In Norway, this was a breach in the approach whereby monetary policy and exchange rate policy had been oriented towards strengthening the internationally exposed sector. Deteriorating competitiveness due to high wage growth would no longer be remedied by means of devaluations. This is clearly indicated in the following quotes from the Steigum Commission which submitted its report in 1988. “If international inflation is low and stable, such an exchange rate policy will contribute strongly to price and wage developments in Norway that are also favourable, assuming that the value of the krone is not gradually devalued.” “If a fixed exchange rate rule is to be credible, the authorities must also refrain from using (devaluations of the krone) in the current economic policy when weakened cost competitiveness leads to a decline in output and employment.” With increasingly mobile capital, it became gradually more difficult to maintain the fixed exchange rate. Small differences in interest rates could result in substantial capital flows and monetary policy easily became pro-cyclical. That fiscal policy dampened fluctuations in the domestic economy and that wage growth was held at bay were not sufficient grounds for a fixed exchange rate either. Currency speculation could be self-fulfilling because interest rate increases that were necessary to counter an attack on the exchange rate could trigger such a low level of activity that confidence in the fixed exchange rate was pulverised. In Norway, the fixed exchange rate regime was abandoned in December 1992. There had been persistent unrest and widespread speculation in European currency markets.

But experience showed that this was not an available option. An attempt to increase output beyond the level that is consistent with stable inflation will over time lead to steadily rising inflation. Economic agents will eventually incorporate higher inflation into their inflation expectations. In the long run, the result will only be higher inflation, not higher employment. Output and employment will return to their potential level. Another important lesson from the 1970s and 1980s was that economic agents look to the future when they make decisions about consumption and investments, wages and prices. They will take into account not only current economy policy, but their expectations of future economic policy. If economic agents expect that tomorrow’s policy will result in high inflation, the cost of reducing inflation may be high in terms of increased unemployment. Therefore, it is important to establish confidence in monetary policy and the objective of price stability. There must be consistency between the stated objectives of economic policy and what is actually done to achieve these objectives. This is the most important reason why the implementation of monetary policy has been delegated to the central bank in Norway, as has been the case in other comparable countries. In Norway, responsibility for interest rate decisions was delegated to Norges Bank through the 1985 Norges Bank Act and through adaptations in practice in 1986. However, confidence in the inflation target also requires that government finances are in order.