Hence, monetary policy works primarily by influencing expectations regarding future interest rates. Monetary policy may thus be more efficient if economic agents understand the central bank’s intentions in its interest-rate setting. In the November 2005 Inflation Report, Norges Bank first published its own forecast for the interest rate for the next three years. The aim is to enhance the predictability of monetary policy. With a predictable monetary policy, market participants can react to new information in a way that contributes to stabilising developments in output and inflation. We try to establish an interest rate path that provides a reasonable balance between the objective of stabilising inflation at target and the objective of stabilising developments in output and employment within a reasonable time horizon, normally 1 - 3 years. Interest-rate setting is also assessed in the light of developments in property prices and credit. The results of this trade-off are published in the Inflation Report in the form of a chart that presents central projections for the interest rate, the exchange rate, inflation and capacity utilisation in the economy. Underlying inflation has been lower than projected in recent months. Nevertheless, several factors point to higher inflation ahead. Capacity utilisation is high and there is little spare capacity in the Norwegian economy. Employment is rising rapidly and unemployment has exhibited a marked decline. There are signs of higher wage growth and expectations of rising inflation. At the same time, the krone exchange rate has depreciated from strong values.

Throughout their history central banks have aimed to ensure the overall soundness of the financial system and this followed naturally from their basic functions. Three historical developments were the key to this. In the beginning central banks were first and foremost banks – and like any bank they needed to consider the soundness and creditworthiness of their clients as well as factors in the general trading environment that might cause them losses. Second, over time, central banks developed a monopoly over ultimate liquidity, the means of final settlement, and they facilitated the settlement of inter bank payments through the rediscounting of commercial bank assets and the collection of reserves in the form of bank deposits. Third, as commercial bank money progressively developed into a larger share of the money stock, the value of money became dependent on the soundness of commercial banks. In this environment the concern of the central bank for the orderly functioning and stability of the banking system arose from the need to maintain the public goods of a stable means of payment, a unit of account and a store of value. This included last resort lending when commercial banks suffered from liquidity strains. This historical development meant that by the end of the nineteenth century, or by the early years of the twentieth at the latest, central banks’ concern for financial stability was an already well-established part of their function. However, the second half of the twentieth century saw many central banks also taking on the responsibility for statute-based micro prudential supervision.