A number of countries had to abandon a fixed exchange rate. The exchange rate target in Norway became more flexible. Monetary policy was oriented towards maintaining a stable exchange rate in relation to European currencies, without defining a central exchange rate with fluctuation margins. At the same time, fiscal policy was to stabilise the domestic economy. With rising petroleum revenues, it proved demanding to use the government budget to curb growth in domestic demand and costs. The krone exchange rate began to fluctuate increasingly from 1997, and interest rate setting had to increasingly be oriented towards maintaining low and stable inflation. 1  See Qvigstad, Jan (2005), “500 års prishistorie – Prisstabilitet er det normale. Hva kjennetegner det unormale?” (500 years of inflation history - Price stability is the norm. What distinguishes the abnormal?) Lecture at Norges Bank’s conference on Historical monetary statistics for Norway, Bogstad Gård, 7 June. BIS Review 43/2005  1  Through the 1990s, inflation targeting had emerged as an attractive alternative. This monetary policy regime was based on experiences from the 1960s, 1970s and 1980s. One important lesson was that it was not possible to reduce unemployment in the medium and long term by merely accepting somewhat higher inflation. Faced with the question of whether an increase in inflation from say 10 to 12 per cent was acceptable if stimulating the economy could at the same time reduce unemployment from say 2 to 1½ per cent, the decision-making authorities would most likely have been inclined to answer yes.

See also Levin, Andrew T., Fabio M. Natalucci and Jeremy M. Piger (2004), “The Macroeconomic Effects of Inflation Targeting,” Federal Reserve Bank of St. Louis Review, Vol. 86, pp. 51-80. 8  See, for example, Stock, J.H. and M.W. Watson (2003), “Has the business cycle changed? Evidence and explanations”, in Monetary policy and uncertainty: Adapting to a change in economy, Federal Reserve Bank of Kansas City. 6  BIS Review 43/2005  Globalisation, increased trade and at times strong growth in productivity may have made the trade-offs easier. It is possible that the costs of holding inflation at bay have been reduced.9 It appears that the short-term trade-off between inflation and unemployment has changed in Norway as well.10 Whereas a given rise in unemployment resulted in a relatively small reduction in inflation in the 1970s and 1980s, the gain in the form of lower inflation was far greater in the 1990s. This may be due to a more successful monetary policy and supply-side conditions in the economy, including wage determination. Inflation targeting has proved to be a sound system and may be particularly well suited for small and medium-sized open economies. A topic currently being discussed by academia and central banks is whether and how monetary policy should contribute to stability in the financial system. Price stability and financial stability often require the same medicine. For example, periods of strong growth in demand for goods and services will usually result in both higher inflation and increased asset prices. Both considerations may imply a tighter monetary policy.