goods exports, depressing investment and job creation.

### Scenarios: slow transition impacts (staff estimates)
- Slow transition scenario assumptions:
  - Out of 40,000 likely lost oil jobs, only a third would be replaced in 2016, and it would take the next five years to replace all lost jobs.
- Projected impacts under slow transition scenario (Fund staff estimates):
  - Unemployment: higher path relative to baseline (chart data span 2015–2021 showing unemployment rising above baseline through 2021).
  - Mainland growth: lower vs. baseline (chart data span 2015–2021 showing persistent drag on mainland growth).
  - Growth impact assumption: higher unemployment subtracts 1ppt from household consumption and private investment growth in 2016 and 0.5ppt for each year during 2017–21; mainland exports also affected.

### Authorities’ views
- Authorities broadly agreed with staff assessment of outlook and risks, noting large regional variation in labor and housing markets.
- Authorities cited shock absorbers: supportive macroeconomic policies, sound fiscal framework, weaker exchange rate, flexible labor force, and solid financial positions of banks and households.
- On a British exit from the EU, authorities saw small direct impact on Norway if a bilateral trade agreement is quickly put in place and major financial market disruptions are avoided.

### Policy discussions
- Overarching policy objective:
  - Policies should mitigate the downturn, facilitate transition to a less oil-dependent growth model, strengthen productive capacity, and enhance resilience.
  - Macroeconomic policies should support growth and employment while smoothing structural adjustment; labor market policies are key for competitiveness and refugee integration; further measures needed to mitigate financial sector risks.

A. Fiscal policy: promoting employment and structural adjustment
- 2015 fiscal stance and GPFG:
  - Fiscal impulse last year was ½ percent of mainland trend GDP.
  - Structural non-oil budget deficit about 6¼ percent of mainland trend GDP — equivalent to 2.6 percent of GPFG assets at year-end — well below the 4 percent “target” of the fiscal rule.
  - GPFG assets have grown rapidly in recent years, in part due to currency depreciation increasing the krone value of foreign-currency-denominated assets.
- 2016 fiscal stance:
  - Authorities expecting a 1.1 percent fiscal impulse this year.
  - Revised 2016 budget forecasts a structural non-oil deficit of about 7½ percent of mainland trend GDP, or 2.8 percent of staff’s projected GPFG assets at year end.
  - An additional 0.4 percent of mainland GDP included to cover asylum seeker-related expenses (broadly budget-neutral).
- Employment and tax measures in 2016 budget:
  - Special employment-enhancing measures amounting to NOK 4 billion (nearly 0.2 percent of mainland GDP).
  - New targeted measures worth NOK 900 million (0.04 percent of mainland GDP) to support employment in southern and western Norway.
  - Net tax reductions worth NOK 8.3 billion (0.3 percent of mainland GDP) in 2016 as part of 2016–18 tax reform proposal, including:
    - Reduction of statutory corporate income tax (CIT) rate from 27 to 25 percent in 2016.
    - Reduction of top marginal tax rate on personal income by 0.3 percentage points in 2016.
    - CIT rate to be reduced further to 23 percent by 2018.
- Staff assessment of fiscal stance:
  - Expansionary fiscal stance in 2016 is justifiable given a widening output gap (staff estimate -1.4 percent), rising unemployment, ample fiscal space, and low debt sustainability risk (Annex II).
  - Fiscal support would complement monetary policy as the key policy rate approaches zero.
- Composition guidance:
  - Fiscal policy should balance countercyclical support and structural adjustment: tax reductions promote private saving and investment and align tax system with international practice; public expenditure should focus on boosting productive capacity and external competitiveness.
  - Public spending should avoid interrupting resource shift to non-oil tradable production by increasing public employment or domestic-goods-and-services demand.

*Source: _cr16214 - 1. Risk Assessment Matrix*

### 18.      As economic growth gathers steam, the fiscal stance should gradually shift to neutral

### 18.      As economic growth gathers steam, the fiscal stance should gradually shift to neutral

### Fiscal policy: Gradual shift to neutral to relieve Dutch Disease pressures
- Fiscal policy has been prudent, with spending of oil revenues "well below 4 percent of GPFG assets" in recent years.
- As the GPFG has grown much faster than mainland GDP, the fiscal rule’s "4 percent target is no longer appropriate as a short-term operational guidance."
- Recommendation: target a transfer more like "the current transfer to the budget as a share of GPFG assets (2.5–3.0 percent)".
  - Rationale: closer to likely returns for the next decade and helps conserve GPFG resources to address long-run aging-related costs.
- Supplementary rule recommended: fiscal impulse should be neutral when the economy is at capacity and negative when the economy is above capacity to help prevent crowding out of tradable goods and services.
- Authorities’ views:
  - Agreed fiscal policy should support employment and growth without inhibiting adjustment to a non-oil growth model.
  - Noted planned fiscal expansion this year can be justified given the shock and available fiscal space and contains targeted measures for hardest hit regions.
  - Agreed it would be undesirable if the public sector absorbed a large part of labor released from oil-related sectors or if fiscal expansion became a new norm.

