Interventions influence the supply of kroner in the exchange market. A change in interest rates influences both conditions in the exchange market and total demand and production. Monetary policy may thus influence price and cost inflation through both these channels. In Norges Bank’s experience, extensive exchange-market interventions have yielded poor results. If the central bank intervenes heavily to defend the krone, this may evolve into a game situation in which market participants perceive central bank interventions as an interesting opportunity to make a profit. Market agents know that a situation in which the krone is being propped up because Norges Bank is intervening cannot be sustained. It is then tempting to take positions in the foreign exchange market against the central bank. This implies that heavy interventions may intensify the pressure on the krone over time, steadily increasing the necessary volume of interventions. If market participants assume that Norges Bank will use the interest rate to defend specific exchange rate levels, this may lead to a similar game situation. Norges Bank does not intend to behave in a way that will prompt such game situations. However, the Bank may use interventions to a limited extent if the exchange rate moves substantially out of line with what we consider to be reasonable on the basis of fundamentals, or in the event of exceptional short-term volatility in thin markets. In such circumstances, there is less risk of ending up in a game situation against exchange market agents.

For example, the recent decision of the Federal Open Market Committee (FOMC) to maintain the pace of its large-scale asset purchases in the face of a generally improving labor market outlook and a widespread perception within financial markets, right or wrong, that the Fed had telegraphed a dialing back of the rate of purchases may have increased uncertainty about the future path of monetary policy. That was one argument raised against the decision not to taper. I know, because I made the argument, and I was not alone. 1  Uncertainty indexes are described and analyzed in the following recent papers: “Measuring Economic Policy Uncertainty,” by Scott R. Baker, Nicholas Bloom and Steven J. Davis, unpublished manuscript, 2013; “Surprise and Uncertainty Indexes: Real-Time Aggregation of Real-Activity Macro Surprises,” by Chiara Scotti, unpublished manuscript, 2013; “Fiscal Volatility Shocks and Economic Activity,” by Jesús FernándezVillaverde, Pablo Guerrón-Quintana, Keith Kuester and Juan Rubio-Ramírez, unpublished manuscript, 2012; “Risk Shocks,” by Lawrence Christiano, Roberto Motto and Massimo Rostagno, National Bureau of Economic Research, NBER Working Paper no. 18682, January 2013; and “Uncertainty Shocks Are Aggregate Demand Shocks,” by Sylvain Leduc and Zheng Liu, Federal Reserve Bank of San Francisco Working Paper no. 2012-10, January 2013. 2  See “The Leverage Cycle,” by John Geanakoplos, in NBER Macroeconomics Annual 2009, vol. 24, Daron Acemoglu, Kenneth Rogoff and Michael Woodford, eds., Chicago: University of Chicago Press, 2010, pp. 1–65. See, also, “Reviewing the Leverage Cycle,” by Ana Fostel and John Geanakoplos, Yale University, Cowles Foundation Discussion Paper no. 1918, September 2013.