Short-term capital inflows and outflows are probably the most important factor determining movements in the krone exchange rate from day to day, from week to week and from one quarter to the next. They are governed by expectations concerning future returns. Changes in expectations concerning the future value of the krone can trigger extensive capital movements. As a rule, Norges Bank does not intervene in foreign exchange markets with a view to influencing the krone exchange rate. The krone is floating, and the value of the krone fluctuates in periods by the same magnitude as exchange rates in other open economies. Nevertheless, the prevailing stability of the krone is largely a reflection of confidence that inflation in Norway will be kept at a low level. Our experience is that changes in the Norwegian interest rate level only have a predictable effect on the krone exchange rate when the change in interest rates also contributes to stabilising inflation. However, the relationship between interest rates and price and cost developments is uncertain. The setting of interest rates thus requires the use of professional judgement and discretion. The basis for exercising discretion is subject to limitations, however. Should any doubt arise as to whether the interest rate is oriented towards nominal stability, this would trigger substantial capital movements. Interaction with income formation A precondition for a stable krone exchange rate against European currencies is that price and cost inflation in Norway must over time not exceed the corresponding aim for inflation of the European Central Bank (ECB).

What we are seeing is a sharp increase in private holdings of assets both in Norway and abroad. This constitutes the core of globalisation. Capital finds its way to the highest return irrespective of national borders. Challenges posed by a global capital market The Norwegian capital market is part of a Nordic market, which is being increasingly integrated into an international capital market. Capital markets are a very efficient tool for channelling funds from savers to investors. Capital markets act as a catalyst for restructuring and growth, but also for financial bubbles and crises. This places new demands on economic policy. If a country is to benefit from a free capital market, it must draw up legislation providing for regulations and supervision that ensure stability. Countries with poorly developed capital markets may benefit from some limitations. They should exercise some caution in opening these markets too suddenly. The flow of capital is like electricity. Adequate insulation should be in place before it is turned on. When the Nordic countries liberalised credit markets in the 1980s, we experienced considerable problems because supervision and rules were not adequate. The same was witnessed in the crisis in Asia and Russia a few years ago. Inadequate and ineffective legislation and supervision resulted in weak control of financial sectors in the beleaguered countries. The liberalisation of the capital market within a country requires national regulations and supervision. The liberalisation of capital movements across national borders requires coordination and regulation at an international level.