generally result in substantially higher stability in inflation and output than a two - year horizon. in some cases, however, it may be appropriate to change the horizon. in situations where the central bank ’ s forecasts indicate that substantial imbalances in the real economy would arise if the interest rate was set so that the inflation forecast two years ahead was the same as the target, it might be appropriate to apply a somewhat longer time horizon. the same may be the case if financial stability is at risk. the entire path for inflation and the real economy, both before and after the two years, will be taken into account when setting interest rates. there are two reasons for this. first, there may be several paths that result in inflation of 2. 5 per cent at the two - year horizon, and developments after the twoyear period may be important to the choice of path. second, the entire path will be considered when assessing whether there are grounds for changing the horizon. we have also begun providing projections for a three - year period in the inflation report. if extraordinary conditions prompt norges bank to apply a different time horizon than two years, the bank will provide a clarification of this. however, confidence and credibility in the conduct of monetary policy are necessary before taking such additional considerations into account. the greater the confidence in the inflation target, the larger the scope for stabilising the real economy. a rapid and pronounced change in the interest rate may be appropriate in cases where there is a risk that inflation might deviate considerably from the target over a longer period, so that inflation expectations might be affected or where heightened turbulence in financial markets or a cost - push shock resulting from wage negotiations indicates that confidence in monetary policy is in jeopardy. in norges bank ’ s inflation report, we present our forecasts for both inflation and the output gap in the same chart. the reason for this is that we want to be as transparent as possible concerning the tradeoffs made in our conduct of monetary policy. transparency enhances confidence in and the understanding of monetary policy. this has been well received internationally, cf. the following quote see for example smets, f. ( 2000 ) : “ what horizon for price stability ”, ecb working paper nr. 24, july 2000 and svensson, l. ( 1997 ), “ inflation forecast targeting : implementing and monitoring inflation targets ”, european economic review, 41, 6, side 1111 - 1146. from a presentation by professor lars svensson at

and employment are given emphasis. since inflation is a monetary phenomenon over time, the level of the inflation target may be chosen by the authorities. a target for output, however, cannot be chosen in the same way. the economy grows over time. this is a result of positive productivity growth and population growth. the level of output that is consistent with stable inflation over time is discussed in economic theory as potential output. the level of potential output cannot be influenced by monetary policy. when the economy grows more rapidly than this level, inflationary pressures will build up in the economy. when the inflation rate becomes high and unstable, self - regulating mechanisms will tend to curb growth. experience shows that periods of high inflation are followed by periods of contraction. over time, it will be impossible to maintain output at a level that is higher than the potential output level. monetary policy ’ s contribution to stabilising output will therefore be to curb fluctuations around the potential output level. the potential output level cannot, however, be observed. it is also difficult to capture changes in productivity and technology. one approach to measuring the level of potential output may be to calculate trend output, which entails a smoothing of historical gdp figures. norges bank bases its calculations of trend growth on an hp filter ( hodrick prescott filter ), but also takes into account other factors such as structural changes or changes in the number of vacation days. our assessment of the volatility of trend growth is also a matter of discretionary judgement. 5 the output gap measures the deviation in output from the level of potential output. there are various methods for estimating the output gap. statistics norway, like norges bank, uses the hp filter, but bases its calculations on quarterly figures for gdp. statistics norway ’ s calculations of the output gap are very similar to the calculations made by norges bank, with the exception perhaps of the last period, where statistics norway did not make adjustments for the increase in vacation days in 2001 and 2002. the oecd calculates the output gap by using the production function method, where trend levels for labour, capital and available technology are inserted into a specified production function. potential output is then determined by trend growth in factor inputs. the imf uses a number of methods, but has chosen to calculate the output gap for norway in approximately the same way as norges bank. as you can see from the chart, the different methods of calculation give roughly the same outcome. to cross - check the projections for potential output