Executive Summary

Spread of the Omicron variant of COVID-19 temporarily damped economic activity, which was hitherto recovering strongly, and led to further fiscal support. In the absence of renewed deterioration in the health and economic situation, fiscal deficit reduction should resume as planned and the withdrawal of monetary stimulus should continue. A close watch on price and cost developments is needed given recent energy-price and wage increases.

Though the Omicron variant affected Norway more than previous waves of the pandemic, the cumulative cases and fatalities from COVID-19 remain substantially below the OECD average on a per capita basis. A high rate of vaccination has helped limit increase in hospitalisations and fatalities. However, outbreaks and need for further social distancing measures remain a risk.

Following a bounce-back from the phase-out of the latest restrictions, the level of economic output will run slightly above trend over the next two years. Annual economic growth is expected to turn out at 3.7% in 2022 and 2.2% in 2023. Household consumption will contribute significantly, helped by the pent-up spending power from savings accumulated during the initial phases of the pandemic.

Strong headline consumer price inflation in recent quarters has been driven by large electricity price increases. Global supply bottlenecks in computer chips, lumber and shipping are also putting pressure on inflation. Furthermore, there are tentative signs of higher wage inflation. Some of these price and cost rises will most likely ease in the coming quarters. However, there is clear risk that a wage-price spiral could emerge.

Withdrawal of macroeconomic stimulus should continue as the health situation improves. Fiscal revenues have grown and spending on government transfers has diminished since the initial large downturn in economic activity. Norges Bank began raising its key policy rate in September 2021 with an increase from zero to 0.25% and a further increase to 0.50% in December. The Bank forecasts a gradual rise to a rate of 1.75% towards the end of 2024. Thus far, the fiscal and monetary response to changing health and economic conditions has been appropriate.

House prices and mortgage debt are a concern for financial stability. Steep rises in house prices in the first year of the pandemic added to past price surges. Steady tightening of monetary policy has contributed to a moderation in price growth. However, prices remain elevated, and this and associated high levels of mortgage borrowing add to risks of a significant house-price correction with impacts on the wider economy.

A decline in the mainland fiscal deficit has been budgeted for 2022. The central government’s core deficit (adjusted for petroleum revenues and oil fund revenues) is estimated at 11.6% of mainland GDP for 2021. For 2022 a deficit of 9.5% was planned, though it is estimated to turn out at 10.4% due to the new COVID measures plus compensation for high electricity prices. This nevertheless continues to represent an appropriately prudent policy; the budgeted deficit will be below the guideline value according to the fiscal rule.

Scope for public spending on new policy measures is set to shrink in the coming years due to slower wealth-fund growth, multi-year spending commitments and population ageing. Unlike in previous years, there will be limited scope within the fiscal rule for new spending initiatives, unless these are accompanied by revenue-raising or cost-saving measures. There will be even less fiscal space if cash flow from petroleum activities or returns to the fund turn out weaker than expected. Public-spending policy needs to focus on strengthening value for money.

Business-sector productivity growth has been picking up but remains below historical levels. The employment rate is no longer among those of top-ranking countries.

Policy needs to ensure good conditions for business innovation and technology adoption. It also needs to address the opportunities and challenges of green transition. Financial pressure on businesses during the pandemic has underscored the important role of insolvency procedures in giving struggling businesses a chance to turn around. Resources need to be reallocated to more promising sectors and firms, including those related to faster digitalisation and green transition. Meanwhile, some areas of business support require reform, notably there is a need to reorient agricultural support away from economically distorting subsidies.

Norway’s generous sick leave and disability compensation systems, in addition to the pension system, remain major challenges for labour participation. Sick leave compensation remains more generous than necessary and disability pension systems could do more to facilitate return to work. Though good progress has been made on pension reform, there remains scope to improve linkage to life expectancy and there are challenges in some occupational pensions in the public sector.

Rising house prices during the pandemic have further reduced housing affordability for first-time homebuyers. Deteriorating accessibility of homeownership and high rent burdens underscore the need for structural reforms to lift new housing supply and temper demand for home buying.

Altering regulation affecting land use, and more efficient planning processes around residential construction are key to making housing supply more responsive. More leeway is needed for the construction sector to respond to housing demand while retaining high standards on other fronts. Scope for adjustment lies in land-use rules, building standards, and planning processes, especially in the largest cities.

Tax concessions for homeowners remain unusually generous compared with other OECD countries. These boost demand for housing, divert resources from more productive investments and inflate house prices, particularly in supply-constrained cities. The tax subsidies also favour current owners at the cost of new homebuyers.

Social-housing shortages have emerged in high-cost cities, while households in private rental dwellings face heavy housing-cost burdens. Beyond targeted assistance for low-income homebuyers, support needs to be bolstered for renters. Increased investment in social rental housing can alleviate cost pressures for disadvantaged households, backed with means-tested allowances for private rental accommodation.

Housing affordability could be improved by reducing labour income tax on low income. Raising disposable income through tax cuts can broadly help households tackle housing affordability. It can also help resolve the welfare issues emerging from other cost increases, for instance those related to climate change measures. Lighter labour taxes can also strengthen labour supply.

Norway’s CO2 emissions are low but are generated in sectors where cutting them is challenging. Norway has raised its ambition on emission reduction and is combining market-based instruments with regulation and support for green technology.

There has been a welcome proposal to increase the price of carbon as part of a new climate action plan. Nevertheless, gaps in the coverage of carbon taxation remain, mainly on emissions of nitrous oxide and methane from the agricultural sector.

Norway is making good progress in the adoption and development of green technologies. Electric vehicle adoption has matured to a point where tax concessions and other advantages can gradually be withdrawn. Substantial green-technology initiatives are underway, notably a flagship carbon-capture and storage programme (Longship). However, there is more ground to cover, including clearing regulatory obstacles to greater materials recycling and extending the service life of residential and other buildings.



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