following day, the executive board summarises its discussions and assesses the consequences for monetary policy for the next four months. this assessment constitutes an important internal reference when the executive board later makes a decision regarding the interest rate. it will also provide the basis for our external communication through speeches and the media. the key rate is assessed by the executive board every sixth week. monetary policy decisions are announced in a press release followed by a press conference. as an example, allow me to present the background for the monetary policy decision in june, when the key rate was raised from 6. 5 per cent to 7 per cent. developments in international financial markets were uncertain at that time, as they are today. we assumed that activity among our trading partners would show only a gradual recovery. oil prices were high, also measured in nok. private consumption had shown a substantial rise as a result of strong income growth. households expected strong income growth and borrowed heavily. housing investment was high and financial investment was low. house prices were rising. public expenditure was growing as a percentage of gdp. it was also expected that the level of petroleum investment would be high. against this background, pressures on real economic resources were deemed to be strong. wage growth was markedly higher than projected earlier. the outcome of the various settlements pointed to wage growth of 5½ - 6 per cent this year. the wage settlement awarded high pay increases with effect from next year for some groups even though they will also be negotiating pay increases in 2003. developments in the krone exchange rate had the opposite effect. the krone had appreciated. expectations of higher interest rates as a result of developments in wage settlements probably contributed to this. against this backdrop, consumer price inflation, with an unchanged key rate of 6. 5 per cent and an unchanged krone exchange rate from the average exchange rate for the second quarter, was projected at 2¾ per cent from the summer of 2004. cf. cournot - nash equilibrium in game theory 2 cf. stackelberg equilibrium in game theory projections showed that price inflation could be lower than 2½ per cent in the short run. if we had tried to reach the inflation target in the short term, i. e. strict inflation targeting, we would have lowered the key rate. we know that would probably imply a weaker krone and higher inflation. a more pronounced increase in interest rates than the increase we actually implemented would then probably have been necessary in a year ’ s time. this would have led to unnecessary

in the norwegian economy, with high and variable inflation. this also resulted in wide swings in output and employment. the absence of a nominal anchor was one of the main reasons behind the pronounced swings. with a policy of low interest rates and devaluations, inflation took root. nominal interest rates were kept at a low level even though inflation and the value of tax - deductible interest rose. frequent devaluations from 1976 were not able to prevent a decline in manufacturing. on the contrary, they proved to be selfreinforcing. the wide fluctuations culminated in a credit boom in the mid - 1980s, followed by a deep recession and high unemployment towards the end of the 1980s. history shows that low unemployment cannot be achieved through high inflation. a monetary policy that fuels inflation does not promote economic growth. on the contrary, it paves the way for recession and unemployment. furthermore, without a nominal anchor, employment and output will not move on a stable path. the economy must have a nominal anchor. this is the task of monetary policy. the norwegian economy was without a nominal anchor under the policy of low interest rates and devaluations in the 1970s and 1980s. the fixed exchange rate regime, which was introduced in 1986, reinstated monetary policy as an instrument of economic policy in norway and laid the foundation for more stable economic developments. with the free flow of capital, deep capital markets and the phasing in of petroleum revenues into the norwegian economy, inflation targeting is the appropriate regime for setting interest rates. the most important monetary policy instrument today is the interest rate on banks ’ deposits with norges bank. the banks can also borrow from norges bank. since the banks combined have net deposits in norges bank, the interest rate on banks ’ deposits with norges bank is the banks ’ marginal deposit rate. the rate forms a floor of the corridor for short - term money market rates and influences bank rates. the interest rate on banks ’ deposits with norges bank is thus norges bank ’ s key rate. norges bank ’ s system for managing interest rates is described in kran and øvre ( 2001 ). let us make a stylised review of what happens if the central bank raises the key interest rate. higher interest rates make it more attractive to take krone positions and borrow in foreign currency. as a result, higher interest rates normally lead to an appreciation of the krone. this reduces prices for imported goods. we call this the exchange rate