Monetary policy in crisis : an assessment of the Norwegian monetary policy response to the Covid-19 pandemic

Abstract

In order to assess the monetary policy response to the ongoing crisis, this thesis combines a broad case study with detailed graphical analyses of key events and economic variables. We discuss how a broad range of policies has been used to tackle the crisis, interpreting central relations through the lens of macroeconomic models. Furthermore, we discuss the shortcomings of existing literature in incorporating the policy tools used in the policy response. We construct a “Taylor gap”, which reveals a systematic divergence between the policy rate and a simple Taylor rule in periods of economic unrest. The most prominent gap, of 4 percentage points, is observed in the third quarter of 2020. We interpret this to result from the prioritization of other policy objectives in addition to reducing the output and inflation gap. Comparing projections of the two rates shows that in the long-term, no-shock scenario, the policy rate seems to converge with our policy rule. Liquidity measures seem to have successfully aided transmission from policy to market rates, stabilized risk premiums, and met interbank liquidity goals. The diverging indicators of selected financial variables explain the moderate reduction in the countercyclical capital buffer and shed light on the trade-off between different policy objectives. We find that financial stability risk in specific indicators may develop from the expansionary policy. Yet, we argue that macroprudential policy has likely softened the blow of the crisis. The monetary policy response to the covid-19 crisis illustrates how combining various measures is necessary to balance conflicting monetary policy objectives in a crisis.