profitability in the internationally exposed sector. it is important to be aware of the relationships between employment, output and inflation. if there is a 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 stimulate demand, which will 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. in the long term, monetary policy determines the average level of inflation. output is determined by the supply of labour, capital and technology and by productivity growth. attempts to increase output beyond the total capacity of the economy will lead to inflation in the long run. what monetary policy can do is to maintain stability without unnecessary fluctuations in output and employment. overall employment is also influenced by wage formation. if wages increase at an unsustainable pace, employment will decline and unemployment will gradually increase. monetary policy cannot prevent an increase in unemployment that is due to a wage - driven cost shock. when there is confidence that monetary policy will contribute to low and stable inflation over time, it can contribute in the short term - under certain conditions - to smoothing fluctuations in output and demand. in the short term, there is a trade - off between the objectives of inflation stability on the one hand, and output and employment stability on the other. an aggressive monetary policy will rapidly bring inflation to the target. this will cause wide fluctuations in the real economy. the interest rate can also be changed more gradually, which will have less impact on the real economy but cause more pronounced fluctuations in inflation. by influencing inflation over time, we can ensure that an overly aggressive monetary policy does not in itself cause unnecessary disturbances to the economy. the impact of monetary policy occurs with considerable and variable lags. our analyses indicate that a substantial share of the effects of an interest rate change will occur within two years. two years is thus a reasonable time horizon for achieving the inflation target. it is nevertheless conceivable that in a situation where a very high rate of inflation is accompanied by sluggish economic growth, norges bank may decide to apply a somewhat longer time horizon than two years to reach the inflation target of 2½ per cent. the choice of monetary policy time horizon reflects the fact that there are real economic costs associated with bringing inflation rapidly back to the target. this horizon is thus an indirect expression of the trade - off between the objectives of, on

inflation target. this indicates that the market previously assumed that in the long term price inflation in norway would be on a par with that in the euro area, i. e. around the ecb ’ s objective of less than 2 per cent rate of increase in prices. the members of norges bank ’ s executive board are collectively responsible for the bank ’ s decisions. the executive board meets every three weeks. at every second meeting, the executive board discusses monetary policy in depth. decisions regarding changes in the interest rate will normally be made at these monetary policy meetings. the executive board discusses the economic outlook at a separate meeting three weeks before the inflation report is presented. on the basis of preliminary projections for the report, the executive board assesses the outlook for inflation two years ahead and the uncertainty surrounding these projections. the following day, the executive board summarises its discussions and assesses the consequences for monetary policy for the next four months. this assessment constitutes an important internal reference when the executive board later makes a decision regarding the interest rate. it will also provide the basis for our external communication through speeches and the media. growth forecasts have been revised downwards as a result of the interest rate increase in july. gdp growth will pick up, but will remain below the growth potential next year. the internationally exposed sectors of the economy are moving on a different path from some sheltered industries. whereas private consumption is buoying demand growth, scaling back is expected in the manufacturing industry. frictional unemployment is expected to rise. high real wage growth is resulting in divergent developments between private and public consumption. a large share of the growth in public spending will go to covering higher labour costs in the central and local government sector. as a result there will be little scope for increased activity in the public sector, and instead high growth in private consumption. a time horizon of two years for interest rate setting allows monetary policy to contribute to stabilising production. this horizon prevents monetary policy in itself from causing unnecessary fluctuations in the economy. as an alternative, we could have sought to achieve the inflation target of 2½ per cent using a time horizon of six months to one year. we would then have had to reduce the interest rate sharply this summer. this would have amplified the pressures in the norwegian economy that are so clearly reflected in wage developments and household demand for loans. in all likelihood, this would have required marked interest rate increases one to one and a half years ahead. strict inflation targeting of this type would thus have