svein gjedrem : on monetary policy and the krone speech by mr svein gjedrem, governor of norges bank ( central bank of norway ), to industrinettverket sunnhordland, stord, 7 june 2004. the text below may differ slightly from the actual presentation. the address is based on the assessments presented at norges bank ’ s press conference following the executive board ’ s monetary policy meeting on 26 may, inflation report 1 / 04 and on previous speeches. the charts in pdf - format can be found on the norges bank ’ s website. * * * the primary objective of monetary policy is to ensure nominal stability. there were wide fluctuations in the norwegian economy in the 1970s and 1980s. economic developments were marked by high and variable inflation. inflation rose gradually and it took a long time before it fell. the absence of a nominal anchor was one of the main reasons behind these pronounced swings in the norwegian economy. with a policy of low interest rates and devaluations, inflation took root. nominal interest rates were kept at a low level even though inflation and the value of tax - deductible interest expenses rose. frequent devaluations from 1976 were unable in the long term to prevent a decline in the manufacturing sector. on the contrary, they proved to be self - reinforcing. the wide fluctuations culminated in a credit boom in the mid - 1980s, and a rise in costs as a consequence of the spring 1986 wage settlement. a pronounced downturn and high unemployment followed at the end of the 1980s. in order to achieve nominal stability, monetary policy must provide a nominal anchor. since the second world war, there have been several monetary policy reforms in norway. in the period between 1972 and 1986, monetary policy was to a limited extent focused on stabilising the rise in prices. during this period, inflation was high and variable. consumer prices in norway rose almost twice as much as in germany. at the same time, the value of the norwegian krone against the german mark was almost halved, contributing to high imported inflation. from the mid - 1980s, during and after the credit bubble and the cost shock, it was recognised that a substantial revision of economic policy would be necessary and that the problems created by inflation had to be taken seriously. from 1986 to 1992, norway operated a fixed exchange rate regime. the fixed exchange rate was the anchor for inflation in norway. the difference between inflation in norway and

germany narrowed substantially. deteriorating competitiveness due to high wage growth would no longer be remedied by means of devaluations. substantial emphasis was placed on the importance of wage formation for developments in employment. only when wage growth dropped below the level of our trading partners did unemployment begin to fall and the manufacturing sector began to pick up. thus, the fixed exchange rate policy was not introduced in order to strengthen the internationally exposed business sector. on the contrary, it was a breach in the approach whereby monetary policy and frequent devaluations had been used to shelter these sectors. the fixed exchange rate was an intermediate target for achieving low and stable inflation. the exchange rate remained stable up to autumn 1996, partly because wage growth was low and overall demand did not generate pressures in the economy. gradually, the krone began to show wider fluctuations. the experience of the last half of the 1990s demonstrated that monetary policy cannot fine - tune the exchange rate. developments in international financial markets led to more pronounced fluctuations. and more fundamentally, when labour market pressures rose and incomes policy failed, exchange rate developments no longer provided signals for wage formation and fiscal policy. high petroleum revenues, fiscal slippage and expectations of increased use of petroleum revenues contributed to this. the exchange rate was therefore no longer suitable as a nominal anchor. towards the end of the 1990s, increased emphasis was placed on the fundamental preconditions for exchange rate stability. monetary policy instruments were oriented with a view to bringing price and cost inflation down towards the price stability objective of the european central bank ( ecb ). monetary policy in most countries, price stability, or low and stable inflation, is the objective of monetary policy. historical experience from norway and other countries has shown that the absence of price stability has resulted in unstable output and employment. history shows that higher growth cannot ultimately be achieved in exchange for higher inflation. an economic policy that fuels inflation does not generate higher economic growth. on the contrary, it paves the way for subsequent recession and unemployment. after the second world war, there was a long period of trying to achieve price stability by means of various intermediate targets such as a fixed exchange rate and a target for growth in the money supply. the first explicit inflation target was introduced in new zealand in 1990. canada followed in 1991, the uk in 1992, and sweden and australia in 1993. inflation targeting is now the norm in small and medium - sized open economies. denmark is an important exception. since the mid - 1980s, denmark has