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Impact Report

1. The Macroeconomic Impacts of the COVID-19 Pandemic

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Principally, the COVID- 19 pandemic resulted in a sharp economic contraction of the Norwegian economy in 2020. In March 2020, the Norwegian Government instituted border closures and mandatory lockdowns for non-essential businesses to mitigate the spread of COVID- 19 (Helgesen, 2021). In turn, the leading indicator of consumer confidence dropped sharply by 5.4% in Q1 of 2020 in response to the deteriorating economic outlook not seen since the Global Financial Crisis (IMF, 2021). Private consumption, the dominant component of GDP, fell by 15. 1% in the first two quarters of 2020 (OECD, 2021). This acute contraction emanated from the 10. 1% decline in household spending on services in the recreation, food and transport sectors due to lockdown measures (IMF, 2021). Consequentially, households instead sharply increased their personal savings ratio to 19.80% during the first half of 2020, the highest rate ever recorded (OECD, 2020). Concurrently, Norway’s industry confidence declined by 17.2% in response to the closing of non-essential businesses (OECD, 2021). This impacted private investment, declining by a cumulative 8.5% in Q1 and Q2 of 2020 (IMF, 2021). Norway’s net exports experienced a positive contribution to GDP with growth of 2.8% (Statistics Norway, 2022). However, this was predominantly due to steeper declines in imports (- 16.7%) than exports (-8.7%) in the first half of 2020 (Statistics Norway, 2022) A sharp decline in oil and gas prices due to weak global demand heavily impacted Norwegian exports. Accounting for a fifth of total export output, the decline of oil and gas prices to their lowest level since the 20th century heavily impacted Norway’s resource-dominant economy (OECD, 2020) Altogether, this decline in total output induced a negative demand shock. Norway’s real GDP contracted by a cumulative 6.8% in Q1 and Q2 of 2020 because of declining consumption and investment induced by containment measures (IMF, 2021) As a result of the acute negative demand shock, unemployment reached a record high, as Norway’s unemployment rate rose to 10% in March 2020 (Juranek, 2021). The impact on the labour market was severely felt in high-contact sectors such as hospitality and tourism where unemployment declined by 8% (Juranek, 2021). Despite the drop in economic output, real wages increased by 1% in 2020 because of reduced headline inflation (OECD, 2021). Lower energy prices and reduced consumer spending resulted in disinflation occurring in 2020 as the headline inflation rate (1.28%) decreased by 0.88% from 2019 (2. 16%), sliding below the Norges bank’s 2% inflation target rate (Norges Bank, 2022).

Figure 1: Impact of COVID-19 Pandemic on Norwegian Economy – AD-AS model

Consumption and investment expenditure are key components of aggregate demand (AD). As shown in Figure 1, the decrease in consumption and investment because of pandemic lockdown measures, produced a negative demand shock. In the short run, AD shifted left to AD2 . Further, tight supply conditions induced a negative supply shock, shifting Short Run Aggregate Supply (SRAS) left to SRAS2 . Supply chain disruptions and business shutdowns caused by pandemic mitigation measures decreased Norway’s capacity utilisation by 3.4% in 2020, reducing production in the short run (OECD, 2021). Thus, the negative demand and supply shocks caused a new short-run equilibrium at point B. At point B, real GDP decreased from Y* to Y2 causing actual output to fall below its potential level signalling a contraction of the economy. Hence, a negative output gap was established which was estimated to be -2.8% in 2020 (IMF, 2021). In turn, output is below full employment, causing unemployment levels to rise. The contrasting effects on the price level with both SRAS and AD shifting left caused the price level to remain at P1 .

2. The Policy Responses

The Norwegian Government’s fiscal policy response to the economic contraction was appropriately vigorous and flexible, helping blunt the downturn. They pursued an expansionary fiscal policy to stimulate AD by increasing government discretionary spending. Discretionary spending of NOK 162 billion was authorised increasing the government component of GDP by 4 ¼% in the last two quarters of 2020 (OECD, 2020). This included income support programs such as the temporary layoff scheme which provided a flexible option for businesses to temporarily reduce employment. Further, authorities aimed to boost consumption by increasing the amount of disposable income available to households. Through the reduction of taxes such as the value-added tax (VAT) from 12% to 6% and the boosting of unemployment benefits, household disposable income increased by 10% to return to pre-pandemic levels (Statistics Norway, 2022). Consequentially, Norway’s strong response to the pandemic helped flatten the contagion curve, boost vaccination rates and end restrictions by 2021 (Helgesen, 2021). Record high household savings coupled with strong disposable income resulted in a sudden release of pent-up demand once restrictions were lifted. Household consumption increased by 20% in the second half of 2020, eclipsing pre-pandemic levels (IMF, 2021). This led to a strong demand-driven economic rebound.

Figure 2: Impact of Fiscal and Monetary Policy– AD-AS model

Shown in Figure 2, increased AD caused by rising government expenditure and consumption produced a positive demand shock shifting AD right from AD2 to AD3 . However, since supply chain disruptions and supply constraints, particularly in the energy sector continued, SRAS remained at SRAS2 . Hence, the positive demand shock produced a new short-run equilibrium at Point C. This closed the output gap as real GDP increased from Y2 to Y* , back to potential GDP. Further, Norway’s unemployment rate (4.3%) returned to its natural level in 2021, decreasing by 5.7% once the expansionary fiscal policy was enacted (OECD, 2021). However, the closing of the output gap increased inflationary pressures as headline inflation rose by 3.5% between 2020-2021 (IMF, 2021). This is shown in Figure 2 as the price level increased upwards from P1 to P2 . A limitation of the increase in government expenditure was it enlarged Norway’s structural budget deficit. Government debt to GDP increased by 5.6% between 2019-2020 because of the cumulative effects of increased expenditure and lower tax revenues (IMF, 2021). However, Norway’s fiscal risks remain fundamentally low because of its AAA sovereign credit rating and control of the world’s largest Sovereign Wealth Fund, allowing it to sufficiently repay its financial obligations (OECD, 2020).

In 2020, Norway’s central bank, Norges Bank, enacted swift expansionary monetary policy. In three steps, Norges Bank cut the cash rate by 150 basis points to zero, signalling monetary policy easing (Norges Bank, 2020). As shown through the monetary transmission mechanism, the cash rate cut enabled the Norges Bank to increase the money supply in the interbank money market. In turn, interest rates on mortgages fell by almost 1.5%, providing a boost to household disposable income (OECD, 2020). The potency of the rate cuts was intensified because of the high share of flexible-rate mortgages and household indebtedness (IMF, 2021). Through the savings and investment channel, the intertemporal substitution effect of the rate cut induced households to save less, stimulating consumption and investment. Hence, because of increased consumption and investment, Norway’s aggregate demand increased. As a result, Norway’s total output expanded past its pre-pandemic level as real GDP grew 3.2% in 2021 (OECD, 2021). A limitation of the Norges Bank’s loose monetary policy is its effect on household indebtedness. Norwegian households are highly leveraged as their debt ratios exceed most other European nations (IMF, 2021). The easing of monetary policy and the continued increase in dwelling prices will contribute further to household indebtedness. This will exacerbate the economic impact on households when future rate hikes occur.

Reference List

Helgesen, Å . (2021). An analysis of the Norwegian economic policy during COVID-19. University of Stavanger. IMF. (2021). Staff Report For The 2021 Article IV Consultation. IMF Publication Services.

Juranek, S. (2021). Labor market effects of COVID-19 in Sweden and its neighbors: Evidence from administrative data. Wiley Online Library.