svein gjedrem : monetary policy and the economic situation speech by mr svein gjedrem, governor of the central bank of norway, at a meeting of the troms fish farming association, harstad, 13 march 2003. the address is based on the assessments presented at norges bank ’ s press conference following the executive board ’ s monetary policy meeting on 5 march and on previous speeches. please note that the text below may differ slightly from the actual presentation. the charts in pdf can be found on the norges bank ’ s website. * * * the operational target of monetary policy as defined by the government is inflation of close to 2½ per cent over time. norges bank sets the interest rate so that future inflation will be equal to the inflation target of 2½ per cent. interest rates were reduced this winter in response to the change in the inflation outlook. the inflation projections were revised downwards as a result of weaker cyclical developments in the world economy, a sharp drop in interest rates internationally and a strong krone. in addition, the norwegian business sector is feeling the effects of the high norwegian cost level. moreover, growth in domestic demand has slowed. household purchasing power has been reduced as a result of higher electricity prices. the weak prospects at home and abroad are in turn having an impact on the norwegian labour market and the outlook for wage growth and inflation in the years ahead. the inflation target provides economic agents with an anchor for their decisions concerning saving, investment, budgets and wages. households, businesses, public entities, employees and employers can base decisions on the assumption that inflation in norway will be 2½ per cent over time. high demand for goods and services and labour shortages normally point to higher inflation in the future. when interest rates are increased, demand falls and inflation is kept at bay. when demand is low and unemployment rises, inflation will tend to slow. interest rates will then be reduced. the inflation target is a vehicle for, not an obstacle to, monetary policy ’ s contribution to stabilising output and employment. this intention is also expressed in the regulation on monetary policy. the inflation target of 2½ per cent is broadly in line with the inflation targets of our trading partners. it is also an anchor for developments in the krone exchange rate. the krone fluctuates. we have open trade with other countries and free capital movements. we do not have the instruments to fine - tune the krone exchange rate. the krone has

been strong. as a result, prices for imported goods have fallen. this has led to low and stable inflation in spite of sharp wage growth. the krone exchange rate fluctuates. this is not surprising because other countries ’ currencies also fluctuate. the swedish krona, sterling and the new zealand dollar have fluctuated considerably in periods. the krone exchange rate is the price of our currency measured in terms of a foreign currency. developments in other countries are just as important for the krone as developments in the norwegian economy. capital flows freely and flows can change rapidly. this can spill over to exchange rates and interest rates as well as output and employment. currency swings are driven by cross - border capital movements. capital flows were heavily influenced by investor focus on stock market returns until the downturn began. in the us, equity prices almost trebled between 1995 and 2000. stock markets in other countries followed suit. the decline was amplified after the downturn in the global economy deepened as a result of terror and fears of war. investors sought to avert the risk in the stock market. capital inflows into the stock market resulted in a strong dollar. however, expectations concerning corporate earnings were higher than later proved to be warranted. when expectations were lowered, equity prices fell. demand for bonds increased, resulting in low long - term interest rates. in response to heightened uncertainty and fears of war, traditional safe havens for capital, such as the swiss franc and gold, have become increasingly attractive. the swiss franc appreciated after the terrorist attacks on 11 september 2001 and towards the end of last year. gold prices moved up sharply after un security council resolution 1441 was adopted in november last year. oil prices fell markedly after 11 september 2001, but have since risen. fears of war in iraq have increased the uncertainty surrounding global oil supplies. strategic oil reserves have risen, while private reserves are low. this has exerted upward pressure on oil prices. the strike in venezuela has also had an impact. the oil market is unstable. the extraordinary conditions in the oil market will not prevail indefinitely. major economies such as the us, germany and france are struggling with stagnation and fears of recession. substantial tax relief and low interest rates are holding up activity in the us. the japanese economy has been in a deflationary recession for a long period. in recent years, the krone exchange rate has shadowed the difference between norwegian and foreign short - term rates