what are the requirements we set for a macro model? first, it is of particular importance that the mechanisms in the model can be interpreted and communicated so that the model is perceived as a sound tool, both in the internal process and in the bank ’ s external communication. in the policy analysis, we also need a framework where the various disturbances can be interpreted and described. the importance of analysing risks also means that we must be able to change the various model mechanisms in a straightforward way. moreover, the model must reflect the lessons that led to a paradigm shift in economic policy. expectations must therefore play an explicit role in the model. the model must reflect that inflation is a monetary phenomenon in the long term and that monetary policy provides the economy with a nominal anchor. norges bank ’ s macro models have played a key role in forecasting work over many years. the models satisfy many of the requirements for a sound model, but the introduction of inflation targeting revealed new needs that these models were not designed to meet. developments in economics and computational technology have also provided new possibilities for constructing and solving macroeconomic models. norges bank has therefore started work on developing a new macro model. an important purpose of constructing a new model is to expand our tool kit so that we are better equipped to conduct policy analyses. i would therefore like to devote some attention to this model here, also because it may help explain our thinking as to the functioning of the economy. we have called the new macro model “ norwegian economy model ”, or abbreviated “ nemo ”. in the work on developing the model, we have benefited greatly from our close cooperation with the imf and the federal reserve bank of new york. we have also been inspired by and learned from the work of a number of other central banks, for example in the uk, sweden and canada. in addition, we have the benefit of a long history of model - building in norway. nemo belongs to a class of macroeconomic models that tends to be referred to as dsge models, which stands for “ dynamic stochastic general equilibrium ”. the term dynamic means that the entire path from the short term to the long term is modelled. the model is stochastic in the sense that the economy is exposed to random disturbances. such disturbances can, for example, stem from a change in preferences, technology and market structure. general equilibrium implies that supply equals demand at all times in all markets, but there may be considerable temporary deviations from the

war for several different measures of inflation. they were all at or very close to 3 % a year. no - one in cambridge at that time – and certainly not the students that were to become part of the inflation generation – heeded the late richard kahn ’ s warning that creeping inflation was about to accelerate. the rest, as they say, is monetary history. i would like those of you revising for your final exams this month to be able to look back in thirty years time and recall that the year in which you graduated was when we finally laid to rest the idea that the uk was an inflation - prone economy. inflation was the norm for most of my adult life. it should not be in yours. why then, you may ask, do we need to build a constituency for low inflation? there are two reasons. first, it is important that support for low inflation not wane as the experience of high and unstable inflation of the past recedes. it would be a counsel of despair to believe that the inflationary excesses of the recent past would have to be repeated in order to retain support for low inflation. yet, in a recent survey of households in germany, robert shiller2 found that support for stability was much higher among those who had experienced hyperinflation. of those born before 1940 as many as 90 % agreed with the statement that “ the control of inflation is one of the most important missions of german economic policy ”, whereas only 51 % of those born after 1950 agreed with the statement. those who value health most are often those who have experienced sickness. there is a lesson here. the past decade has been good for central banks and central bankers. but that success should not blind us to the realisation that if public acceptance of price stability is based on no more than recent experience of the opposite, then the democratic legitimacy of central banks requires a more solid foundation. so how can we build the constituency for low inflation? openness and transparency of the mpc, and explanations of our actions, are an essential part of our task. but we can do more. over the past few months i have been chairing a working party in the bank designed to answer the question of how we can build the constituency for low inflation. we have been exploring possible educational initiatives to increase public understanding of the benefits of monetary stability. and we have also been considering the way in which public opinion polls might be used to tell us about the degree of public understanding of the inflation target