on imports, while lower demand will reduce the general inflation level. over time both the inflation rate and the activity level will influence the exchange rate. thus, norges bank needs to exercise discretion in monetary policy by considering the effects of interest rate changes not only directly on the exchange rate, but also on the rest of the economy, and to focus on the fundamental conditions for exchange rate stability over time. chart 10 how interest rates affect the economy exchange rate nbs interest rates • market interest rates • lending and deposit rates • demand & production • loans, investment, share prices • wages and prices • external balance legg inn filadresse her 8. exercising discretion in monetary policy the mandate stipulates the objective of monetary policy, but norges bank has to choose how to achieve the objective. as shown, the krone exchange rate has fluctuated in recent years in spite of norges bank ’ s active use of instruments, indicating that norges bank cannot fine - tune movements in the krone exchange rate. the exchange rate will also in the future be influenced by factors that are not under the control of norges bank, like fluctuations in international financial markets, the evolution of the price of oil, fiscal policy, and developments in domestic prices and costs. thus, in its use of the interest rate norges bank focuses on the preconditions for stability of the krone exchange rate over time. the interest rate affects the exchange rate directly through returns on holding kroner, but also indirectly through the effects of the interest rate on inflation and output. more specifically, stability of the exchange rate requires that : • price and cost inflation must be brought down to the level aimed at by euro countries. • monetary policy must not in itself contribute to deflationary recessions, as this would undermine confidence in the krone. let me explain in more detail. suppose that price and cost inflation in norway were allowed to be higher than in the euro countries. the nominal exchange rate would then have to depreciate in order to keep the real exchange rate constant over time. thus, stabilising inflation at around the level aimed at by the ecb is a means of achieving exchange rate stability against the euro. in a situation with the prospect of increased inflationary pressure and a depreciating exchange rate, an increase in the interest rate may at the same time bring the exchange rate back towards its initial range and reduce inflationary pressure through lower demand and lower imported goods inflation.

not tell us the absolute dollar amount of price gaps between the two countries. to assess the price - gap level, we use information about the prices of specific goods in both countries gathered from an informal internet survey conducted by bank of canada staff. we record the prices of a list of identical goods in canada and the united states at the same retail outlet. u. s. dollar prices are converted into canadian dollars using the bilateral exchange rate for that day. using these two sources of information, the bank of canada ’ s best estimate is that the canada - u. s. retail consumer - goods price differential was 11 per cent in september, down from 18 per cent in april. in other words, prices of a set of comparable goods in canada are an average of 11 per cent higher than the prices of these same goods in the united states. i caution that these are estimates and there is some uncertainty around them. an important question is why has the gap not narrowed more for similar goods, given the increase in the value of the canadian dollar. for your consideration, allow me to discuss bis central bankers ’ speeches some of the possible factors, both macroeconomic and structural, that influence the prices of goods and services in both countries. first, cyclical issues may be responsible for some differences between canadian and u. s. prices. unexpected economic weakness in one country could lead to an undesirable buildup of inventories and result in local discounting of prices. in addition, as long as markets are partially segmented across international borders, market power may enable firms to respond to local demand conditions — possibly resulting in lower prices in areas with weaker demand. secondly, from a macro perspective, prices take time to adjust. importantly, this is not only true in response to the exchange rate, but also to anything that changes the economic environment ( and this is why there are lags in the effect of monetary policy ). in addition to the macro elements, there are structural factors, including profit margins and underlying costs, that influence the prices of goods and services and that can also contribute to the gap in prices in canada and the united states. operating profit margins for both the wholesale and retail sectors will have an impact on the prices of consumer goods in retail outlets. one possible reason that margins have remained elevated in canada may be that the retail environment is more concentrated in canada than in the united states. in canada, the top four retailers have a 28 per cent market share, compared with only 12 per cent