svein gjedrem : current monetary policy issues in norway speech by mr svein gjedrem, governor of norges bank, at the general meeting of aci norway, held in tromsø, on 19 august 2000. * * * introduction i would like to start by expressing my thanks for being given the opportunity to give this presentation of monetary policy in norway. i will start my presentation with a brief review of the basis for monetary policy, and will go on to mention some of the considerations and reasoning behind norges bank ’ s recent setting of interest rates. finally, i will turn to certain structural features of particular importance to developments in the capital account balance which can shed light on the relationship between the setting of interest rates in norway and international interest rate developments. the basis for monetary policy the chart shows movements in the krone exchange rate between 1980 and the present. there have been three major crossroads since 1986. chart 1 krone exchange rate • following the last devaluation in may 1986, the norwegian authorities decided to introduce a fixed exchange rate system for the krone. the monetary policy authorities bound themselves to the mast. under this system, the interest rate was to be set solely with the aim of maintaining exchange rate stability within narrow margins. at the same time, the krone was supported through extensive exchange - market interventions. the fixed exchange rate system led to a gradual slowing of price inflation. a counter - cyclical fiscal policy also helped reinforce the credibility of the choice of monetary policy regime, since unemployment in this period was lower than would otherwise have been the case. • in december 1992, the fixed exchange rate system had to be abandoned following a sustained period of unrest and extensive speculation in european exchange markets. after this the krone remained stable for several years without any significant changes to norges bank ’ s policy response pattern. the stability of the krone during this period was largely due to the norwegian economy entering a period of balanced growth. fiscal policy was well suited to economic developments, while wage inflation was moderate and oil prices were relatively stable. the monetary policy instruments merely accompanied these developments. chart 2 daily variation in the krone exchange rate nok per ecu / eur daily variation in the krone exchange rates against ecu / eur. percent • from late 1996 the krone became less stable : the value of the krone fluctuated substantially, despite more active use of monetary policy instruments to dampen the fluctuations. this period saw high levels of

##r in one month the corresponding bell for the exchange rate between the euro and the us dollar indicates that there is considerable uncertainty surrounding the future exchange rate between the two currencies. since autumn 1999 this uncertainty has mounted, while at the same time the euro is expected to fall against the us dollar. chart 9 gdp mainland norway projections for 2000 from inflation reports december 1998 to june 2000 the assessment of the economic outlook has changed over the past 18 months. a year and a half ago ( in the march and june 1999 inflation reports ) we forecast a period of slower growth in the mainland economy. we were uncertain as to how long it would take for the decline to be reversed. the basis for these projections was high cost increases peculiar to norway following the 1998 wage settlement, together with low international demand in the wake of the asian crisis, low oil prices, sluggish price trends for other norwegian export goods, and major restructuring in key manufacturing sectors. we assumed that there was a relatively high risk of a major recession. the greatest uncertainty with regard to setting interest rates was linked to developments in the sheltered sector, where price and cost pressures remained strong. a relatively tight central government budget for 1999 laid the foundations for curbing growth in the sheltered sector. on the basis of these analyses and the approved government budget for 1999, norges bank announced that it would be easing its monetary policy stance. the key rates were lowered in five stages by a total of 2. 5 percentage points in the course of the first nine months of 1999. this helped stabilise the norwegian economy, and hence the krone. the outlook for the global economy and the norwegian economy improved unexpectedly quickly. it now appears that the period of slower growth in the norwegian economy was in fact over by summer 1999. the upswing in the global economy spread to the norwegian economy through strong export growth and higher prices for norwegian exports. at the same time, demand in the sheltered sector remained buoyant. there was also slippage in government budget spending allocations throughout 1999. private consumption continues to rise, fixed investment is increasing in service sectors, and unemployment remains low. the decline in petroleum investment is necessitating restructuring and lower production levels in some norwegian manufacturing sectors. developments so far indicate that this turnaround has been offset by continued high employment growth in the public sector, private services and non - petroleum - related manufacturing. chart 10 wage shares by industry labour costs as a percentage of factor income however, enterprises ’ financial position is vulnerable.