*Source: IMF staff report content.*

### Monetary policy: Supporting demand and maintaining price stability
- Norges Bank reduced its key policy rate to "½ percent in March 2016" in view of weakened growth prospects and subdued inflation outlook.
- Inflation and wages:
  - Wage growth in 2016 expected to be "about 2½ percent"—down from "2.8 percent in 2015".
  - This implies social partners assume "approximately unchanged real wages in 2016".
  - Inflation should stay slightly above target this year but return to target next year as low capacity utilization weighs on domestic inflation and exchange rate effects unwind.
- Policy stance and risks:
  - Monetary policy can stay accommodative for now; further easing could be considered if growth is significantly weaker, provided inflation expectations remain well anchored.
  - Negative rates should not be ruled out in a more adverse scenario.
  - Monitor wage developments and spillover risk from imported inflation to domestic inflation.
  - Financial stability concerns argue for caution as policy rate is lowered given risks of acceleration in property prices and household debt growth.
- Longer-run normalization:
  - A gradual return from current negative real rates to Norges Bank’s estimated normal real interest rate of "about 1½ percent"—corresponding to a normal nominal interest rate of "about 4 percent" given the inflation target—will be needed over time.
- Authorities’ views:
  - Monetary policy can facilitate the transition by easing credit and avoiding appreciation, provided confidence in stable inflation remains firm.
  - Possibility of a negative key policy rate cannot be ruled out for new major shocks, but further easing will be considered with greater caution.
  - Macroprudential policy is the first line of defense in maintaining financial stability.

*Source: IMF staff report content.*

### Financial sector policy: Strengthening resilience and reducing vulnerabilities
- Banking sector performance:
  - Banks are profitable compared with peers; NPL ratio trended down to "1.1 percent of total loans".
  - FSAP 2015 stress tests suggest banks’ buffers position them to withstand severe shocks such as persistently low oil prices plus a contraction in house prices.
- Key vulnerabilities:
  - Elevated household debt, overvalued house prices, and heavy reliance on external wholesale funding.
  - Persistently low oil prices could deteriorate household and corporate balance sheets and build up banks’ credit risks.
  - Specific figures:
    - Banks’ direct exposure to the oil sector is "1 percent of banks’ corporate lending portfolios".
    - Measured by percentage of banks’ equity returns attributable to oil-related firms, banks’ total exposure to the oil sector could be "as high as 30 percent".
- Recent and planned policy actions:
  - Countercyclical capital buffer to be increased to "1½ percent from July 1, 2016".
  - New liquidity rules set minimum total "all currency" LCR requirement at "100 percent", effective from 2016 for the three systemically important banks and gradually phased in for other credit institutions.
  - Housing sector measures:
    - Lending guidelines on new mortgages introduced in 2010 and converted into regulations in mid-2015 that are set to expire at "end-2016".
    - FSA tightened parameters for IRB model estimation of residential mortgage risk in 2014–15.
    - Staff analysis suggests these measures impacted mortgage growth but "may not be enough to contain housing market vulnerabilities."
- Further recommended actions (key FSAP recommendations):
  - Consider additional targeted measures to contain systemic risks from house price and household indebtedness growth, including:
    - Higher mortgage risk weights.
    - Tighter LTV limits (current LTV cap "85 percent" described as relatively high).
    - Supplementing affordability tests by adding LTI or DSTI ratio limits.
    - Tailoring measures regionally given divergent housing market developments.
  - Enhance stress tests to account for funding risks and monitor/limit banks’ wholesale funding including maturity mismatch between currency swaps and underlying exposures.
  - Strengthen crisis management, safety nets, and bank resolution: finalize recovery plans, initiate resolution planning, and conduct resolvability assessments for the largest banks.
  - Strengthen regional cooperation on financial stability issues, notably in light of Nordea’s planned conversion of Nordic subsidiaries into branches and negotiations on a new Memorandum of Understanding.
- Authorities’ views:
  - Broad agreement scope exists to strengthen the policy framework.
  - Authorities monitor housing market and household debt closely and assess macroprudential measures’ impact.
  - On broadening macroprudential instruments, authorities view the current affordability test as serving similar purpose to DTI/DSTI limits and being more "granular."
  - Further proposals on individual currency LCR requirements and BRRD implementation expected in the second half of 2016.

