Jan F Qvigstad: On the topic of keeping promises
Speech by Mr Jan F Qvigstad, Deputy Governor of Norges Bank (Central Bank of Norway),
at a seminar arranged by Norges Bank and Det Norske Videnskaps-Akademi (The
Norwegian Academy of Science and Letters), Oslo, 11 November 2008.
* * *
1. Why is keeping promises so difficult?
This house, which now belongs to the Norwegian Academy of Science and Letters, was built
by Hans Rasmus Astrup in 1886-87. Astrup was an entrepreneur. At the age of 20, he left
Norway for Barcelona on a ship laden with a cargo of dried cod. He gradually built up a large
trading business and later became an industrialist, not unlike businessmen of our own era.1
For innovators and the business sector, a stable operating environment has always been
important, providing a foundation for adaptation, economic growth and social progress. A
stable value of money is also a component of this foundation.
We were taught as children to keep our promises. If we made a promise, we had to make
good on it. But we were also taught that we should not promise too much. If we do not keep
our word, others lose confidence in us and our credibility takes a toll. In recent months, we
have witnessed that this is of particular importance for the financial system. A proximate
example is the situation in our neighbouring country Iceland.
The value of confidence and credibility has been the subject of extensive analysis in many
fields, including jurisprudence and the social sciences. One conclusion is clear - progress
can be achieved if promises are kept.
If keeping promises is clearly beneficial, why is it then so difficult? The expressions empty
promises and empty threats reflect the temptation to renege. The social scientist and
Jon Elster
philosopher writes in his book "Ulysses and the Sirens"2 about weakness of will,
shifting preferences over time, and the complexities of human nature. This is familiar ground.
As early as 1960, the economist Thomas Schelling3 discussed similar issues in analyses for
which he was awarded the Nobel Prize in economics. According to Schelling, a credible
threat can be difficult to establish when realising the threat involves costs for all the parties
involved. A promise or a threat will be more credible if the person who has made the promise
ties himself to the mast.
Two other economists carried out groundbreaking work when they applied Schelling's
analysis to economic issues. In 1977, Finn Kydland from Norway and Edward Prescott4 from
the US wrote an article showing that authorities who attempt to follow an optimal economic
policy plan may have strong incentives to depart from the same plan at a later time. This
applies even if no news has emerged to indicate that the plan should be changed.5 Later,
Kydland and Prescott were awarded the Nobel Prize in economics for their work.
There is a common denominator between Elster, Schelling, Kydland and Prescott: keeping a
promise is difficult, because reneging on a promise will often be the tempting or rational
choice in the short-term. If loss of credibility is taken into account, the best solution in the
long term will nonetheless often be to keep your word.
A key issue is how we can establish mechanisms that also safeguard long-term objectives in
the short term. Jon Elster suggested the metaphor of "tying oneself to the mast". We all know
the myth of Ulysses and the sirens, referred to in Elster's work. Ulysses wanted to hear the
sirens sing, but he knew that he and his crew would then come under the sirens' spell,
bringing their voyage to an end. He therefore ordered the crew to tie him to the mast, but
before they did so, he filled their ears with wax. This prevented him from steering the ship
towards the sirens himself, and the crew were prevented from hearing him when he would
later succumb to temptation and order the ship to be steered towards the sirens' island. The
story cannot be directly transferred to economic management, but the concept of "tying
oneself to the mast" is used in promoting mechanisms that prevent short-term objectives
from taking precedence over long-term objectives. Precluding the possibility of breaking a
promise makes the promise more credible. Ensuring accountability for promises made
through reporting and review can be a mechanism that ties us to the mast.
A central bank's most important task is to ensure a stable value of money. The value of
money relies on responsible economic policies. For a central bank to be able to keep its word
and deliver a stable value of money, it must have the backing of the political authorities.
Otherwise, the central bank will not be able to keep its word.
In the long term, the instruments available to the central bank allow it to deliver only the
promise of a stable value of money. Earlier, this promise was kept by regulating the amount
of money issued. Today, the instrument is the interest rate. The central bank cannot steer
real wages, the labour supply, employment or the level of unemployment in the long term.
But it can contribute to curbing short-term cyclical fluctuations if price stability is firmly
anchored.
Throughout history central banks have attempted to bind themselves to the mast in different
ways. In the following, I will discuss the temptations facing issuers of notes and coins, the
binding mechanisms that have been tested, and the potential gains for society associated
with a central bank that keeps its word.
