the krone showed a tendency to appreciate. this partly reflected lowered market expectations concerning an interest rate increase abroad and expectations that interest rates might rise earlier in norway than in other countries. changes in the krone resulted in unintended tightening of monetary policy. this trend was reversed, however, by low inflation figures and reductions in the interest rate. the interest rate reduction was probably of considerable importance as it eliminated the excess return on nok investments. the krone, measured by a broad index ( i - 44 ), appreciated again markedly from mid - february 2004 to the first half of may. after that, the krone depreciated through june. the publication of lower - than - expected consumer price figures for may contributed to weakening market expectations of an increase in interest rates in the near future, and the krone depreciated. after the monetary policy meeting on 1 july, the krone was stable for a long period, but since then it has fluctuated in line with changes in oil prices. past experience shows that the krone is at times heavily influenced by developments in the interest rate differential between norway and other countries. this is given weight in interest - rate setting. however, as mentioned, themes in foreign exchange markets shift, and norges bank does not have instruments to fine - tune the exchange rate. normally, norges bank will not intervene in the foreign exchange market in order to influence the exchange rate. exchange market interventions, either buying or selling foreign currency, are not suitable as an instrument for influencing the krone exchange rate over a somewhat longer period. if norges bank intervenes in the foreign exchange market instead of changing the interest rate, foreign exchange market participants may receive ambiguous signals, and complicated game situations may arise between the market participants and the central bank. however, interventions may be appropriate if the krone exchange rate differs substantially from what is reasonable on the basis of fundamentals, and exchange rate movements also reduce the prospect of achieving the inflation target. although the krone may fluctuate in the short term, it will tend to stabilise over time when inflation is low and stable. when inflation has been higher in norway than among our trading partners for a longer period, the krone has tended to depreciate. when inflation in norway is expected to be broadly the basic balance is normally defined as the current account surplus minus net long - term capital outflows. in line with that of other countries, the exchange rate will usually also

inflation. therefore, the interest rate is low. monetary policy influences the economy with long and variable lags. norges bank sets the interest rate with a view to stabilising inflation at the target within a reasonable time horizon, normally 1 - 3 years. the more precise horizon will depend on disturbances to which the economy is exposed and how they will affect the path for inflation and the real economy ahead. the economy grows over time. output will in some periods lie above and in others below the long - term trend. 2 stabilising output means seeking to maintain actual output near trend. there is one main monetary policy instrument : the interest rate. the interest rate is set with a view to achieving low and stable inflation, while at the same time seeking to avoid substantial variations in output and employment. in recent years, household income has shown solid growth, and household confidence has been high. high growth in labour costs over a number of years, the cyclical downturn in the world economy and a strong krone in periods resulted in deteriorating profitability in many companies. employment and berg, clas and lars jonung ( 1998 ) : “ pioneering price level targeting : the swedish experience 1931 - 37 ”, conference on monetary policy rules, stockholm, 12 - 13 june 1998. trend growth has been used as a rough estimate of potential output. potential output is the level of output that is consistent with stable inflation over time. investment fell. the level of household borrowing is high, while enterprises have reduced debt. high debt growth increases the vulnerability of households to economic disturbances. wage growth has slowed now and the krone has depreciated. a turnaround is taking place in corporate earnings and there are also signs of this in investment and credit demand. the interest rate can be used to reduce credit demand. at present - with low interest rates abroad and a close relationship between domestic interest rates and the krone - a tighter monetary policy would curb credit demand primarily because a stronger krone would reduce job security. a flexible inflation targeting regime reduces the possibility of exposing households to a dual shock in the form of higher unemployment and higher interest rates, as was the case at the beginning of the 1990s. if the economy is exposed to disturbances that can lead to higher unemployment, inflation will normally decline and interest rates will be lowered. a flexible exchange rate an important channel for monetary policy in a small, open economy is the foreign exchange market and the exchange rate. the krone fluctuates. this is