svein gjedrem : the monetary policy response to the economic outlook speech by mr svein gjedrem, governor of norges bank ( central bank of norway ), at the mjøs regional business seminar, hamar, 21 may 2003. the address is based on previous speeches and on the assessments presented at norges bank ’ s press conference following the monetary policy meeting on 30 april. please note that the text below may differ slightly from the actual presentation. the charts in pdf can be found on the norges bank ’ s website. * * * the operational objective of monetary policy as defined by the government is inflation of close to 2½ per cent over time. norges bank sets the interest rate so that future inflation will be equal to the inflation target of 2½ per cent. the interest rate reductions last winter and this spring were a response to changes in the inflation outlook as a result of slower global economic growth and a sharp decline in international interest rates. in addition, the norwegian business sector is feeling the effects of the high norwegian cost level. growth in domestic demand has also slowed. household purchasing power has been reduced as a result of higher electricity prices. the weak prospects at home and abroad are in turn having an impact on the norwegian labour market and the outlook for wage growth and inflation in the years ahead. even though the krone has depreciated this year, it is still fairly strong, contributing to a fall in prices for imported goods and services. the inflation target provides economic agents with an anchor for their decisions concerning saving, investment, budgets and wages. households, businesses, public entities, employees and employers can base decisions on the assumption that inflation in norway will be 2½ per cent over time. the inflation target is a vehicle for allowing monetary policy to stabilise developments in output and employment. this intention is also expressed in the regulation on monetary policy. high demand for goods and services and labour shortages normally point to higher inflation. when interest rates are increased, demand falls and inflation is kept at bay. when demand is low and unemployment rises, inflation will tend to slow. interest rates will then be reduced. the mandate implies that the interest rate must be adapted to the outlook for the norwegian economy. if it appears that inflation will be higher than 2½ per cent with unchanged interest rates, the interest rate will be increased. if it appears that inflation will be lower than 2½ per cent with unchanged interest rates, the interest rate will be reduced

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