number of channels. when interest rates rise, it becomes more profitable to save and to postpone consumption. this reduces growth in household consumption. at the same time, a higher interest rate may increase the required rate of return, thereby reducing business investment. in addition to the direct effect on demand, a rise in interest rates may moderate demand through reduced access to liquidity, a decline in asset values and a stronger exchange rate. moreover, a stronger exchange rate will reduce the rise in prices for imports, which account for 40 % of goods and services in the consumer price index. an increase in interest rates may also have an effect through inflation expectations. expectations of lower future inflation will increase the real interest rate, and may therefore in itself have an impact on the real economy. inflation expectations may also influence price and wage formation as well as the exchange rate. see akram ( 2000 ). however, the relationships between the interest rate, expectations, demand and inflation must be expected to be unstable. analyses have been published showing how changes in interest rates affect the economy in various countries. in december 1999, norges bank presented an analysis based on calculations which showed that an interest rate rise of 1 percentage point reduces gdp growth and price inflation by just under half a percentage point. a considerable portion of the effect on price inflation is due to effects via the exchange rate, where it was assumed that the krone exchange rate moved in line with uncovered interest rate parity. the central banks of england and sweden have published calculations that show effects of roughly the same magnitude. in view of the uncertainty concerning the effects of the interest rate on economic developments, it is not possible to fine - tune price developments and the exchange rate. however, it is possible to conduct a monetary policy that reinforces confidence in nominal stability. the experience of norway and other countries shows that monetary policy can be effective, as seen by developments before and after the shift in economic policy in 1986. a monetary policy that results in an interest rate that is too low will unleash strong forces in financial markets. an inappropriate interest rate will generate erroneous price signals to households and financial institutions in the housing and property market. with interest rates that are too low and nominal price pressures, the buyer and seller will find it more difficult to discover the real change in value, and they will buy and sell on the basis of erroneous price signals. similarly, those extending loans will find it more difficult to assess the real value of collateral security and the

shocks, but we can curb the effects to ensure that economic developments are optimal in the long term. fiscal policy in norway has had an important role in stabilising demand and production. the petroleum fund shelters the mainland economy from the effects of oil price fluctuations to some extent. developments in the real economy are of importance to price and cost inflation and hence for norges bank ’ s setting of interest rates. at the same time, changes in the interest rate and exchange rate may influence developments in the real economy in the short run. this means that fiscal and monetary policy have a combined effect on the overall level of activity in the economy. with large and to some extent varying budget revenues, the basis for determining central government expenditure and taxes from one year to the next may easily be impaired. if budget expenditure fluctuates to a large extent in step with oil prices, the result will be abrupt shifts and instability in the norwegian economy. changes in oil prices may then quickly influence wage and price expectations, the exchange rate and long - term rates. in that case it will be very demanding to achieve nominal stability. short - term interest rates will have to be changed frequently and sharply, and long - term rates will reflect a high risk premium for the norwegian krone. it is therefore important that the annual budgets are anchored in a long - term strategy that takes sufficiently into account that oil revenues can fluctuate from one year to the next. it is advantageous if fiscal policy can also be used to counter fluctuations in demand and production. the political assessment has also been that a countercyclical fiscal policy provides the best basis for sound developments in the distribution of income and wealth. if fiscal policy is used to smooth fluctuations in demand and production, it will also contribute to stability in the krone exchange rate and in the competitive conditions for the business sector. if fiscal policy lacks a long - term anchor, the interplay in economic policy will not function and the result will be a more unstable krone exchange rate and wider cyclical fluctuations. this will also result in poorer use of our resources, partly because strong fluctuations in domestic activity and long - term interest rates and the exchange rate will prompt investment decisions that are made on a very uncertain basis. concluding remarks allow me to conclude where i began. i would like to highlight two points. first, the main function of monetary policy is to contribute to nominal stability. this is the best contribution monetary policy can make to a sound distribution policy, to employment,