*Source: IMF staff report content.*

### Supporting transition and improving efficiency
- Competitiveness and wages:
  - Between 1995 and 2013, Norway’s ULC measured in common currency has "appreciated by over 70 percent relative to trading partners," driven by high wage growth—particularly in oil- and gas-related sectors—and subdued productivity gains.
  - Recent exchange rate weakening has reversed some lost ground, boosting traditional goods exports.
  - Curbing future real wage increases is important. Centrally-negotiated pay in this year’s bargaining round: "0.3 percent" nominal increase (similar to last year).
  - Economy-wide nominal wage growth for 2016 estimated at "about 2.4 percent", implying flat real wages.
  - Continued restraint in wage settlements critical to deliver sustained downward adjustment in ULC relative to trading partners.
- Productivity:
  - Productivity growth in mainland Norway has fallen considerably since the mid-2000s for cyclical and structural reasons (e.g., rising labor immigration, resource reallocation from booming oil prices).
  - Productivity Commission recommendations include reforms in education, research and innovation, workforce mobilization, public sector efficiency, cooperation between higher education and industry, softer regulation of working hours, making social security benefits more activity-oriented and enforcing activity requirements, and reforming local government organization.
  - Authorities should continue ongoing reforms and prioritize measures likely to generate large productivity payoffs.
- Labor market and social protection reforms:
  - 2011 pension reforms increased labor force participation among older workers in the private sector; public sector pension reforms need completion along similar lines.
  - Disability and sickness claims account for a large fraction of lost labor; recent changes to disability benefits and pilot programs to enforce activity requirements for sickness benefits show encouraging results.
  - Further reforms to sickness and disability benefits would help maintain labor force participation amid aging and support reallocation during the transition.
  - Active labor market policies can improve search and matching efficiency.
- Tax and structural reforms:
  - Tax reforms should shift taxation from labor and corporate income to property and consumption.
  - Reducing tax preferences for housing would channel investment to more productive uses, including non-oil tradable sectors.
  - Recent tax reform reduced corporate tax rate and marginal personal income tax rate, but a shift to higher taxes on property has not been implemented.
  - Recent political agreement for additional reductions in personal and corporate income tax rates would, if implemented, be positive.
  - Relaxing constraints on new property construction, including at municipal level, could boost housing supply and reduce housing price pressure.
  - Reducing protection and subsidy to agriculture would have positive distributional effects and free up resources for more effective rural policies.
- Authorities’ views:
  - Agreed on need to restore competitiveness and continue structural reforms.
  - Noted substantial downward adjustment in unit labor costs due to weak currency and forecast low wage growth for next year.
  - Ongoing reforms in higher education, research and innovation, and local government organization noted.
  - Discount on taxable values of second dwellings and commercial property reduced from "50 to 20 percent over the last three years."

*Source: IMF staff report content.*

### Accommodating and integrating refugees
- Short- and medium-run challenges:
  - Surge of asylum seekers strains reception and asylum processing systems, raising fiscal cost in short run.
  - Medium-run concern: capacity to integrate refugees into economy and society, partly depending on labor market success.
  - Employment stats: "Just over half of non-Western immigrants, which includes most refugees, are employed, a rate that is 15 percentage points lower than that for natives."
  - Recent slowdown and lower labor demand may make absorption of refugees more difficult.
- Potential macroeconomic impact of successful integration:
  - Increasing refugees’ employment rate to the level of natives could temporarily increase labor force growth rate by "as much as 0.3 percentage points", which would in turn add "as much as 0.1–0.2 percentage points to potential growth for a couple years."
- Policy recommendations to improve integration:
  - Combine language lessons and other training with work where appropriate to ensure stronger and more rapid labor force attachment.
  - Improve assessment of refugees’ formal and informal qualifications to better match refugees with jobs and training.
  - Spread successful municipal approaches more widely, as the likelihood of refugees being in work or education one year after the introduction course varies substantially across municipalities.
  - Consider greater wage flexibility in a temporary and targeted manner to incentivize hiring of refugees, given compressed wage distribution and high effective minimum wage in Norway.
  - The White Paper introduced to Parliament in May 2016 takes several steps toward improving the introduction program and refugee integration into the labor market.
- Authorities’ views:
  - (Authorities’ views are referenced but not expanded further in the provided content.)

