That is why in its monetary policy strategy, the Committee has interpreted “high employment” to mean the highest level of employment consistent with price stability over time. This level may vary over time and is primarily determined by structural conditions, such as labour force composition, the tax and social security system and wage formation. If we had attempted to use monetary policy to keep employment over that level permanently, inflation could have accelerated rapidly. An even higher policy rate may then have been required at a later stage, which may in turn have increased the risk of an economic downturn. In the Norwegian wage formation model, the social partners put weight on employment and firms’ profitability in wage negotiations, which is also an assumption underlying our economic projections. Over time, the system of coordinated wage determination has likely contributed to greater real wage flexibility and to keeping unemployment low by international standards. Experience nevertheless shows that there is a clear tendency for wage growth to increase when the labour market is tight and competition for labour intensifies. Similarly, wage growth tends to edge lower when the unemployment-to-vacancy ratio is high. Monetary policy trade-offs in the event of a cost shock Let me now turn to how we are seeking, in the current high-inflation environment, to strike a balance between the aim of low and stable inflation and the aim of high and stable employment. Over the past year, the policy rate has been raised from a very low level.

Capital markets play a comparatively larger role in our financial system. As a consequence, shocks get  2  BIS Review 9/2005  diffused more broadly, and weakness in traditional intermediation channels can be offset by the strength in other channels. Here in the United States, financial innovation has advanced farther and more rapidly than elsewhere. This reflects a regulatory model that is more supportive of competition, of financial innovation, and of market-driven improvements in risk management. The U.S. financial system has embraced opportunities for risk transfer much more rapidly and extensively than other systems. Finally, we have larger and more developed venture capital, private equity, and hedge fund segments within our financial system. These are important sources of liquidity, they add depth and breadth to capital markets, and they play a valuable arbitrage role in reducing or eliminating mispricing in the financial markets. However, no system is invulnerable to stress and crisis. Recent U.S. financial history is not a history of the uninterrupted achievement of ever higher returns. The stock market crash of ’87, the stress that surrounded the Russian default and the collapse of Long Term Capital Management, and the more recent fall in equity prices that came with the collapse of the technology boom all posed significant potential threats to financial stability. In each case, however, with a swift monetary policy response and other actions the process of recovery and repair was reasonably quick. The relative ease with which we managed through these events has reinforced confidence in the stability of the system.