svein gjedrem : monetary policy and the outlook for the norwegian economy speech by mr svein gjedrem, governor of norges bank ( central bank of norway ), to the mid - norway chamber of commerce and industry, trondheim, 13 november 2003. the speech is based on the assessments presented at norges bank ’ s press conference following the monetary policy meeting on 29 october, norges bank ’ s inflation report 3 / 03, the report on monetary policy 2003 - the first eight months and on previous speeches. the text below may differ slightly from the actual presentation. the charts in pdf can be found on the norges bank ’ s website. * * * i would like to thank the mid - norway chamber of commerce and industry for inviting me to speak to you today on monetary policy and the outlook for the norwegian economy. the operational target of monetary policy as defined by the government is inflation of close to 2. 5 per cent over time. it is equally important to avoid an inflation rate that is too low as it is to avoid an inflation rate that is too high. the inflation target provides economic agents with an anchor for their decisions concerning saving, investment, budgets and wages. the inflation target also provides a framework for monetary policy ’ s contribution to stabilising output and employment. this intention is also expressed in the regulation on monetary policy. normally, norges bank sets the interest rate with a view to achieving inflation of 2½ per cent at the two - year horizon. however, it would in general have been possible to attain the inflation target in the nearer term by changing the interest rate more rapidly and more markedly. hence, in norges bank ’ s conduct of monetary policy, emphasis is given to variability in both output and inflation. this is called flexible inflation targeting. the impact of monetary policy occurs with a lag. the current inflation rate does not therefore provide sufficient information to determine the level at which interest rates should be set now. our analyses indicate that a substantial share of the effects of an interest rate change will occur within two years. the choice of a two - year horizon is thus based on striking a balance between inflation stability and output stability and on a perception of how interest rates influence the path of inflation and output. activity in the economy moves in waves. this variability can be described by developments in what is known as the output gap. the output gap shows capacity utilisation in the mainland economy measured as the difference between actual gdp and the level indicated

plans as their preferred loss - mitigation technique. under these plans, delinquent borrowers typically repay the mortgage arrears over a few months in addition to making their regularly scheduled mortgage payments. these plans often are most appropriate if the borrower has suffered a reversible setback, such as a temporary illness. however, anecdotal evidence suggests that even in the best - case scenarios, borrowers given repayment plans redefault at a high rate, especially when the arrears are large. loan modifications, which involve any permanent change to the terms of the mortgage contract, may be preferred when the higher payments associated with a repayment plan do not result in a sustainable solution. in a loan modification, the borrower's monthly payment is reduced through a lower interest rate, an extension of the maturity of the loan, a write - down of the principal balance, or a combination of all three of these measures. the effort by the hope now alliance to freeze interest rates at the introductory rate for five years for eligible borrowers with an adjustable - rate mortgage is an example of a modification, in this case applied to a class of borrowers. to date, permanent modifications in this credit cycle episode, as in the past, have typically involved a reduction in the interest rate or an extension of the loan terms, while reductions of principal balance have been quite rare. but the current housing difficulties differ from those in the past, largely because of the pervasiveness of situations known as negative equity positions in which the amount owed on the mortgage exceeds the current market value of the property. a distressed borrower with a negative equity position may have neither the means nor the incentive to remain in the home. in this environment, servicers and investors may well find principal reductions that restore some equity for at - risk homeowners to be an effective means of avoiding delinquency and foreclosure. although principal write - downs may be especially germane today given the prevalence of negative equity positions, they are not necessary or appropriate for all borrowers who have negative home equity or who become delinquent on their mortgage. on the contrary, a strategy of targeting write - downs to certain groups of borrowers may provide the best path forward. for example, one possibility would be to limit the availability of write - downs to those borrowers with high debt payment - to - income ratios and loan - to - value ratios significantly in excess of 100 percent before loan modification