*Source: IMF staff report content.*

### 41.      The authorities emphasized the need to quickly integrate refugees into the labor

### _cr16214 - 41.      The authorities emphasized the need to quickly integrate refugees into the labor

### Refugee integration and labor market
- The authorities emphasized the need to quickly integrate refugees into the labor market.
- Measures proposed in the White Paper sent to the Parliament in May should:
  - accelerate integration of high-skilled refugees, and
  - speed up processing of those asylum seekers who are more likely to obtain refugee status.
- Efforts underway:
  - personalize integration plans, and
  - learn from municipalities that have been more successful in integration of refugees.
- STAFF APPRAISAL: Timely integration of the newly arrived refugees into productive employment is crucial for reducing fiscal costs.
- Specific policy suggestions:
  - Make the two-year introduction program more personalized and work-oriented, building on the experiences from the more successful municipalities.
  - The proposals in the recent White Paper on accelerating integration of refugees into Norwegian society and providing access to employment are welcomed.

### Macroeconomic outlook for the mainland economy
- The Norwegian mainland economy is feeling the impact of lower oil-related income, but a modest recovery is expected to take root next year.
- Mainland growth last year slowed to the lowest level since the crisis, alongside rapidly rising unemployment in oil-dependent regions.
- Exchange rate depreciation is providing a cushion for the economy, boosting external competitiveness of non-oil industries.
- The housing market is seeing continued upward price pressures—albeit with large regional variation, and household debt is at an elevated level.
- Consumer and business confidence remains weak, but there are signs that the drag from declining offshore demand on mainland industries has bottomed out.
- Mainland growth is set to hold steady this year before picking up in 2017.

### Fiscal policy guidance
- The expansionary fiscal policy stance this year is justifiable, but fiscal measures should avoid inhibiting the necessary economic adjustment.
- Rationale and constraints:
  - Norway has ample fiscal space for fiscal stimulus.
  - A permanent shock such as the expected decline in demand from the offshore economy requires permanent adjustment in the private sector growth model and new sources of net export earnings.
- Recommended fiscal approach:
  - Focus stimulus on temporary measures that do not inhibit the necessary transition.
  - Non-oil-related tradable industries, rather than the public sector, should absorb a large share of the workers separating from oil and gas-related industries.
  - As economic growth gathers steam, the fiscal stance should shift to neutral to relieve so-called “Dutch disease” pressures.
  - Staff would welcome a rethinking of the fiscal framework to provide better operational guidance to fiscal policy, avoid crowding out of production of tradable goods and services, and conserve the GPFG’s resources for future generations.

### Monetary policy guidance
- Monetary policy should stay accommodative.
- The current monetary stance is appropriately supportive and should remain so given the slack in the economy and the stable inflation outlook.
- Monitoring and contingency:
  - Potential second-round effects on domestic inflation merit continued monitoring.
  - Provided that inflation expectations remain well-anchored, further easing could be considered should growth turn out significantly weaker than projected.
- Financial stability caveat:
  - While financial vulnerabilities suggest greater caution may be warranted as the policy rate is lowered, financial stability concerns should be addressed primarily through macroprudential and other measures in the first instance.

### Financial sector and macroprudential recommendations
- Norwegian banks are profitable and well-capitalized, and stress tests indicate that they are well-positioned to cope with severe shocks.
- Progress and remaining actions:
  - Authorities have made progress on implementing FSAP recommendations, including several measures to address risks in the housing sector.
  - Given still overvalued house prices, elevated household debt, and banks’ heavy reliance on external wholesale funding, further measures to reduce risks are called for.
- Specific recommendations:
  - Regulations on residential mortgages that went into effect on July 1, 2015 and are set to expire at end-2016 should be made permanent and tightened if the rapid household debt and house price growth of recent months continues.
  - Continue work on stress-testing for banks to improve liquidity monitoring and on recovery and resolution planning for the largest banks.

### Structural reform priorities
- Continued implementation of key structural reforms is important to promote a successful transition and improve efficiency.
- Key reform areas:
  - Curb future real wage increases and reinvigorate productivity growth to lower unit labor costs relative to peers in a sustained manner.
  - Further reforms to the public sector pension system and sickness and disability benefits to help address labor market challenges and maintain labor force participation.
  - Efficiency gains from reducing tax preferences for owner-occupied housing, relaxing unnecessary supply restrictions in the housing market, and lowering the level of protection and subsidy for agriculture.

### Institutional recommendation
- It is proposed that the next Article IV consultation with Norway be held on the standard 12-month cycle.

*International Monetary Fund — staff appraisal excerpt from the Norway country report*

### Box 1. Risk Assessment Matrix

### Box 1. Risk Assessment Matrix

### Overview
- The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff).  
- The relative likelihood of risks listed is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability of 30 percent or more).  
- The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non mutually exclusive risks may interact and materialize jointly.