2. A king's word is worth a throne - but sometimes not a krone
It has always been tempting for issuers of money to exploit this privilege. It costs less to
produce a coin or a banknote than the value printed on it. The added value accruing to the
issuer is called seignorage.
Over-issuance of notes and coins leads to inflation and a fall in the value of money, and
holders of money pay a so-called inflation tax. A sharp fall or strong rise in the value of
money also impairs the functioning of the economy because it becomes more difficult to keep
track of changes in the price of one good relative to another. It is important that changes in
relative prices are easy for both consumers and producers to observe. Otherwise, the
function of prices as conveyors of information for consumption, production and investment
decisions will be impaired. The economy will operate less efficiently, resulting in lower growth
and welfare.
In the earliest monetary systems, the value of money corresponded to the metal value of the
coin. Measured in metal, the value of money was inevitably stable. This system was not as
dependent on confidence, since the metal content of the coin could in principle be verified in
every transaction.
Those in power nevertheless managed to exploit the system. Roman emperors were in the
habit of financing their wars by reducing the precious metal content of their coins. This
resulted in higher seignorage revenues from each coin issued. For a period, these revenues
were sufficient to finance an army, a long war or several monuments. This is the number one
temptation facing money issuers.
Henry VIII of England was one of the most renowned exponents of this kind of behaviour.6 In
the 1500s, he reduced the silver content in coins to 1/3 of the original to finance wars against
France and his own expensive lifestyle.
In addition to coins, a system gradually developed involving paper money. Banknotes were a
receipt for a money issuer's claims on silver or gold. Instead of using coins as a means of
payment, the receipt was used. This was more practical, but with the introduction of
banknotes the authorities also introduced a new promise. They promised the bearer that they
would redeem the nominal value of the notes in silver or gold. The value of the notes was
entirely dependent on confidence in the issuer's promise. The authorities' ability to fulfil their
promise depended on government finances. Brutal tax collectors, abundant tax coffers and
peace with neighbouring countries inspired confidence in the authorities' ability to redeem the
notes in a precious metal then or at some time in the future.
The authorities often granted a monopoly on banknote issuance to an institution they
controlled. This was no coincidence as printing money generated seignorage revenues. This
way of raising seignorage is temptation number two: the authorities borrow money from the
issuing bank and the issuing bank provides the loan by printing banknotes. This was
particularly common in times of war. It can be difficult to raise taxes or borrow directly from
the public to fund an unpopular war. Naturally, a regime at war will be more interested in
winning the war than in the long-term economic costs. Who cares about high inflation and
debt repayment if surviving as a regime is at stake?
Confidence - and the lack of it - had important consequences for England and France during
the Napoleonic Wars. England was able to finance these wars more easily than France. The
English government could draw on several funding sources. They raised taxes, but could
also borrow, partly from the public and partly from the central bank. They had previously
demonstrated that they stood by their commitments, and were therefore granted loans. The
French government, on the other hand, had lost its creditworthiness after Louis XVI was sent
to the guillotine. The only source of funding that remained was taxation, eliminating the
option of spreading war expenditure over time.7
Our own history also illustrates the costs associated with inflation and a loss of confidence.
Soaring inflation in Norway during and after the Napoleonic Wars impaired the functioning of
the payment system. The function of money as a unit of measurement was also undermined.
An example of this is described in the local history books for the coastal districts of Karlsøy
and Helgøy in Troms, northern Norway. At that time, accounts were sometimes kept in silver,
or in goods such as cod liver oil, large saithe or flour.8 Inflation also resulted in the transfer of
assets from creditors to debtors: the real value of the fishermen's debt to merchants in
Bergen decreased. This marked a historic shift. The fishermen were of course happy to see
their debt diminish. Creditors, however, lost money, which probably did not increase
confidence and a willingness to lend the next time someone needed a loan.
3. The promise of a stable value of money against gold and silver
I have given examples of how easily monarchs succumbed to the temptation of an
apparently free lunch by exploiting opportunities for raising seignorage revenues. In times of
political instability, they sometimes had no choice. But eventually, the authorities learned that
the costs were high. The public pays an inflation tax, the monetary system is impaired and
economic growth slows.
