In the first round, heightened competition affects companies’ profit margins. But enterprises will respond by reducing their costs. This will occur in part in the enterprise itself, but subcontractors will also be required to reduce their prices and enhance efficiency. Increased competition therefore usually triggers higher productivity growth in the economy. Low inflation may thus be matched by higher productivity. Low inflation in the Nordic countries Norway is not the only country where inflation has been low. In Sweden, underlying inflation fell sharply. Excluding energy prices, core inflation stands at 0.8 per cent in Sweden. Inflation has also slowed in Finland and Denmark. One explanation for this, common to all these countries, appears to be intensified competition, which has led to high productivity growth. Real exchange rate and competitiveness High wage growth over several years as from 1998 has eroded the competitiveness of the Norwegian business sector. The nominal krone exchange rate, as measured by the trade-weighted index, has now reverted to around the level prevailing in the mid-1990s, while labour costs in manufacturing have risen considerably more than among our trading partners in the same period. However, the business sector is still feeling the effects of the loss in competitiveness that resulted from high wage increases. The exposed sector has been scaled back. Companies that are still in operation may be in a better position to cope with the high wage level. A more effective service sector may also have strengthened the export industry. Nevertheless, costs may limit activity and employment.

Inflation targeting has proved to be particularly appropriate in very open small and medium-sized economies. Commodity exports play a particularly important role in several of the countries that were the first to introduce inflation targeting. Exchange rates fluctuate Over the past 10-15 years, many countries have made the transition from a fixed exchange rate regime to inflation targeting. In open economies with free capital movements, the exchange rate will be influenced by economic developments. The krone fluctuates. This is not surprising because other countries’ currencies also fluctuate. The krone exchange rate does not stand out as particularly unstable compared with other countries’ currencies. The krone exchange rate is the price of our currency measured in a foreign currency. Developments in other countries are just as important for the krone as developments in the Norwegian economy. Capital flows freely and flows can change rapidly. This can spill over to exchange rates and interest rates as well as output and employment. There is a cost involved for businesses in hedging against fluctuations in the krone. A krone that is stable - but too strong - also entails costs to the economy in the form of low activity. Similarly, a krone that is stable - but too weak - is a source of high inflation. Flexible inflation targeting The most important contribution monetary policy can make to sound economic developments in the long term is low and stable inflation. The inflation target provides an anchor for economic agents’ expectations concerning future inflation.