As a result of the high level of earnings and fluctuations in these petroleum revenues, the most important contribution fiscal policy can make to stabilising the Norwegian economy is to provide a sound, longterm strategy for the use of petroleum revenues. In other words, fiscal policy is subject to the fiscal rule. Attempts to use the central government budget to fine-tune economic activity may have a destabilising effect if these attempts are perceived as a breach of the long-term strategy for the phasing in of petroleum revenues. As a general rule, central banks influence the shortest money market rates via the policy rate. However, economic agents’ consumption and investment decisions depend more on their interest rate expectations. Hence, monetary policy functions primarily by influencing expectations regarding future interest rates. Economic agents therefore need to understand the central bank’s intentions in its interest-rate setting. In the November 2005 Inflation Report, Norges Bank published its own projection for the interest rate for the first time. 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. So far, the Reserve Bank of New Zealand is the only other central bank that has experience in publishing its own interest rate projections. Most central banks that publish projections base their forecasts for developments in the economy on either a constant interest rate or on the assumption that the interest rate will shadow market interest rate expectations.

That influence tempted 1  See Tobin (1972), “Inflation and unemployment”, American Economic Review, 62. Inflation can have large redistributive effects. Volatile inflation arbitrarily re-distributes wealth across borrowers and savers. And most recently, there has been a debate about how the stance of monetary policy has affected the distribution of wealth and income. In a series of recent analysis and speeches, members of the MPC have shown that, while distribution is not an objective of monetary policy, the evidence strongly suggests that policy since the crisis has been associated with better outcomes. 2  2  All speeches are available online at www.bankofengland.co.uk/publications/Pages/speeches  2  authorities to promise low inflation in the future, but then to renege in order to boost activity. Electoral cycles 3  reinforced this predisposition. Firms and households began to anticipate these incentives, however, and eventually pre-empt them. The economy ended up in a worse equilibrium with higher inflation and 4  unemployment. Such time-inconsistent policies contributed to excessive inflation and higher structural unemployment in the UK during the 1970s and 1980s (when inflation averaged 9.5% and unemployment over 7.5%). In light of similar experiences, many societies came to recognise that macro outcomes can be improved by having society first choose the preferred rate of inflation and then delegate operational responsibility to the 5  monetary authority to take the necessary monetary actions to achieve that objective. By “tying the hands” of authorities, time inconsistency is resolved and better outcomes for both inflation and unemployment become possible.