shortage of labour and other economic resources, a tight monetary policy stance will reduce inflation by affecting aggregate demand. conversely, when unemployment is high, low interest rates will stimulate demand and contribute to stable wages and prices. a monetary policy stance that is aimed at stabilising inflation will thus also contribute to stabilising aggregate output and employment. the time it takes for a change in interest rates to affect demand and inflation will vary. our analyses indicate that an interest rate increase of 1 percentage point over two years reduced mainland gdp by ¾ - 1 percentage point after two years. the effect is thereafter reversed. 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. we have taken into account that an interest rate change will affect the krone exchange rate. it is assumed that monetary policy credibility remains intact. developments in the krone exchange rate have a considerable impact on inflation in a small economy such as norway. our analyses, which are based on relationships in the norwegian economy over the past 20 - 30 years, indicate that it takes some time for the effects of a lasting change in the exchange rate to pass through to consumer price inflation. the effect seems to be strongest the second year and then shows a gradual decline. a sustained appreciation of the effective krone exchange rate of 5 % could reduce the rise in consumer prices by a quarter percentage point the first year, by close to half a percentage point the second year and about a quarter percentage point the third year. our analyses indicate that a sustained increase in wage growth of 1 percentage point will, in isolation, push up consumer price inflation by a quarter percentage point the first year and half a percentage point the second year. 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 % with unchanged interest rates, the interest rate will be increased. if it appears that inflation will be lower than 2½ % with unchanged interest rates, the interest rate will be reduced. this orientation of monetary policy will normally also contribute to stabilising output and employment. the impact of monetary policy occurs with long and variable lags. our analyses indicate that a substantial share of the effects occurs within two years. a time horizon of two years when setting interest rates allows monetary policy to contribute to stabilising production. this horizon prevents monetary policy in itself from causing unnecessary fluctuations in the economy.

øystein olsen : economic perspectives annual address by mr øystein olsen, governor of the norges bank ( central bank of norway ), to the supervisory council of norges bank and invited guests, oslo, 14 february 2014. * * * accompanying charts can be found at the end of the speech. introduction this year is the bicentenary of the signing of the constitution of norway. two hundred years ago, norway was a poor country on the periphery of a europe that was then the world ’ s economic centre of gravity. thomas robert malthus, one of the foremost experts of his time in the field of demography, toured norway in 1799. in his travel diary, malthus describes an agricultural society where most people lived a simple life subsisting on a diet of whatever they were able to harvest. wealthy norwegians, on the other hand, complained about how expensive it was to maintain a respectable lifestyle when everything had to be imported. 1 the napoleonic wars brought harsh economic realities. blockades, epidemics and crop failures took their toll on the population. large parts of southern norway experienced severe famine in 1809 and again in 1813. population numbers fell. the timber trade and shipping industry showed a marked contraction. chart 1 : inflation in norway king fredrik vi financed public expenditure by printing money. combined with goods shortages, the result was hyperinflation and failing confidence in the monetary system. the level of prices rose more than twentyfold in the period from 1806 to 18132, and in 1813 the currency was devalued by almost 90 percent. the first national assembly at eidsvoll was attended by representatives of a nation in deprivation. for the 112 sworn representatives, popularly known as the men of eidsvoll, who took their places as the constituent assembly in spring 1814, the atmosphere was nonetheless full of hope for freedom and a better future. several of them had spent time abroad and had been influenced by the enlightenment philosophers and by the american and french revolutions. the norwegian constitution was inspired by the thoughts and ideas they brought home with them. absolute monarchy under the danish king was to be replaced by the sovereignty of the people and the separation of powers. institutions with clearly distinguished roles would prevent the arbitrary use of power and foster confidence. this evening we are gathered in one such institution. in the discussion at eidsvoll, christian magnus falsen, a key member of the constituent assembly, said that no state can exist without a well functioning monetary system. another prominent