in the short and medium term. nemo is an empirical model, that is to say it is estimated on norwegian data. nemo can help us provide economic interpretations of observed developments. changes in key variables such as gdp and inflation can be explained by factors such as productivity, competitiveness in labour and product markets and the propensity to save. in that respect, nemo is quite different from the “ weather forecasting models ” i cited earlier, which provide little scope for interpretations based on economic theory. chart : effect of monetary policy shocks in the var models and in nemo as indicated by the red line in the chart, nemo provides a description of monetary policy that is broadly consistent with that derived from the var models9. in nemo, an unexpected interest rate increase of 1 percentage point implies, in isolation, a decline in gdp of around 0. 4 per cent around one year later. inflation is reduced by about ¼ percentage point with a lag of around two years. compared with the var models, nemo is in the upper part of the area for gdp and in the lower part for inflation. nemo is estimated from the mid - 1990s and the results are also close to those derived from the var models that are estimated over the same time period. a model will never be able to provide an exact indication of how the interest rate should be set. the ultimate assessment is, as mentioned, a result of norges bank ’ s professional the estimation is based on a one percentage point increase in the interest rate, followed by a gradual reduction in line with the response pattern in the model. the analysis shows the impact of the interest rate increase on mainland gdp for norway and inflation adjusted for tax changes and excluding energy products ( cpi - ate ). bis central bankers ’ speeches judgement and will also capture considerations that are not sufficiently safeguarded by our models. as such, the models are only a tool. but, a model such as nemo is a very useful tool for analysing developments and in interest rate setting. it helps us interpret and understand the dynamics of the norwegian economy. the model apparatus is continually being developed. among other things, we are exploring how financial markets and the linkage to the real estate market can be incorporated into such a model. norges bank ’ s response pattern expresses the assessments we make and how we set the interest rate to attain our objectives. we must use professional judgement and our experience of how the norwegian economy functions. we attempt to incorporate

low interest rates made it possible for us to make use of the potential for higher consumption and investment. there are now signs that price and wage inflation is on the increase. higher food and energy prices are fuelling inflation in other countries. thus, we cannot assume that prices for imported goods will continue to fall. moreover, domestic productivity does not seem to be improving as quickly as earlier. the rise in prices is therefore likely to quicken for goods and services produced in norway. since summer 2005, the key policy rate has gradually been raised again to a more normal level in order to prevent inflation from becoming too high. as mentioned, external interest rates are again moving down and the interest rate differential against other countries has widened recently. this may lead to a stronger krone, but there are also opposing forces in the foreign exchange market. in the long run, the krone exchange rate is determined by changes in the terms of trade and permanent differences between domestic and external inflation and productivity. but the krone exchange rate also shows monthly and yearly fluctuations. the krone was strong towards the end of the previous cyclical expansion, but depreciated when interest rates declined in 2003. thereafter, the krone appreciated again as growth in the norwegian economy recovered. over the past two years, the krone has appreciated by close to 5 per cent. inflation has nevertheless picked up and is now fairly close to 2½ per cent. 3 norges bank uses different measures of underlying inflation. in january, the twelve - month rise in the cpi - ate was 1. 9 per cent, a weighted median showed a rise of 2. 4 per cent and a trimmed mean 2. 9 per cent. the twelve - month rise in the cpi was 3. 7 per cent following a sharp increase in energy prices. the sizeable basic balance deficit may result in a renewed depreciation of the krone. if the bleak prospects for the world economy translate into lower prices for oil and other export goods, this may also lead to a depreciation of the krone. we have already observed that investors sell nok in periods of turbulence. if the krone depreciates, the interest rate will then have to be set higher to keep inflation at bay unless a slowdown in activity has a dampening impact on inflation. the opening of the labour market to the new eu countries has provided us with access to a reserve of labour. there has been a substantial flow of labour into norway. labour migrates