economic resources. the challenge to monetary policy is how the interest rate should be set ahead in order to prevent disturbances both to inflation and economic growth. as a general rule, central banks influence the shortest money market rates via the policy rate. however, economic agents ’ consumption and investment decisions depend more on their interest rate expectations. hence, monetary policy functions primarily by influencing expectations regarding future interest rates. economic agents therefore need to understand the central bank ’ s intentions in its interest - rate setting. in the november 2005 inflation report, norges bank published its own forecast for the interest rate for the first time. the aim is to enhance the predictability of monetary policy. with a predictable monetary policy, market participants can react to new information in a way that contributes to stabilising developments in output and inflation. norges bank ’ s interest rate forecast is based on seeking to achieve an interest rate path that provides a reasonable balance between the objective of stabilising inflation at target and the objective of stabilising developments in output and employment within a reasonable time horizon, normally 1 - 3 years. interest - rate setting is also assessed in the light of developments in property prices and credit. norges bank forecasts inflation, output and the interest rate simultaneously. there is considerable uncertainty associated with the estimates of capacity utilisation in the economy ( the output gap ), and there is no simple relationship between developments in capacity utilisation and developments in inflation. it cannot therefore be argued with great conviction that it is possible to identify one particular interest rate forecast that provides the indisputably " best " trade - off in monetary policy. more often than not, there will be a number of possible interest rate paths that might be said to provide a reasonable balance, in view of the uncertainty involved. the results of balancing this trade - off are published in the inflation report in the form of a chart that presents central projections for the interest rate, the exchange rate, inflation and capacity utilisation in the economy. the formulation of a precise inflation target, our projection for the interest rate 3 - 4 years ahead and our desire to achieve a balance between output and inflation stability may perhaps give an impression of excessive optimism with respect to managing the economy and invite a repeat of earlier attempts to fine - tune the economy. but it is important to bear in mind the lessons drawn from the 1970s and 1980s, i. e. high stabilisation policy ambitions may lead to wide fluctuations in the economy, with high and variable inflation

##rone and lower wage growth contributed to boosting activity in manufacturing industry. profitability has improved for mainland enterprises. mainland fixed investment has also gradually increased. thus, it may appear that growth in the norwegian economy has become more self - driven. even with a pronounced upswing in output, the increase in the number employed has been limited so far in this cyclical upturn. measured in terms of the number of person - hours worked, however, employment growth was high last year. registered unemployment has shown a small decline over the past year. productivity probably increased more than normally in some industries in the early phase of the recovery. a marked fall in sickness absence may have reduced the need for new employees. capacity utilisation in the norwegian economy has increased, notwithstanding the decline in sickness absence and efficiency gains in the business sector. the output gap is a measure of capacity utilisation in the economy. we interpret a positive output gap to mean that output and capacity utilisation are higher than the level consistent with stable inflation over time. high domestic interest rates in 2002 and fiscal policy management contributed to substantially lower cost inflation in the private and public sectors over the past two years. monetary policy easing through 2003 and the beginning of 2004, and low interest rates in 2004 brought capacity utilisation up to a normal level. the norwegian economy seems to have experienced a fairly soft landing after a period of weak cyclical developments in the international economy and high domestic wage and cost inflation. there are nevertheless some clouds on the horizon. in spite of solid growth in the us economy last year and in the first quarter of this year and continued expansion in china, developments in the euro area are sluggish – unemployment remains high and consumer confidence is falling. there are substantial trade and balance - of - payments imbalances in the world economy. the deficit in the us is matched by surpluses in other countries, particularly in asia. strong demand in the us has underpinned growth in the world economy. increased imbalances generate uncertainty as to economic developments in many countries. moreover, high oil prices may curb international growth. communication and implementation of monetary policy interest rate developments in other countries have been an important factor behind interest - rate setting in norway. weak growth in the world economy in autumn 2002 and into 2003 led to lower international interest rates, which remained low for a considerably longer period than expected, as illustrated by actual and expected interest rate developments in the us. combined with developments in international equity markets and the risk