4  BIS Review 113/2010  Change in interest rate forecast over time  The interest rate forecast is an expression of a balance between various monetary policy considerations and a response pattern that households, firms and financial institutions can build on. The interest rate forecast is based on our understanding of the functioning of the economy. The uncertainty surrounding the interest rate forecast is highlighted in our fan charts with uncertainty intervals around the interest rate forecasts. The forecasts have shifted considerably over time. This reflects that the interest rate is an instrument that should react to all news that may influence the inflation outlook. Publication of interest rate forecasts – how does the market react? When we started forecasting the interest rate in 2005, we could refer to the experience of New Zealand 2, which had just experienced pronounced shifts in the interest rate and interest  2  The chart is from Archer, D. (2005): “Central-bank communication and the publication of interest rate projections”, presented at Sveriges Riksbank’s conference: “Inflation targeting: implementation, communication and effectiveness”: http://www.riksbank.com/templates/Page.aspx?id=15814. BIS Review 113/2010  5  rate forecasts. The chart illustrates that we were not able to anticipate the financial crisis in autumn 2008, but have otherwise been on track. Our latest interest rate forecast suggests that the interest rate will remain low for a long period. But we also note that market participants believe it will take even longer for the interest rate to move up to a more normal level.

A lack of confidence in some countries’ debt-servicing capacity and ability to boost growth capacity led to a flare-up in financial market turbulence last spring. A number of countries are in a position where they feel compelled to raise taxes and curtail spending. Exports from India, China and other Asian countries are expanding rapidly. Substantial trade deficits in the western world are partly being financed by an increase in reserves in Asian countries. Real exchange rates in western countries are most likely too strong. This is reflected in pressure tendencies in China and a number of other emerging economies and high unemployment and low inflation in traditional industrialised countries. In western countries and Japan exchange rates react to news. Pessimism translates into a flight to safe havens. Positive news, however, reduces risk premiums and tends to lead to a strengthening of exchange rates in commodity-based economies where interest rates are somewhat higher. But the nominal exchange rates of many Asian countries remain fixed. Thus, exchange rates are not allowed to fully contribute to reducing trade imbalances, narrowing cost differentials and spreading growth impulses. Growth in the world economy has an influence on the Norwegian economy. Norway is reaping the benefits of continued high commodity prices and sizeable investments by oil companies. Moreover, we have had economic policy leeway thanks to the credibility associated with solid government finances and firmly anchored inflation expectations. The Norwegian economy is experiencing a mild downturn and inflation is on the low side, while capacity utilisation now seems to have stabilised.