### Identified Risks, Likelihood, Expected Impact, and Policy Responses
- Persistently lower energy prices, triggered by supply factors reversing only gradually.  
  - Relative likelihood: High  
  - Expected impact if realized: High — Prolonged low oil prices would undercut growth through a further reduction in the oil-related demand for mainland goods and services, and adverse spillover effects on confidence and consumption in the rest of the economy.  
  - Policy response: Ample fiscal space allows more supportive fiscal policy to facilitate the transition and monetary policy has some scope for further easing.

- Sharper-than-expected global growth slowdown:  
  - Specific sources: Significant China slowdown (Low/Medium); Structurally weak growth in key advanced and emerging economies (High/Medium).  
  - Relative likelihood: High  
  - Expected impact if realized: High — Sharp global growth slowdown would hurt the ongoing recovery of non-oil exports and further weaken oil prices. This would lead to lower output and higher unemployment.  
  - Policy response: When this risk materializes, ample fiscal space and the fiscal rule allow automatic stabilizers to fully operate and additional discretionary spending to support demand as needed.

- Widespread and large reduction in house prices:  
  - Context: House prices growth slowed in 2015 but accelerated recently and remain at high levels with a risk of significant overvaluation. Household debt is elevated and keeps rising.  
  - Relative likelihood: Medium  
  - Expected impact if realized: High — Substantial falls in house prices would dampen private consumption and reduce residential investment. Reduced corporate earnings could lead to an increase in default rates that would hurt banks’ balance sheets.  
  - Policy response: Extend the temporary regulations on new mortgages beyond end-2016 and take additional preemptive and targeted macroprudential measures to contain risks from a further buildup of high household debt.

- Tighter or more volatile global financial conditions:  
  - Specific triggers: Sharp asset price decline and decompression of credit spreads.  
  - Relative likelihood: Medium  
  - Expected impact if realized: Medium — Renewed stress in global wholesale funding markets could lead to liquidity strains for Norwegian banks that rely on wholesale funding. The large presence of foreign-owned banks increases spillover risks. Lower asset prices may have negative impact on GPFG’s investment returns.  
  - Policy response: Introduce NSFR requirements and further strengthen monitoring of liquidity.

- A failure of non-oil-related parts of the mainland economy to pick up slack resulting from lower oil prices:  
  - Context: A shift to a less oil-dependent growth model could stall if wages fail to adjust or if exchange-rate induced inflation in imports becomes generalized inflation.  
  - Relative likelihood: Medium  
  - Expected impact if realized: Medium — Resources need to shift from oil-related to non-oil related sectors, and labor market flexibility will be tested in the process. Exchange rate depreciation should also help the process unless offset by higher domestic inflation.  
  - Policy response: Avoid using public employment to replace declining oil-related demand in the mainland economy. Adopt competitiveness and productivity enhancing reforms.

- Dislocation in capital and labor flows:  
  - Specific source: Heightened risk of fragmentation/security dislocation in part of the Middle East, Africa, and Europe, leading to a sharp rise in migrant flows, with negative global spillovers.  
  - Relative likelihood: High  
  - Expected impact if realized: High — If not effectively integrated into the labor market, the increased number of refugees could weigh on medium to long-term growth and the public finances.  
  - Policy response: Take policy actions to support the integration of migrants into the labor force, e.g., strengthening refugees’ access to ALMPs and accelerating the settlement process.

- British voters elect to leave the EU in their June 23rd referendum, with subsequent renegotiation of cross-border trade, financial, and migration relationships. A period of elevated financial volatility and heightened uncertainty could ensue, with potential contagion.  
  - Relative likelihood: Low  
  - Expected impact if realized: High — If financial market disruptions following a British exit from the EU severely affect euro area and U.S. financial markets, this could lead to higher costs and liquidity strains for Norwegian banks that rely on wholesale funding. If a British exit from the EU is accompanied by a significant slowdown in the UK, it could (i) hurt Norway’s exports to the UK; and (ii) adversely affect the profitability of Norwegian banks, insurance companies, and real estate companies given their direct and indirect exposures, and may result in deterioration in asset quality.  
  - Policy response: Be prepared to supply liquidity in the event of system liquidity crunch and re-double efforts to reach new economic cooperation and trade agreements to minimize disruptions.

*Source: Box 1. Risk Assessment Matrix (RAM) as presented in the IMF staff document.*

### Annex I. External Sector Assessment

### Annex I. External Sector Assessment

### Key developments in the external position
- The current account (CA) balance fell from 14.9 percent of (mainland) GDP in 2014 to 10.8 percent of GDP in 2015.
- The fall in the CA balance was largely driven by the 36 percent decline in the value of oil exports as oil prices fell.
- The terms of trade shock has led to 27 percent depreciation in the nominal effective exchange rate (import weighted) since early 2013.
- The net international investment position (NIIP) rose 30 percentage points to 239 percent of GDP, partly due to the depreciation of the exchange rate raising foreign asset values in local currency terms.
- Banks remained net external debtors, with banks’ net external liabilities at around 57 percent of GDP.
- Reserve assets held steady at just over 19 percent of GDP.

