The economy is a like spider-web
The macroeconomy is a complex organism. There are incredibly many relationships that are interconnected, that together make up a network, a “spider-web” across the economy. If a shock occurs somewhere in the economy, it causes many effects which again causes new effects. And just like that, like dominoes, money flows through the economy. If the productivity in one sector, e.g. the oil sector, drops, this has many effects. Many of those employed in the oil sector might be let go. These people may have to significantly reduce their consumption, they might default on their debt obligations and they might have to reduce their savings. Since consumption is falling, the revenues in other industries will fall. This might cause a further increase in unemployment. There are more resources sitting idle. Even those who are still employed in the economy might decrease their consumption and increase their savings. The reason is that even though people haven’t lost their job yet, they might be scared that they could. People’s trust in the economic performance might deteriorate. The Norwegian economy is in a slump. We saw this when the oil price halved in 2015-16. There is no guarantee that this, or other shocks, might lead the Norwegian economy into a recession in the future.
Keynes vs the classical economists
The so called “classical economists” believed that economic cycles should just be allowed to happen. When the economic performance deteriorates, then the economy should just be allowed to “bleed dry”. The economy would have to bleed labour income and profits. Eventually, as the marginal productivity (the output produced by one unit of input such as one hour of labour) would increase as the unemployment rose. The wage required by workers would continue to fall as people became increasingly desperate to find work. It would be profitable to hire workers again and this would make the economy improve again. It might be the case that the classical economists were right, but there is no way to tell how long this would take. In the meantime, social unrest and crime would pick up as people became desperate to find food and other necessities. This was what happened during the Great Depression in the ‘30s. The British economist John Maynard Keynes had a different answer, altogether. He pointed out that “in the long run, we’re all dead”. It doesn’t matter that the economy picks up eventually, because what people really care about is what happens here and now. He suggested that the government should use expansionary fiscal policy (the government should increase their budgets) in times when the economy is in a slump.
It was wise to use more “oil money” when the economy was in a slump…
Stately fund as a tool for economic policy
Today, we have a wide array of economic policy. The two major categories of economic policy on the macro-level is fiscal policy and monetary policy. The aim of fiscal policy is to lift the economy out of recession by increasing the government’s spending and investments. Monetary policy, on the other hand, is concerned about using the interest rates in the economy in order to incentivize people to increase consumption and save less. Experts believe that monetary policy is best suited for regular business cycle stabilisation, whereas fiscal policy should be focused on correcting extraordinary fluctuations. But there is a way for monetary policy to facilitate fiscal policy. When the key interest rate is lowered (expansionary monetary policy), this will cause other interest rates in the economy to fall as well. This makes investing in Norwegian assets appear less attractive to foreign investors and they withdraw their investments. They sell Norwegian kroner. This makes the Norwegian krone weak against foreign currency. Since the Norwegian oil fund is invested in foreign assets, it’s value depends on how strong foreign currency is relative to Norwegian kroner. When Norwegian kroner is cheap compared to other currencies, the price of withdrawing money from the fund is low. Let’s say that Norwegian kroner has weakened by 10% against foreign currency. This implies that we can increase the outtake, as measured in Norwegian kroner, by 10% without having to increase the actual outtake from the fund. The government can expand state budgets. This is expansionary fiscal policy facilitated by expansionary monetary policy. This is one of the many benefits of having a large fund, in fact the world’s largest stately fund, invested abroad. It was wise to use more “oil money” when the economy was in a slump in 2015-16. I will the Solberg government that.
Balance is very important
Of course, the problem with using expansionary economic policy is that it is easier for politicians to give money than to take money. In order for economic policy to remain effective in the long-run, it is important to use contractionary fiscal policy in periods when the economy is booming. If not, the government is just increasing their debt. The same goes for transfers from the oil fund to the Norwegian government. When the Norwegian krone is strong, the price of withdrawing from the fund is high. This implies that as the Norwegian krone is strengthening, we have to reduce our outtake from the fund. Since the Norwegian krone is still very weak against foreign currency, the price of Solberg’s latest stunt with the state budget is low. However, this does not justify it. It hurts my fiscally conservative soul to see a conservative government spending excessively of our wealth.