svein gjedrem : business cycles and monetary policy speech by mr svein gjedrem, governor of norges bank ( central bank of norway ), for norges bank ’ s regional network, arranged by the centre for economic research at ntnu – norwegian university of science and technology in trondheim, fosen, 3 may 2006. please note that the text below may differ slightly from the actual presentation. the address is based on the assessments presented at norges bank ’ s press conference following the executive board ’ s monetary policy meeting on 26 april, inflation report 1 / 06 and on previous speeches. the charts in pdf - format can be found on the norges bank ’ s website. * * * introduction monetary policy in norway is oriented towards low and stable inflation, with annual consumer price inflation of close to 2. 5 per cent over time. this is also the most important contribution monetary policy can make to sound economic developments in the long term. low and stable inflation provides the economy with a nominal anchor. this contributes to predictability for agents who make decisions about saving and investment today, although the result depends on economic developments ahead. in its conduct of monetary policy, norges bank operates a flexible inflation targeting regime, so that weight is given to both variability in inflation and variability in output and employment. flexible inflation targeting builds a bridge between the long - term objective of monetary policy, which is to keep inflation on target and provide an anchor for inflation expectations, and the more short - term objective of stability in the real economy. the economic situation growth in the norwegian economy has been strong since summer 2003. the reduction in norges bank ’ s key rate through 2003 and into 2004 resulted in low interest rates. low interest rates have contributed to a relatively sharp rise in household demand throughout this upturn. at the same time, solid growth globally has generated increased demand for many norwegian export goods and thereby high prices. fixed investment in the petroleum sector has increased strongly, resulting in growing demand for goods and services supplied by mainland enterprises. mainland fixed investment has also picked up gradually. the mainland economy expanded by 3. 7 per cent in 2005. growth in private services, construction and electricity production was strong. so far, a substantial share of output growth has been attributable to strong growth in person - hours worked. the fall in sickness absence in 2004 provided an additional supply of labour to enterprises, but sickness absence increased through 2005. wage developments reflect and influence business cycles. strong employment

to the deregulation of the housing and credit markets in the 1980s, after many households burned their fingers immediately after deregulation. in recent years, household income growth has been solid, household confidence regarding the future has been strong and households probably perceive higher income levels as permanent. this may have resulted in a further rise in house prices and debt. in addition, low real interest rates are currently making a contribution. in countries whose credit markets have been liberalised for a long period, for example denmark, where credit markets were liberalised over a hundred years ago, the debt - to - income ratio for households is higher than in other countries. monetary policy assessments since last summer, interest - rate setting has been oriented towards a gradual increase in the interest rate – in small, not too frequent steps – towards a more normal level. according to the assessment in the march inflation report, higher growth in the economy could, in isolation, warrant a faster rise in the key rate ahead. this would reduce the risk of bottlenecks in the economy, with rising cost inflation and continued debt build - up. on the other hand, the objective of bringing inflation up to the target of 2. 5 per cent and anchoring inflation expectations suggested in isolation that further interest rate increases should be delayed until there are clearer signs of a further rise in inflation. the trend in prices for consumer goods over the past two or three years is a result of favourable developments in the norwegian and global economy. the shift in trade towards low - cost countries has led to lower prices and higher real income. in addition, the changes in the world economy have provided norway with higher income because our terms of trade have improved. increased competition has curbed the rise in prices for a number of domestically produced goods and services. when inflation deviates substantially from the target for a period, the interest rate will be set with a view to gradually returning it to the target, so that we avoid substantial variations in output and employment. through the 1990s, inflation generally remained in the interval 1½ – 3½ per cent. inflation has varied slightly more in the past few years. in a period of increasing cross - border labour flows, substantial technological advances, changes in competitive conditions and new trading patterns, we may, with our very open economy, have to accept a somewhat greater variation in inflation and deviations from the target, as we have witnessed over the past two to three years. an overall assessment implies that the interest rate in the baseline scenario gradually increases