The economic progress experienced by Norway and other countries in the second half of the
1800s was founded on more than a thousand years of money and credit history. The
authorities probably knew that a credible promise of a stable value of money measured in
metal was one of the cornerstones of the success experienced by towns in northern Italy
during the Renaissance and in 17th century Netherlands They knew that confidence in the
promise of a stable value of money could be maintained by relinquishing seignorage and
limiting the issuance of money. The opposite was equally true. Kåre Lunden, for example,
writes that "after 1387, no coins were minted in Norway for a hundred years". According to
Lunden, the deep crisis in the Norwegian economy between 1350 and 1500 was not only
due to the Black Death but also to the absence of a monetary system.9
Stability in the value of money eliminated uncertainty and doubt among potential investors.
Long-term planning became easier. Providers of credit could be reasonably certain that their
investment would not be inflated away. They did not have to move their wealth into property
or other fixed investment in order to preserve it. The willingness to save and accumulate
wealth increased.
History had taught the authorities the value of price stability, and the commitment mechanism
was a monetary system linked to silver or gold. The whims of French kings were replaced by
parliaments that were accountable to the people. It is no coincidence that the name of the
most prominent great power's monetary unit - the pound - reflected a measure of weight:
the value of a pound of silver.10
Credibility hinged on orderly government finances and a stable political situation, which
contained seignorage temptations and in turn strengthened public confidence in the value of
money. A number of conditions need to be in place to enable a central bank to keep its
promise!
When Norges Bank was established in 1816, the government sought to ensure credibility by
establishing a tax-financed silver fund. A par value against silver for the new paper money -
the speciedaler - was announced. However, the market value of the speciedaler was
considerably below par value - the authorities in our young country were in a difficult
financial situation and had not yet established confidence. It was not until 1822 that the
authorities were able to establish a more orderly system when the Storting adopted a
longterm strategy whereby the silver value of the speciedaler would gradually increase to par
value.11 This goal was reached in 1842, twenty years later, bearing witness to long-termism
and persistence in policy implementation.
And persistence was rewarded. The rest of the 1800s and the period to the Second World
War were generally characterised by price stability and strong growth in the Norwegian
economy, even though there were also periods of weaker growth.12 Towards the end of this
period, confidence provided Norges Bank with the scope to adjust the interest rate to the
domestic economic situation rather than solely in relation to the gold standard.13,14
4. The era of broken promises
The interwar years proved to be highly turbulent, both in Norway and abroad. In 1921, for
example, per capita GDP in Norway fell by 11 per cent. The structure of the economy had
changed, the functioning of the labour market had deteriorated15, external trade had become
more important and the share of employment in agriculture had declined. We had become
more vulnerable to external economic developments.
The objective of monetary policy continued to be a stable value of money in relation to gold.
However, the authorities set an ambitious goal: they aimed to restore the krone's pre-war
value, which implied deflation. Moreover, they were more patient than had been the case
after the Napoleonic Wars a hundred years earlier. At that time, the par value of money had
been restored over a period of 20 years, but now the authorities achieved the same in a
quarter of the time at considerable real economic costs.16 We usually refer to this as "parity
policy".
The ambition to keep their promise was admirable, but the follow-through lacked flexibility.17
We might say that in the 1920s, the central bank adhered rigidly to "the letter of the law".18
After the Second World War, unemployment in the 1920s and 1930s was often associated
with the rigidity of "parity policy", which led to considerable changes in views on economic
policy.19
The objective of a fixed exchange rate and a gold standard nevertheless remained intact and
was achieved. Norway and a number of other countries pegged their currencies to the dollar
under the Bretton Woods Agreement. In reality, they also linked the value of their money to
gold, since the dollar was linked to gold.20
13
In Norway, the silver standard was replaced by the gold standard on 1 January 1874. See annex by Ragna
Alstadheim in Qvigstad, J.F. and A. Skjaeveland (1994) "Valutakursregimer - historiske erfaringer og
fremtidige utfordringer (Exchange rate regimes - historical experience and future challenges)", in Berg, S. A.,
J. F. Qvigstad and K. Storvik (Eds.) Stabilitet og langsiktighet: Festskrift til Hermod Skånland (Stability and a
long-term perspective: Festschrift for Hermod Skånland), 1994, Aschehoug.
14
Øksendal, Lars Fredrik (2008), "Monetary policy under the gold standard - examining the case of Norway,
1893-1914", Working Paper 2008/14, Norges Bank.
15
See Bjerkholt, Olav and Jan F. Qvigstad (2007): "Introduction to Ragnar Frisch's 1933 pamphlet Saving and
Circulation Regulation", in Revisita di Storia Economica, Banca d'Italia.
