have become increasingly efficient in their use of resources, and the supply of labour has been ample. nevertheless, in the face of such strong external influences, smoothing developments in the norwegian economy is no easy task. government revenues include large net cash flows deriving from oil, which gives us an economic base that is not available to many other countries. the size of the cash flow from petroleum activities varies, however. and if petroleum revenues were to be spent as they accrue, the result would be wider fluctuations in the norwegian economy. petroleum revenue spending also has an impact on competitiveness in norwegian business and industry. extensive and uneven spending of petroleum revenues would have a negative impact on exposed industries. the particular challenges of petroleum revenues can be illustrated by looking at the basic relationship between aggregate production, consumption and relative prices. the potential production frontier shows alternative combinations for the production of sheltered goods and goods exposed to international competition when labour and capital are used efficiently. consumers prefer a combination of sheltered and traded goods. in equilibrium, the relative price of sheltered goods in terms of traded goods is the price that clears the markets. in this simple one - period model, the trade balance is zero. furthermore, the relative price is equal to the real exchange rate. introducing petroleum revenues, which can be seen as a cost - free foreign exchange gift, separates the consumption possibility frontier from potential production in mainland norway. consumers can increase their consumption of traded goods without producing more. however, with a higher income level, demand for sheltered goods also increases. in order to facilitate the transfer of resources, wages are bid up and prices for sheltered goods increase. consequently, the real exchange rate appreciates. the new equilibrium implies that consumption and production of sheltered goods have risen. production of traded goods has declined, while the consumption of these goods has increased due to the foreign exchange gift. structural changes – i. e. the transfer of resources from production of exposed to sheltered goods – are amplified when petroleum revenue spending increases substantially. and the challenges resulting from these structural changes would be amplified if petroleum revenue spending varied from one period to another. victor norman has described this mechanism and presented charts similar to the ones shown here in textbooks that have been widely used at norwegian universities and business schools since the early 1980s. this mechanism was also recognized at an early stage by the norwegian government. in 1974, in a report 1 to the parliament entitled “ the role of petroleum activities in norwegian society ”, this issue was discussed in depth. i quote : “ a

svein gjedrem : terms of trade shocks and challenges for stabilisation policy speech by mr svein gjedrem, governor of norges bank ( central bank of norway ), at the symposium in honour of victor d norman, bergen, 7 june 2006. the speech does not contain new assessments of the economic situation or of current interest rate setting. please note that the text below may differ slightly from the actual presentation. the charts in pdf - format can be found on the norges bank ’ s website. * * * ladies and gentlemen, let me first say that i am glad of the opportunity to speak at this symposium. victor norman has made valuable contributions to our understanding of international economics, both as a researcher and teacher. most economists that have graduated in norway since the early 1980s are familiar with victor ’ s textbooks. victor has also been a powerful contributor to the public debate for more than a quarter of a century. while international trade and capital flows are key topics in his teaching and research, his involvement in the public debate also include issues like the competitive condition for business and industry, the effective utilization of resources – not least in the public sector – taxation and the tax system, pensions, health care, and many more. substantial improvements in norway ’ s terms - of - trade looking at economic developments globally and in norway over the last few years, it is reasonable to say that victor ’ s main fields of interest are more important than ever. trade liberalisation, political changes, technological advances, and a sharp reduction in transaction costs have fuelled a globalisation process that seems to have accelerated over the last 15 - 20 years. as a result, cross - border flows of goods, services and capital are growing at a markedly faster pace than world production. few countries are benefiting as much as norway – and losing as little – in the current environment of freer trade and increased cross - border labour mobility. prices for goods we import are falling in relation to prices for goods we export. norway ’ s terms - of - trade are improving. the norwegian economy has experienced a strong positive income shock. real national disposable income will increase by 25 - 30 per cent in the period from 2003 to 2006. the impact of the rise in oil and gas prices is particularly strong, but the terms - of - trade gains for the mainland economy have also been high. the situation in norway differs from that of our nordic neighbour countries. sales of swedish and finnish high - tech