### External Balance Assessment (EBA) results and staff evaluation
- The different EBA approaches produce an unusually broad range of exchange rate misalignment estimates for Norway:
  - EBA CA Analysis-1.33.7
  - EBA REER (Index) Analysis---9.3
  - EBA REER (Level) Analysis---29.7
  - EBA External Sustainability Approach-10.529.6
- Interpretive guidance quoted from the methodology: CA gaps: minus indicates overvaluation. REER gaps: minus indicates undervaluation. REER gaps between -5 and +5 percent are considered to indicate the REER is broadly in line with fundamentals. Estimates based on data available in April 2016.
- Staff assessment:
  - Staff considers the CA and REER index analyses to be more reliable in Norway’s case and concludes the exchange rate is not significantly undervalued.
  - The REER level and ES approaches give large and opposing indications of misalignment, raising questions about their suitability for Norway.
  - Specific concerns include:
    - The model fit of the REER level is not very good in comparison with the CA and REER index analyses.
    - The fitted values of the REER level model would have the REER appreciating strongly when the country is suffering a negative terms of trade shock.
    - The ES approach’s estimate of the optimal current account balance suffers from several sources of uncertainty, including about future commodity prices and quantities.

### Competitiveness, REER history, and interpretation
- Deterioration in cost competitiveness since the 2008–09 crisis has only recently been unwound by the krone’s depreciation, which also suggests that the exchange rate is not substantially undervalued.
- During 1995–2013:
  - The ULC-based REER appreciated more than 70 percent.
  - The CPI-based REER was essentially flat.
- Since early 2013:
  - The 20 percent depreciation of the ULC-based REER has only reversed the worsening of cost competitiveness since the crisis.
  - The ULC-based REER is still 40 percent higher than it was two decades ago.
- Note: the External Sustainability approach indicated strong overvaluation despite the nearly 20 percent depreciation of the REER since early 2013.

*Source: IMF staff calculations and associated annex text.*

### Annex V. Authorities’ Response to Past IMF Recommendations

### _cr16214 - Annex V. Authorities’ Response to Past IMF Recommendations

### Fiscal Policy — Findings and Authorities’ Actions
- Fund advice: maintain the fiscal impulse next year given risks to economic growth; adopt a more neutral stance over the medium term to allow resource shift to other tradable industries.
- Fund advice: adopt fiscal rule recommendations to smooth spending of oil revenues.
- Authorities’ 2016 budget: forecasts a positive fiscal impulse of 1.1 percent of trend mainland GDP (compared to 0.5 percent in 2015), with measures to support employment in regions hardest hit by oil price shocks.
- Authorities’ commitment: will provide a response to the recommendations of the Commission on the Fiscal Rule in the context of Spring 2017’s White Paper on Long-Term Perspective.
- Annex analysis:
  - Adherence to the fiscal rule has allowed the GPFG to grow to 286 percent of mainland GDP at end-2015.
  - Structural non-oil deficits have been kept well below 4 percent of the GPFG capital in recent years, yet GPFG growth relative to the mainland economy has allowed a widening non-oil deficit as percentage of mainland GDP and a positive fiscal impulse on average since 2001.
  - Response to mid-2014 to early-2016 shock: authorities allowed structural non-oil deficits of 6.3 and 7.5 percent of mainland GDP in 2015 and 2016, corresponding to estimated fiscal impulses of 0.5 percent and 1.1 percent of mainland GDP respectively.
  - Most of the increase in the headline deficit is explained by automatic stabilizers.
  - Structural deficits for both last and this year remain below 3 percent of the value of the GPFG.

### Macroprudential Policy — Recommendations and Actions
- Fund advice: vigilance and prudent policies to safeguard growth and financial stability; timely implementation of macroprudential measures to contain rising household credit to leave room for monetary policy to support growth while pursuing the inflation target.
- Authorities’ actions:
  - The countercyclical capital buffer will be increased to 1½ percent from July 1, 2016.
  - On 25 November 2015, new liquidity rules set the minimum total “all currency” liquidity coverage ratio (LCR) requirement at 100 percent, effective from 2016 for the three systemically important banks and gradually phased in for other credit institutions.
  - In June 2015, the Ministry of Finance adopted a regulation on requirements for residential mortgage loans, converting FSA guidelines into explicit requirements, effective from 1 July 2015 to end-2016; the requirements will be continuously assessed in light of developments in the housing market, household borrowing, and competition between lenders.
- Norges Bank stance (monetary-macroprudential interaction):
  - Norges Bank judges the risk of medium term inflation in excess of the target to be low given low capacity utilization, real wage growth close to zero, well-anchored inflation expectations, and the temporary influence of exchange rate depreciation on consumer prices.
  - On elevated and rising house prices and household debt, the view is that macroprudential policies should be the main instrument to address the risk that lower interest rates could further increase financial vulnerabilities.