16
See Eitrheim Øyvind., Jan T. Klovland and Jan F. Qvigstad (Eds.) (2004), page 293: "Historical Monetary
Statistics for Norway 1819-2003", Occasional Papers No. 35, Norges Bank, Oslo.
17
However, they were more flexible in September 1931. It only took seven days for Norway to follow the UK's
lead in abandoning the gold standard.
18
There was a consensus on parity policy in the 1920s. See for example Hodne, Fritz and Ola Honningdal
Grytten (2002), pages 111-112: Norsk økonomi i det 19. århundre (The Norwegian economy in the 19th
century), Fagbokforlaget and Skånland, Hermod (1967) "Det norske kredittmarked siden 1900 (The
Norwegian credit market since 1900) Samfunnsøkonomiske studier No. 19, Statistics Norway, Oslo. See also
Mykland, Knut (ed.) Cappelens Norgeshistorie, Vol. 13 page 86.
19
For further discussion of parity policy and Norges Bank's role, see Ecklund, Gunhild J. (2008), pages 46-51
and 67-71: "Creating a new role for an old Central Bank: The Bank of Norway 1945-1954", Series of
Dissertations 2/2008, BI Norwegian School of Management, Oslo.
20
This link to gold was not as strong as when the obligation to redeem in gold applied. Under the Bretton Woods
system, countries whose public finances were in disequilibrium, or who allowed inflation to rise for other
reasons, had to let their exchange rate depreciate against the dollar. When the exchange rate against the
dollar fell, the value of money measured in gold decreased.
The post-war period was marked by the strong conviction that the economy could be
finetuned by the coordinated use of instruments decided at a centralised level. The value of the
krone was pegged to the dollar and to gold while a policy of low interest rates was
accompanied by an ample credit supply. This was possible in a highly regulated economy.
The positive attitude to regulation probably stemmed from the period of rationing and
centralised government during World War II. The system had functioned reasonably well and
a regulatory apparatus was already in place.21
Internationally, there was widespread desire to stabilise economic developments, originating
in theories published by John Maynard Keynes in the early 1930s. This was part of the
background for Norwegian politicians' ambition to fine-tune the economy in Norway. The
works of A. W. Phillips22, published in 1958, also supported this view. According to Phillips, a
country could apparently choose between low unemployment and low inflation. This menu
option is often referred to as the Phillips curve. And what kind of "option" was that?
Unemployment is real, while inflation is only changes in an index! By formulating the question
in this way, the choice was obvious. This analysis had a considerable impact on economic
policy.
The global economic situation became difficult into the 1970s, with low growth and high
inflation in Norway and other countries. The US and European authorities opted to pursue an
active counter-cyclical policy rather than combating inflation. But the trade-off between
inflation and unemployment did not hold in the long term, as economists had first thought.
The analyses had not factored in expectations formation. When higher inflation gradually
came to be expected by economic agents, it no longer led to lower unemployment.
In his work, Phillips introduced the dilemma of short-term gains and long-term costs in a new
area. The benefit was lower unemployment for a period. But confidence that inflation could
be kept low would eventually be eroded. The cost was persistently higher inflation. The
shortterm benefit evaporated along with confidence.
It is easy to see that it can be tempting to exploit the short-term gains even though the
longterm costs are known. In 1971, for example, US president Richard Nixon sought higher
growth in the money supply and an attendant reduction in unemployment in order to increase
his chances of being re-elected.23 He was aware of the inflation problems that would
subsequently arise, but his view was that they could be addressed at a later stage. Perhaps
he believed that if he were not re-elected, the long-term costs would be someone else's
problem. The lesson we can learn from this is that a system involving changing governments
may be particularly prone to short-term temptations. Finding an effective commitment
mechanism is of particular importance in this context.
Because of a lack of fiscal discipline, the Federal Reserve suspended its obligation to
redeem dollars for gold in 1971 and the Bretton Woods Agreement collapsed. This was the
beginning of a period of inflation and economic instability in many parts of the world, referred
to as the decade of Great Inflation. In Norway as in other countries, the government moved
in practice away from the objective of a permanently stable exchange rate.24 It carried out 10
de facto devaluations of the krone in the period 1976-198625, which led to high inflation. Data
on price developments in Norway are available back to 1516. Five hundred years of price
history show that in historical terms the inflation period in the 1970s and 1980s is unique.26
Previously, periods of high inflation had been associated with government deficits as a result
of war and unstable governments. This time, inflation was related to the system of economic
policy management.
