on imports, while lower demand will reduce the general inflation level. over time both the inflation rate and the activity level will influence the exchange rate. thus, norges bank needs to exercise discretion in monetary policy by considering the effects of interest rate changes not only directly on the exchange rate, but also on the rest of the economy, and to focus on the fundamental conditions for exchange rate stability over time. chart 10 how interest rates affect the economy exchange rate nbs interest rates • market interest rates • lending and deposit rates • demand & production • loans, investment, share prices • wages and prices • external balance legg inn filadresse her 8. exercising discretion in monetary policy the mandate stipulates the objective of monetary policy, but norges bank has to choose how to achieve the objective. as shown, the krone exchange rate has fluctuated in recent years in spite of norges bank ’ s active use of instruments, indicating that norges bank cannot fine - tune movements in the krone exchange rate. the exchange rate will also in the future be influenced by factors that are not under the control of norges bank, like fluctuations in international financial markets, the evolution of the price of oil, fiscal policy, and developments in domestic prices and costs. thus, in its use of the interest rate norges bank focuses on the preconditions for stability of the krone exchange rate over time. the interest rate affects the exchange rate directly through returns on holding kroner, but also indirectly through the effects of the interest rate on inflation and output. more specifically, stability of the exchange rate requires that : • price and cost inflation must be brought down to the level aimed at by euro countries. • monetary policy must not in itself contribute to deflationary recessions, as this would undermine confidence in the krone. let me explain in more detail. suppose that price and cost inflation in norway were allowed to be higher than in the euro countries. the nominal exchange rate would then have to depreciate in order to keep the real exchange rate constant over time. thus, stabilising inflation at around the level aimed at by the ecb is a means of achieving exchange rate stability against the euro. in a situation with the prospect of increased inflationary pressure and a depreciating exchange rate, an increase in the interest rate may at the same time bring the exchange rate back towards its initial range and reduce inflationary pressure through lower demand and lower imported goods inflation.

years. on the basis of its analyses, norges bank does not find grounds for regarding this level as inappropriate. 9. how does the norwegian regime differ from inflation targeting? price stability is an important part of long - term exchange rate stability, and the setting of interest rates will often be the same whether the goal is exchange rate or inflation targeting. however, norwegian monetary policy differs in some respects from monetary policy in countries with an inflation target. • norway has a long tradition of cooperation between the political authorities and social partners. income and wage determination is fairly centralised, and the social partners evaluate the effects of wage outcomes on employment. • in a number of countries that have switched to a monetary policy regime based on inflation targeting, fiscal policy is oriented towards reducing government debt and deficits. a passive fiscal policy implies that in practice monetary policy assumes a greater role in stabilising the economy. in norway fiscal policy has an important role in demand management. the fulfilment of this task is facilitated by the fact that the norwegian government has greater financial leeway than most other countries due to its oil revenues. fiscal policy has been fairly well adapted to the economic situation over the last decade. the active role it has played in demand management has functioned as an anchor for fiscal discipline. the government petroleum fund is meant to be a buffer against changes in the terms of trade. in other countries this role must be filled by the exchange rate. chart 12 how does the norwegian regime differ from inflation targeting? • co - operation : – tradition of co - operation between political authorities and social partners – wage - setting considering employment effects • fiscal policy : – fiscal policy has financial leeway for stabilisation policy – petroleum fund buffer against terms of trade variability, not the exchange rate • monetary policy : – different formulation of target – different institutional setting legg inn filadresse her • monetary policy in norway is oriented towards stability of the exchange rate and not an explicit inflation target. the setting of interest rates will more or less be the same. norges bank focuses on keeping a low rate of inflation and on avoiding a situation in which monetary policy in itself contributes to a recession that may threaten the fundamental conditions for stability of the krone. • the institutional set - up for monetary policy in norway is different. in a country with inflation targeting, the central bank will inform the political authorities if the inflation target is not met. in norway, norges bank will inform the authorities that measures other than those available