The krone depreciated by about 13 per cent from its strongest level in January 2003 up to summer 2003. In autumn 2003, the krone showed a tendency to appreciate against the euro. This partly reflected  BIS Review 34/2004  3  lowered market expectations concerning an interest rate increase abroad and expectations that interest rates might rise earlier in Norway than in other countries. At the same time, the euro appreciated in relation to other currencies. Changes in the krone resulted in an unintended tightening of monetary policy. The krone depreciated again in December, however, owing to low inflation figures and a reduction in interest rates. The interest rate reduction was probably of considerable importance as it eliminated the excess return on NOK investments. The krone has again appreciated since last winter. Parallels can be drawn with the situation towards the end of 2002. The current high oil prices and expectations that oil prices will remain high for a long period may have been important for the appreciation of the krone. When there is considerable uncertainty with regard to future developments in oil prices, market participants may hedge against risk by investing in NOK. As mentioned earlier, the Petroleum Fund acts as a buffer against wide fluctuations in the krone exchange rate as a result of petroleum revenues. An increase in petroleum revenues will normally also result in higher capital outflow from the Petroleum Fund. The market may at times have a tendency to underestimate this stabilisation mechanism.

The fixed exchange rate was an intermediate target for achieving low and stable inflation. The exchange rate remained stable up to autumn 1996, partly because wage growth was low and overall demand did not generate pressures in the economy. Gradually, the krone began to show wider fluctuations. The experience of the last half of the 1990s demonstrated that monetary policy cannot fine-tune the exchange rate. Developments in international financial markets led to more pronounced fluctuations. And more fundamentally, when labour market pressures rose and incomes policy failed, exchange rate developments no longer provided signals for wage formation and fiscal policy. High petroleum revenues, fiscal slippage and expectations of increased use of petroleum revenues contributed to this. The exchange rate was therefore no longer suitable as a nominal anchor. Towards the end of the 1990s, increased emphasis was placed on the fundamental preconditions for exchange rate stability. Monetary policy instruments were oriented with a view to bringing price and cost inflation down towards the price stability objective of the European Central Bank (ECB). BIS Review 34/2004  1  Monetary policy In most countries, price stability, or low and stable inflation, is the objective of monetary policy. Historical experience from Norway and other countries has shown that the absence of price stability has resulted in unstable output and employment. History shows that higher growth cannot ultimately be achieved in exchange for higher inflation. An economic policy that fuels inflation does not generate higher economic growth. On the contrary, it paves the way for subsequent recession and unemployment.