### Structural Reforms — Recommendations and Authorities’ Actions
- Fund advice: reduce preferential tax treatment for residential properties relative to productive investments; further reforms to the pension system and sickness and disability benefits; invest in infrastructure, education, and research to raise productivity.
- Authorities’ actions:
  - Recently proposed tax reform reduces the discount on the taxable values for secondary dwellings and commercial property from 30 to 20 percent.
  - Negotiation on public sector’s occupational pension scheme started among social partners but has recently been delayed.
  - Further change to the calculation of disability benefits in early 2016 to enhance incentives to work while receiving benefits.
  - Pilot programs for new measures to enforce the activity requirements for sickness benefits are underway in several counties and showing encouraging results.
  - Ongoing reforms in the higher education and research sectors.

### The Fiscal Policy Rule — Analysis of Operation in an Oil Price Shock
- Fiscal rule summary: gradual phasing-in of oil revenues in line with expected real returns on the Government Pension Fund Global (GPFG), estimated at 4 percent; permits spending more than expected return in cyclical downturns and less when capacity utilization is high.
- Performance during shock:
  - The fiscal rule operated largely as intended during the mid-2014 to early-2016 drop in oil prices and decline in offshore demand.
  - Mainland GDP growth slowed from 2.3 percent in 2013–14 to 1.0 percent in 2015.
  - Structural non-oil deficits allowed of 6.3 and 7.5 percent of mainland GDP in 2015 and 2016 with fiscal impulses of 0.5 percent and 1.1 percent of mainland GDP respectively.
  - Structural deficits remain below 3 percent of GPFG value.

### The Monetary Policy Rule — Inflation Targeting and Policy Response
- Norges Bank inflation target: annual consumer price inflation of close to 2.5 per cent over time; monetary policy shall also contribute to stabilising output and employment.
- Norges Bank criteria for policy rate: (i) achieve inflation target; (ii) maintain flexibility to avoid excessive output/employment fluctuations; (iii) robustness to mitigate risk of financial imbalances by adopting a gradualist approach.
- Monetary response to the shock:
  - Policy rate was reduced four times from 1.5 to 0.5 percent between December 2014 and March 2015.
  - Rationale: support the economy and avoid appreciation when many neighboring economies reduced policy rates to negative levels.
  - Observed macro developments: exchange rate depreciation increased imported consumer goods inflation while domestic goods and services and wage inflation remained subdued; house prices continued to grow strongly in real terms in the Oslo area; growth slowed significantly in 2015 and early 2016 but remained positive.
  - Norges Bank view: macroprudential policies should be primary tool to address elevated house prices and household debt rather than aggressive interest rate cuts.

### Transition from Oil and Gas — Structural Adjustment and Policy Recommendations
- Historical effects:
  - Oil boom (2003–11) led to resource reallocation toward oil-related and nontradables sectors, with employment and capital stock growth up in nontradables but down in the traditional sector.
  - Decomposition of aggregate TFP growth suggests within-sector productivity contributed about two-thirds of the decline in TFP during the boom, and sectoral reallocation contributed one third.
  - Input-output comparisons indicate increasing dependence of mainland industries on the oil and gas sector.
- Current transition dynamics:
  - Preliminary data: marked decline in oil-related production and investment as offshore investment drops from its peak and oil prices retreat from their 2014 high.
  - Traditional goods sector activity holding up but not sufficiently to pick up slack.
  - Weak krone cushions mainland businesses—boosting traditional goods exports and helping oil-related firms adapt to alternative markets.
  - Unemployment increase concentrated in oil-related parts of the economy; net immigration still positive but trending down.
  - High labor mobility and flexible immigrant labor supply may dampen unemployment rise.
- Policy recommendations to smooth transition:
  - Monetary policy: support demand while preserving price stability to create favorable environment for private sector adjustment.
  - Fiscal stimulus: focus on expanding productive capacity while avoiding crowding out of tradable goods and services production.
  - Wage formation: facilitate labor movement and ensure international competitiveness.
  - Active labor market policies: improve search and matching efficiency.
  - Housing policy: reduce constraints to new housing construction, particularly in big cities such as Oslo, to relieve housing price pressures and facilitate geographic mobility.
  - Long-term: invest in research and innovation to attract resources to the knowledge-based economy.

