are low, companies may also find that raising capital by means of new issues is not an attractive alternative. strong growth in private consumption has contributed to sustaining activity in the norwegian economy. sharp wage growth, combined with reductions in direct and indirect taxes, resulted in close to 5 % growth in household real disposable income last year. real income growth will be considerably lower in 2003 and probably lower than projected earlier. imbalances in the norwegian electricity market have resulted in a sharp increase in electricity prices. this implies a considerable reduction in household real income growth. the interest rate reductions this winter will have the opposite effect. in addition, developments in employment are expected to be weaker and wage growth somewhat lower this year than previously projected. during the last six months, households have become less optimistic about the economic outlook. increased uncertainty in the labour market and lower confidence point to heightened caution and increased saving in the household sector. lower interest rates have the opposite effect. household saving behaviour may also be affected by high electricity prices. on the whole, a moderate, temporary decline in household saving is expected in 2003. next year, a normalisation of electricity prices will contribute to increasing real income growth compared with 2003. at the same time, we have assumed that a share of the increased use of petroleum revenues over the central government budget will entail increased transfers or tax cuts for households. these factors, combined with lower interest rates, may fuel relatively brisk growth in private consumption in the next few years. in the last few months, house prices have risen at a slower pace than in previous years. activity in the housing market has declined and it takes longer to sell a dwelling. growth in household borrowing remains high, but has eased somewhat recently. weaker developments in house prices and reduced household optimism may further restrain credit growth in the future. growth in mainland gdp is projected to be lower than trend growth, at 1¼ % in 2003 and 2 % in 2004. in 2005, growth is projected at 2¼ %. the underlying rise in prices in the coming year will be marked by the appreciation of the krone over the last two years. despite high wage growth, the year - on - year rise in consumer prices adjusted for tax changes and excluding energy products ( cpi - ate ) will most likely range between 1½ and 2 % until the summer. subsequent developments will partly depend on externally generated inflationary impulses, changes in the exchange rate and how these changes feed through to consumer prices in norway. the sharp rise in

higher costs can reduce firms ’ profits and thereby business investment. chart : costs shock – monetary policy trade - offs these effects of a cost shock can be illustrated in a model with different types of households – a so - called tank model. [ 11 ] the model assumes that there are two types of households. one group can spread the effect of a decline in real disposable income on consumption over time, that is to say they can smooth consumption. the other group, called hand - to - mouth households, spends all its disposable income in each period. the cost shock hits the hand - to - mouth households relatively hard, and aggregate demand falls. a smaller rate increase is then needed to stabilise the economy than if the cost shock had only affected inflation. in the model exercises, it is assumed that the hand - to - mouth households do not have debt, but if we had introduced debt for this group, an interest rate increase would have reduced disposable income to a further extent. in most new keynesian models, monetary policy primarily works through the real interest rate, which is also the case in the model simulations i have shown. but, in practice, the nominal interest rate probably has a greater effect than the real interest rate on the cash flow of indebted households, at least in the short run. chart : decomposition of main drivers behind rate path when we make forecasts for the purpose of interest rate setting, we incorporate that an increase in prices and costs influences household real disposable income and firms ’ profits. [ 12 ] we also incorporate that the effect of interest rate changes has likely increased over time due to higher debt ratios. we also assume that both real and nominal interest rates have a bearing on demand. the decomposition chart in our monetary policy report shows the contribution from different types of shocks to changes in the policy rate path from the previous report. in the latest report, the decomposition showed a negative contribution from demand, represented by the dark blue bars. these negative contributions reflect, among other things, the fact that we take into consideration many other conditions than those included in the simplest models. the model exercises i have presented so far build on the assumption that inflation expectations are anchored. as long as households and firms assume that inflation will return to target over time, neither small nor large cost shocks will have a lasting effect on inflation. the central bank can then put relatively large weight on the aim of high and stable output and employment. chart