The era of high inflation must be viewed against the background of the mixed experience of
the parity system and reduced weight on keeping promises, ambitious economic stabilisation
policies and belief in the validity of the Phillips curve. In addition, perhaps the importance of a
stable value of money had lost some of its prominence.
As there are many lawyers present here today, I will venture to comment on a case in your
field of expertise: the so-called gold clause case ("Gullklausulsaken").27 The Norwegian
government had issued a number of bonds in the period 1896 to 1909.28 Many of the bonds
were held by French moneylenders. The bonds were issued in the gold standard period and
the moneylenders were promised repayment in "monnaie d'or". When the bonds matured,
the Norwegian government wanted to make the repayment in banknotes that had lost much
of their value. This implied a devaluation that could perhaps be compared to the devaluation
under Henry VIII. The case finally came before the Supreme Court in 1962. In their voting,
the Supreme Court gave weight to a law from 1923, which stated that the gold clause, i.e.
repayment in gold money, did not apply when the obligation to redeem banknotes for gold
had been suspended, which was permanently done in September 1931. In the explanation of
their ruling, the Supreme Court also referred to "vital national interests". It would cost
Norwegian taxpayers far too much to repay the gold money that had been borrowed 60 years
earlier.
It would be far too pretentious of me to offer an opinion on the court ruling as such. What
makes this case interesting in the light of today's topic is that in the Supreme Court's
assessments of "vital national interests", there is no discussion of what the nation's interests
are in the short term versus the long term. However, it must be added that it is probably not
easy for a court to review other government authorities' assessments of this point. There is
also the question of whether this falls within the court's purview.
5. Modern monetary policy - a promise both possible and right to keep
The theoretical breakthrough by Kydland and Prescott and the era of high inflation eventually
had implications for practical policy. It was observed that countries where weight was given
to low inflation recorded favourable economic developments.
Theoretical works published some years later showed that expected and rules-based policy could stabilise the
economy provided price and wage rigidity existed. Some examples are: Fischer (1977): "Long-Term
Journal of Political
Contracts, Rational Expectations, and the Optimal Money Supply Rule", Economy, 85, No.
1, pages 191-206), Taylor (1980): "Aggregate Dynamics and Staggered Contracts", Journal of Political
Economy, 88, No 1, pages 1-24 and Calvo (1983): "Staggered Prices in a Utility-Maximizing Framework",
Journal of Monetary Economics, 12, No. 3, pages 983-998. Only when these articles were published was the
theoretical basis in place for keeping promises while at the same time allowing monetary policy to contribute to
stabilising the economy.
25
See reference in footnote 13.
26
See Eitrheim, Øyvind (2005) in Eitrheim and Qvigstad (Eds.): "Tilbakeblikk på norsk pengehistorie.
Konferanse 7. juni 2005 på Bogstad gård (Norwegian monetary history in retrospect. Conference, 7 June
2005, Oslo)", Occasional Papers No. 37, Norges Bank.
27
Bahr, Henrik (1962): "Høyesteretts dom i gullklausulsaken (The Supreme Court ruling in the gold clause
case)", Lov og Rett: norsk juridisk tidsskrift, booklet No. 5, pages 193-211.
28
Two government-guaranteed banks had also issued bonds.
BIS Review 136/2008
Since the beginning of the 1980s, there has been a broad consensus that monetary policy
must be geared towards price stability. This paradigm shift also reached Norway, but not until
the end of the 1980s. The government recognised that the repeated devaluations were
ineffectual. Confidence had been lost. In Norway, inflation had also soared without a fall in
unemployment. Even if it was costly to restore credibility, in reality we had no choice.29 The
alternative was to bring the country even closer to the brink of financial chaos and runaway
inflation. The devaluation in 1986 would become the last in the series.
Internationally, the 1980s ushered in three innovations that would become decisive for the
design of modern monetary policy as we know it today.
