The real krone exchange rate may move more in the short term than is necessary in the long term. The krone may be expected to depreciate at a later stage because a higher real interest rate, combined with expectations of a depreciation of the krone, contribute to 4 convergence between the expected real return on capital invested in Norway and in other countries. Moreover, there may be additional fluctuations in the krone exchange rate if market expectations concerning the use of petroleum revenues deviate from what is actually the case. Given today's  2  See e.g. Clarida, Richard, Jordi Galí and Mark Gertler (1999): “The Science of Monetary Policy: A New Keynesian Perspective”, Journal of Economic Literature, Vol. 37, no. 4, 1661-1707. 3  I refer here to a more detailed discussion in my lecture entitled “The Role of the Central Bank”, given at a conference hosted by the Power and Democracy Research Group and FAFO Institute for Applied Social Science, Oslo on 6 September 2002. 4  See Svensson, Lars E.O. et al. (2002): “Norges Bank Watch 2002 - An Independent Review of Monetary Policy and Institutions in Norway”. Research Report 17/2002, BI Norwegian School of Management. 4  BIS Review 2/2003  exchange rate, it would appear that foreign exchange operators have already factored in a substantial increase in the use of petroleum revenues. Cyclical divergence is reflected in the interest rate differential between Norway and Germany and the US. What makes the current situation unusual is the extremely low foreign interest rates.

Instead, imbalances in the labour market would be counteracted by means of a counter-cyclical policy. Substantial emphasis was placed on the importance of wage formation for developments in employment. Only when wage growth dropped below the level of our trading partners did unemployment begin to fall and the manufacturing sector began to pick up. Thus, the fixed exchange rate policy was not introduced in order to strengthen the internationally exposed business sector. On the contrary, it was a breach in the approach whereby monetary policy and “exchange rate policy” had been oriented towards safeguarding these sectors. The fixed exchange rate was an intermediate target for achieving low and stable inflation. The exchange rate remained stable until the autumn of 1996, partly because wage growth was low and aggregate demand did not contribute to pressures in the economy. Gradually, the krone began to fluctuate more. The experience of the last half of the 1990s showed that monetary policy cannot fine-tune the exchange rate. Developments in international financial markets provided fertile ground for more pronounced fluctuations. And more fundamentally, when labour market pressures rose and incomes policy failed, exchange rate developments were no longer providing signals for wage formation and fiscal policy. High petroleum revenues, fiscal slippage and expectations of increased use of petroleum revenues contributed to this. Therefore, the exchange rate was no longer suitable as a nominal anchor. The introduction of new guidelines for economic policy in March 2001 and the conduct of fiscal policy have altered the interplay between economic policy components.