the nominal exchange rate. the latter would be the least painful method, and with a flexible exchange rate, it is also the most probable. norges bank watch also raises the issue of how monetary policy should safeguard the objective of financial stability. the report emphasises that economic literature does not provide unequivocal recommendations as to whether or how this should be done. the report nevertheless expresses concern with regard to the rise in house prices and credit growth. the report notes that asset prices, and particularly house prices, can influence household and business saving and investment decisions, and thereby affect real economic developments. monetary policy can also influence developments in inflation, output and employment through its impact on asset prices. this description corresponds closely with our own understanding of how the economy functions. household debt has increased sharply since the mid - 1990s. at the same time, house prices have shown a marked increase. debt developments in the 1990s can probably be viewed to some extent as a delayed adaptation 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 now making a contribution. in countries that have had liberalised credit markets for a long time, denmark for example, where credit markets were liberalised over a hundred years ago, the household debt - to - income ratio is higher than in other countries. norwegian households have a high level of debt, but there are examples of countries where household debt is even higher when we compare norway with some of our trading partners. developments in growth in credit to households in norway nevertheless give cause for concern. we have examples showing that the subsequent effects of a period of unusually high house prices can persist for a very long time. at the end of the 1800s, house prices rose sharply in christiania ( now oslo ). the effects of the very high level of housing construction that resulted from the rise in prices are still perceptible in parts of oslo. at that time, the housing market collapsed. the market for new dwellings was saturated. real house prices did not revert to the 1899 level until the mid - 1980s. the rise in house prices has been high in norway in recent years, but not particularly high compared with other countries. we have limited scope for

2½ years after the cyclical change. inflation is still being restrained by the fall in prices for imported consumer goods, increased competition in a number of markets and the current period of lower nominal pay increases. 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 economies. low inflation is being accompanied by real income growth and a rise in production. it cannot be ruled out that small open economies are particularly vulnerable to fluctuations in international prices. deviations from the inflation target in norway are broadly in line with sweden and new zealand, but are larger than for example in the uk and canada. developments in recent years have also been influenced by the fairly large favourable disturbances to which the norwegian economy has been exposed. developments in norway ’ s terms of trade provide an illustration of this here. as consumers, we enjoy the benefits of falling prices for many imported goods. as a nation, we benefit from a fall in prices for the goods we import in relation to prices for the goods we export. norway ’ s terms of trade are improving. the impact of the rise in oil and gas prices is particularly strong – and the domestic economy is shielded to a certain extent through the oil fund mechanism – but there have also been terms - of - trade gains in the mainland economy. the situation in norway differs from that of our nordic neighbours. it should also be noted that the figures for the twelve - month rise in consumer prices are considerably more volatile in norway than in other countries. we see from the figures that consumer prices in norway, even when tax changes and energy products are excluded, are more volatile than indices in other countries where these products are included. low inflation is not the result of declining demand, activity or employment. in our conduct of monetary policy, we weigh the objective of stabilising inflation close to 2½ per cent over time against the objective of stable growth in output and employment. since inflation is low, we have chosen to keep the interest rate at a low level and have at times considered an even lower interest rate. however, as the norwegian economy has shown solid growth since summer 2003, we decided instead to use some time to bring inflation back to target. 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