- First, market deregulation led to freer cross-border capital flows. Promises could no
longer be relegated to the future. Failing credibility was promptly reflected in higher
interest rates and weaker exchange rates. Nixon's disinflation plan to bring down
inflation at some point in the future would have had immediate consequences. On
the other hand, it also became clear that a credible and transparent monetary policy
could be more effective precisely thanks to financial markets' swift reactions.30
- Second, the notion of central bank autonomy regained favour. The political
authorities, who wanted to show the world that they were committed to delivering
their promise of price stability, did as Ulysses and tied themselves to the mast. The
mechanism was central bank independence and Norway was no exception. The
new Norges Bank Act of 1985 gave Norges Bank the authority to set the interest
rate. Democratic control is now ensured through a clear mandate defined by the
government for the central bank's conduct of monetary policy. The political
authorities can verify the central bank's compliance with the mandate without
deciding on the use of the instrument.31
- The third innovation sprang out of New Zealand. In connection with economic
reforms, the authorities introduced fiscal performance targets. They then started
searching for good and realistic performance targets for monetary policy. They
found that what monetary policy should deliver was stable inflation in the medium
term - New Zealand introduced a so-called inflation target for monetary policy.32
What is the difference between what is referred to as inflation targeting and the former policy
of parity? Let me explain the difference using a stylised example. Assume that the price
index has been 100 over a longer period. The price level is thus stable. An increase in, say,
energy prices then occurs and the index moves up to 105. Energy has become more
expensive in relation to other goods. Under the parity system, other prices had to be reduced
to move the index back to 100. This could require a substantial decline in output and
employment, as was the case in the interwar years. Under an inflation targeting regime, it is
in this example accepted that the index remains at 105. The central bank will ensure that
economic agents do not believe that inflation of 5 per cent has become the normal level,
29
The new recognition that policy should be based on confidence rather than a series of surprises reflects the
influence of theoretical developments on practical policy, c.f. footnote 24.
30
In recent times, central banks throughout the world have become more independent but at the same time
more predictable in their communication with other economic agents. This is also related to the new
recognition referred to in footnote 24.
31
Norges Bank reports on the conduct of monetary policy in its Monetary Policy Report and Annual Report.
Norges Bank's reporting obligations are set out in § 75c of the Constitution and § 3 of the Norges Bank Act.
The Annual Report is submitted to the Ministry of Finance, presented to the King in Council and
communicated to the Storting in the Government Credit Report. The Governor of Norges Bank also appears at
an open hearing of the Standing Committee on Finance and Economic Affairs.
32
The objective of EMU is consumer price stability in member countries as a whole, rather than stable prices in
the individual country. The arguments for a stable value of money are the same as for Norway.
BIS Review 136/2008
thereby preventing such a belief from affecting their behaviour. Under an inflation targeting
regime, the central bank will accept, when shocks occur, a price increase without having to
reduce other prices. The promise made under an inflation targeting regime is easier to keep
when the economy is exposed to major shocks than the promise made under a parity
system.33
From 1986 to the beginning of the 1990s, Norway pursued a fixed exchange rate against
European currencies without devaluations. In practice, this meant that Norway also had to
pursue the same inflation goal as those countries. In autumn 1992, the fixed exchange rate
regime collapsed. Even if we no longer operated a formal fixed exchange rate system, in the
following years monetary policy was still oriented towards maintaining a stable exchange rate
at all times.34 However, the currency turbulence in the latter part of summer 1998
demonstrated that like other central banks, Norges Bank could not make good on the
promise to maintain a stable exchange rate from hour to hour, day to day or week to week.
Domestic economic considerations indicated that there were limits to how high the interest
rate could be set in support of the krone exchange rate. An excessively high interest rate
would not have been credible since it would have resulted in an excessively sharp
downswing in domestic economic activity.
In August 1998, Norges Bank shifted policy to setting the interest rate with a view to keeping
inflation low and stable over time.35 The shift in monetary policy was explained in articles and
statements in early winter 1999.36 The inflation target was finally formalised in a new
regulation on monetary policy in 2001, a good eleven years after New Zealand, nine years
after the United Kingdom and eight years after Sweden.
The mandate for Norges Bank states that monetary policy shall, in addition to securing price
stability, contribute to stabilising output and employment. It is possible to give weight to
cyclical fluctuations in interest rate setting, and to new information, as long as there is
confidence that inflation remains near the target. The central bank's announced interest rate
strategy ahead will be adjusted as new information emerges. This stands in contrast to the
parity system, which was more rigid.
The authorities cannot systematically allow policy to be more expansionary than announced
to bring down unemployment. As Kydland and Prescott demonstrated, this would lead to
33
Another difference is that under parity policy the authorities stabilised the price of gold and not the price of a
basket of representative goods - the consumer price index. Today, stabilisation of the consumer price index
would be described as price level targeting. Inflation targeting, on the other hand, implies stabilisation of
changes in the consumer price index. There is also a difference in that there is no longer any redemption
obligation. Confidence is not based on gold reserves, but more generally o