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**Make your own scenario-analysis about the effect of the interest rate on inflation etc. **

We have made an Excel spreadsheet (oekosirk.xls) with the price-ecocirc for scenario-analysis about the effect of the interest rate on inflation etc. for researchers, students and other people. You can order it free of charge by using the mailform at the bottom of this page. This spreadsheet is freeware, and you can use it as you please. If you have any questions use the mailform below.

Best regards *P. Johansen *and *H. Fagerhus* for IIFOR

**Open letter to Norges Bank **

**Norges Bank's interest-rate hikes have most likely given a price-hike,
and thus have increased inflation. Not reduced inflation. **

**Criticism of Norges Bank's policy and its models **

Norges Bank, the Norwegian central bank, mainly uses wrong models, outdated Keynes-based models, and comes thus to the wrong conclusion, that an interest-rate hike will decrease inflation, see http://www.norges-bank.no/Pages/Article____12134.aspx . In fact an interest-rate hike will usually increase inflation. Norges Bank demonstrates in practice it cannot use price-ecocirc or puts too little weight on it, and structural scenario-analysis, and thus comes to the wrong conclusion. In general we think Norges Bank overestimates other factors. The price-ecocirc is the following:

(i) p = (1/(1-m))(w+rk)/a [= (1- (market power + scale coefficient))(w+rk)/a ; where market power = (p-b')/p and scale coefficient = (b'- b )/p ]

<=> w/p = [a(1-m) -rk/p]

Symbols: A export; B import; C consumption, i.e. public + private; I net real investment, i.e. public + private; (C+I+A-B) total demand, i.e. nominally; R = total supply R , net national product, i.e. nominally (R = C+I+A-B); p price level for x, x net national product volume principally measured by output (i.e not input) in private and public sector, (R = px); a averagely workers productivity; r interest rate; K real capital [K(time + 1) = K(time) + I(time)]; N employment, i.e. factual supply equal to factual demand of labor, x = aN; k capital/employment ratio; N(u) unemployment = N(full)-N, N(full) full employment, i.e. total work force, potential labor supply, not factual, it is however an aim for society to use the whole potential, N = N(full); w = average wage, for the people. R net national product = realincome R = mR + wN + rK, distribution of realincome, where m = profit margin, i.e. market power coefficient (p - b')/p + scale coefficient ( b' - b )/p, were b' is marginal costs and b is average costs of resources, payments for resources , used to produce x, i.e. m = (p-b')/p + (b'- b )/p = (p- b )/p), where b = (wN+rK)/x, and b' = d(wN+rK)/dx . R = Gross output value - intermediate input value - depreciation value. w/p = real wage.

From (i) it is clear that increased r, other parameters equal, will hike the price level p, not the opposite. The profit margin, m, is dependent on the demand function, the competition structure and cost-structure, all in all usually relatively independent of r. Very likely m is rather constant in the relatively short to medium time perspective, and thus (i) is approximately a cost-plus model with r as one of the price-hiking cost factors. And w is either relatively unaffected, or likely to increase if r is hiked via negotiations, to compensate for the hike in r. We see the real wage will decrease with increased r, the net effect is negative, and the labor organizations will most likely not accept that. The parameter a will probably also not be significantly affected by a hike in r. Thus the conclusion is that a hike in r will usually increase p. Norges Bank has made several hikes in r recently, see table below, and p is going up. The price level in (i) is principally the price-index of R, however the CPI and CPI-ATE are also interesting indicators. The consumer price index (CPI) was 121.9 (1998=100) per April 2008 compared with 118.2 at the same time last year. This is equivalent to a year-to-year growth of 3.1 per cent. The CPI-ATE increased by 2.4 per cent from April 2007 to April 2008, up 0.3 per cent points from March (source SSB).

This is of no surprise to us. Thus, if Norges Bank will reduce the price level p, it must reduce r, not increase it. This is valid as long as the unemployment ratio AKU is more than 1,5%, the "natural" level of unemployment in Norway, under certain conditions, discussed at "Anarkistisk kommentar til stats- og nasjonalbudsjettet for 2008 og revidert stats- og nasjonalbudsjett våren 2008" at http://www.anarchy.no/enronism.html and more principally at "No to Euro! Full employment!" at http://www.anarchy.no/ija132.html . If the unemployment ratio (N(u)/N(full))100% is below 1,5% the cost structure, via b', will probably be affected, hiked, and thus p hiked. But the unemployment ratio is not so low at the moment. Thus we suggest that Norges Bank lowers the interest rate a bit in the following months. This will also contribute to a more moderate solution in the wage bargainings. In general we recommend a low r. Decreased r will usually contribute to lower, p, less inflation.**About the price-ecocirc spreadsheet Excel oekosirk.xls **

The price-ecocirc spreadsheet Excel oekosirk.xls has two formulas (i) and (ii).

Variables:

m = profit margin

w = wage

r = interest rate

k = capital/employment ratio

a = productivity

p = price

Estimation of p given the other factors

(i) p = (1/(1-m))((w+rk)/a)

We are also interested in estimation of the consistent profit margin, given the other factors

(ii) m = 1 - ((w+rk)/pa) (Then we can a.o.t. test the stability of m over time)

A. Scenario-analysis Norway 1998 - 2007, Excel oekosirk.xls Data (data used with bold lettering):

r medio 2007, 4,5% = **0,045**

Fixed real capital 5 648 898 mill kroner 2007

Wage cost 972 634 mill kroner 2007

Employment N = 2 443 000 for 2007

Wage cost per employed = w = 398 131 = **ca 400 000**

Capital/employment ratio, k = 2 364 545 = **ca 2 300 000**

Priceindex for p for simplicity estimated equal to ca CPI. p 1998 = 100 , p 2007 **= 1,18**

Net national product 963 970 mill in 1998

Net national product 1 995 648 in 2007

x = NNP volume 1 995 648/1,18 = 1 691 227 mill. kroner 2007

x/N = a, in 2007 = 692 275 kroner = **ca 700 000 **

This implies **m = 0,3904356 **. (VAT etc are included in m.)

B. Scenario-analysis 1 % increase in interest rate in 2007 to 0,055, cet. par. => p = 1,2339026. (1,2339026 - 1,18)/1,18 = 0,04568 = ca 4,5%. Interest-rate hike may thus be a major source of inflation. Excel oekosirk1.xls

C. Scenario-analysis 1% increase in interest-rate to 2008, with 3% increased a = 721 000. p = 1,1979637. (1,1979637 - 1,18)/1,18 = 0,015223474 = ca 1,5%. Excel oekosirk2.xls

D. This should be done by you. Try, say, with effects on m, w, and other variables. Try other years... in general estimate as you please.

Statistics from SSB and Norges bank

We have used “,”, the European standard instead of American/UK standard, i.e. “.” as decimal separator. The term “ca” is an abbreviation for the latin circa, which means about or approximately.