we cannot expect the interest rate to have the same impact from one period to the next. the economy is also exposed to unexpected disturbances. as a result, we cannot fine - tune economic developments using the interest rate, but avoid the largest effects when the economy is exposed to disturbances. experience seems to indicate that inflation expectations remain stable even if inflation varies somewhat as long as the interest rate is used actively to curb effects. given our highly open economy, we may have to accept somewhat wider variations in inflation than some other countries. the last time i was here, almost exactly a year ago, norges bank ’ s executive board had just decided to reduce the key rate by 0. 25 percentage point to 1. 75 per cent. since then, the key rate has remained at this historically low level. real interest rates are also low. from december 2002 to march 2004, the key rate was reduced by a total of 5. 25 percentage points. the interest rate decline can be ascribed to a number of factors. in late autumn 2002, inflation started to fall. the inflation projections were also revised down. gradually new information about the outlook for other countries and the norwegian economy indicated that inflation might be very low. short - term interest rates fell by close to 4 percentage points. it would seem that it is not only changes in the real interest rate that have an influence, but also the level of real interest rates. between december 2002 and march 2004, the interest rate has moved from a high to a low level. the real interest rate is now lower than a neutral interest rate. a real interest rate that is lower than the neutral rate will stimulate activity even after the effects of the interest rate fall itself have been exhausted. calculations seem to indicate that the neutral real interest rate for norway is between 2½ and 3½ per cent, and it has probably fallen somewhat in recent years. it takes time for an interest rate reduction to have an impact on inflation. we are now seeing the effects of monetary policy decisions some of which were taken two years ago. the interest rate has affected inflation via the krone exchange rate and via demand for goods and services. in particular, the rise in prices for domestically produced goods and services has picked up. in addition, the reduction in the interest rate has probably contributed to holding up expectations of future inflation even when inflation is low. if there is confidence in monetary policy, economic agents will expect inflation to be close to target over time. this will provide a basis for company budgets.

the one hand, stable output, and on the other hand, low and stable inflation. historical data for norway and other countries show that interest rate changes affect aggregate demand fairly quickly. using the rimini model, we have estimated the effects of a 1 percentage point increase in interest rates over a period of two years. the chart shows that, in isolation, an interest rate increase of this magnitude may reduce mainland gdp by ¾ - 1 per cent after two years. the effect will depend on a number of factors, such as household loan debt and corporate profitability. household and business expectations may also play a part in determining the impact of interest rates. the band in the chart illustrates some of this uncertainty as shown by our models. in practice, it is often difficult to determine how long the interest rate will be kept at high or low level. the associated effects, for example on the exchange rate, will inevitably change if the interest rate is changed for a shorter or longer period than in our analysis. experience shows that the time it takes for a change in interest rates to have an impact will also vary. for example, the interest rate increases in 1998 had an impact on wage growth as early as the following spring. in other situations, it may take longer. the impact on consumer price inflation is also uncertain. the inflation rate is reduced by an estimated 0. 20 - 0. 35 percentage point after two years and 0. 30 - 0. 40 percentage point after three years. the result will depend partly on how the exchange rate reacts to the increase in interest rates. all the above estimates are based on the assumption that monetary policy credibility remains firm. for example, if an interest rate decrease reduces credibility, the impact on the exchange rate and inflation may be substantially stronger than indicated here. however, it is impossible to quantify these effects. sizeable interest rate changes could theoretically influence monetary policy credibility. the above estimates are therefore based on small interest rate changes. pronounced interest rate changes could have a different impact from that described here. forward rates reflect the market expectation of future levels of short - term interest rates. the difference between german and norwegian forward rates reflects different inflation expectations and a risk premium. during the period when the objective of monetary policy was a stable exchange rate against the euro, the difference between norwegian and german long - term interest rates was about ½ percentage point less than it is today. the difference between norwegian and germany 10 - year forward rates widened by about ½ percentage point after the introduction of the