### Firm-Level Analysis of Productivity and Product Market Regulation (PMR)
- Dataset and methods:
  - Orbis database: 80,474 public and private firms for 2005–2014, over 125,000 firm-year observations.
  - Productivity measures: labor productivity (real value added per worker) and three measures of TFP using three methodologies.
  - PMR burden measured by combining OECD PMR indicators for seven network sectors, retail and professional services with input-output linkages from Norway’s 2013 input-output table (upstream PMR).
- Key empirical findings:
  - Panel regressions show a negative and significant correlation between upstream PMR and firm productivity in downstream sectors; results robust across specifications and productivity measures.
  - Firms that rely more heavily on inputs from regulated industries are likely to be less productive.
  - Impact by firm size:
    - Most pronounced for medium-sized firms, least pronounced for large firms, micro and small firms in between.
    - Example: a one standard deviation reduction in PMR is associated with higher TFP by over 15 percent for medium-sized firms, but only by 6 percent for large firms.
  - Impact by sector type:
    - HTKIS (high-tech and knowledge-intensive sector) firms bear a relatively heavier burden from anti-competitive regulation versus non-HTKIS firms.
    - Differential impact largest for medium-size class—about three times as large for HTKIS firms as for non-HTKIS firms.
- Policy implication:
  - Further easing of product market regulation—particularly in regulated network sectors and retail/professional services—could raise downstream firm productivity, with large gains for medium-sized and innovation-intensive firms.

*Source: _cr16214 - Annex V. Authorities’ Response to Past IMF Recommendations*

### Annex IX. The Housing Boom and Macroprudential Policy in

### Annex IX. The Housing Boom and Macroprudential Policy in Norway

### Macro-financial risks from house prices and household debt
- Real house prices have risen more than 80 percent in Norway since 2000.
- House prices are estimated to be 40 percent overvalued (averaged across three standard overvaluation measures).
- Household indebtedness has risen along with house prices, exceeding 220 percent of disposable income by end-2015.
- High household debt and house prices increase the risk of a sharp house price correction, with potential adverse impacts on:
  - consumption and output;
  - non-financial firms;
  - loan defaults and banks’ balance sheets.

### Authorities’ housing-market measures
- Mortgage lending guidelines introduced in 2010–11 were made temporary regulations in mid-2015 (effective until end-2016).
  - The most important was the LTV ratio limit of 85 percent.
- The Financial Supervisory Authority (FSA) effectively raised risk weights on mortgages during 2014–15 in response to a marked decline in mortgage risk weights for IRB banks after the introduction of Basel II in 2007.

### Empirical assessment of effectiveness (mortgage credit and house prices)
- Two separate equations for the growth of mortgage credit and house prices were estimated (following Krznar and Morsink (2014)), controlling for other factors.
- Estimated effects on mortgage credit growth:
  - A 10 percentage point increase in mortgage risk weights is estimated to significantly reduce mortgage credit growth by 2.4 percentage points.
  - Tightening of LTV limits begins to have a statistically significant dampening impact on mortgage growth only after several months.
  - A ten point change in the net balance measure of banks’ tightening of their LTV limits over the next 3 months would reduce mortgage credit growth by 0.6 percentage points.
- Counterfactual calculations using the estimated parameters indicate recent credit growth would have been substantially higher without the rise in risk weights.
- Through their impact on mortgage credit growth, tightening of macroprudential instruments can significantly slow house price growth.

### DSGE model illustrative results
- A DSGE model calibrated to the Norwegian economy was used to illustrate impacts of three instruments: tightening the LTV cap, increasing amortization requirements, and reducing tax deductibility of mortgage interest.
- Timing and magnitude of effects vary by instrument:
  - Reduction in tax deductibility:
    - Achieves almost all of its steady state impact in 5 years.
    - Reduces the steady state debt-to-income (DTI) ratio by just over 11 percentage points.
  - Tightening the LTV cap:
    - Achieves about half the impact on the debt ratio after 5 years.
    - The new steady state DTI ratio is about 20 percentage points lower.
  - Strengthening the amortization requirement:
    - Leads to about a 20 percentage point reduction in the DTI ratio in the new steady state.
    - Achieves about one third of that reduction after 5 years.
- In all simulated cases, the impact on consumption is minimum and even slightly positive for most.

### Policy implications and recommendations
- Systemic risks from overvalued house prices and high household debt levels suggest macroprudential measures could be tightened further.
- Addressing structural contributors to high household debt and house prices, such as mortgage interest tax deductibility, would reinforce the impact of macroprudential policies.

*Source: _cr16214 - Annex IX. The Housing Boom and Macroprudential Policy in Norway*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16214.pdf_