Those who experienced the banking crisis in the 1990s have a clear perception of this. Financial instability is characterised by wide fluctuations in prices for assets, such as dwellings, commercial property and securities or failure in the functioning of financial institutions (a “run” on banks) or financial markets. Financial instability is also characterised by disturbances in credit availability or the flow of capital. This may have consequences for output, employment and for inflation. Financial stability therefore promotes price stability. In tandem with the trend towards lower inflation since the mid-1980s, asset prices have shown wider variations and financial crises have become more frequent. In the short term, a conflict may arise between achieving the inflation target and financial stability. In Japan, equity and property prices increased sharply in the 1980s, while inflation was subdued. In the US, household and corporate debt rose fairly sharply and equity prices trebled between 1994 and 1999, while inflation was moderate. This has prompted a debate as to whether monetary policy must take financial stability into account to a greater extent. Low interest rates and low inflation may contribute to a rise in asset prices and debt build-up (financial bubbles) through several channels. With confidence in the inflation target, inflation may be less affected by changes in the economic situation. Increased international competition and imports from low-cost countries can keep inflation at a low level even during a period of strong expansion in the domestic economy. High productivity growth contributes to low inflation, but also to high earnings.

When economic agents also understand Norges Bank’s response pattern in connection with events in the economy, market expectations concerning the interest rate will change as a result of economic news and to a lesser extent as a result of Norges Bank’s interest rate decisions in themselves. Norges Bank reduced the key rate at the monetary policy meeting on 17 September 2003. Short-term interest rates showed little change since the interest rate decision was expected by market participants. At the same time, the Bank changed its bias concerning future inflation. At the monetary policy meeting in August, the Bank stated that, with an interest rate of 3 per cent, the probability that inflation two years ahead would be lower than 2½ per cent was greater than the probability that it would be higher. Following the meeting on 17 September, the Bank stated that, with an interest rate of 2.50 per cent, the probability that inflation two years ahead would be higher than 2½ per cent was the same as the probability that it would be lower. Expectations concerning future short-term interest rates rose slightly, probably as a result of the change in Norges Bank’s bias concerning future inflation. This was perceived as new information by market participants. The yield curve was therefore a little steeper following the monetary policy meeting. 4  6  Svensson, L.E.O. (September 2002), "Monetary Policy and Real Stabilization". Princeton University  BIS Review 46/2003  The market’s expectations concerning future short-term rates can be reflected in forward rates.