and effective systems. it has also become increasingly important for our settlement systems to have good international links. interdependence of financial and monetary stability the objective of monetary stability - which in norway means exchange rate stability and low inflation - and the objective of financial stability are interdependent. high - and thereby in practice varying inflation and unstable exchange rates can threaten financial stability through several channels. first, it is more difficult to assess the risk of an investment project. inflation makes it difficult to differentiate between a change in prices for a good or service and a change in the overall price level. it makes it more difficult to determine the discount rate to be applied. second, fluctuations in the inflation rate are often accompanied by interest rate variations. a sharp rise in interest rates can also result in substantial losses on financial assets such as bonds and equity. loans that have been granted against collateral in the form of such assets are even more exposed to losses. when rising inflation and inflationary expectations necessitate a tightening of monetary policy a crisis often ensues. in several countries the financial system has been on the verge of collapse during such a period of adjustment. this was the case in the us in the early 1980s and in the nordic countries around 1990. financial stability primarily contributes to price and exchange rate stability by facilitating the use of monetary policy instruments. unstable institutions and markets constrain the use of interest rates because tighter liquidity and higher interest rates may increase the uncertainty concerning the stability of the financial system. asset prices are an important linkage between monetary and financial stability. a surge in property prices with a risk of a subsequent fall threaten to undermine banks ’ collateral. 5. crisis management analyses of the norwegian banking crisis provide a positive assessment of how the crisis was managed. the imf relies to a large extent on the solutions applied to the banking crises in the nordic countries as a model for its proposals for resolving the current banking crises in asia. the division of banking crisis management into three elements has gained general acceptance in norway. the first element is that the banks ’ earnings and capital shall serve as the first line of defence. this limits moral hazard. the second line of defence is the collective guarantee system for the banking industry. the third line consists of government resources that will be made available should the collective guarantee schemes fail to resolve the crisis. liquidity support from norges bank is part of the third - line defence. i would like to underscore the importance of the conditions that were attached to

the gain is achieved at the expense of other new zealanders, since in aggregate we are all worse off. to put it bluntly, if the reserve bank is to be able to “ look through ” the impact of things like the increase in petrol and cigarette prices in implementing monetary policy, we new zealanders also need to “ look through ” the impact of those things on the cpi. to the extent that we don ’ t, and instead seek compensation for the impact of those things on the cpi, the bank will need to tighten monetary policy to a greater extent. the only alternative would be permanently higher inflation, and that would help nobody and hurt those least able to protect themselves. in recent years, the reserve bank has been happy to report that inflationary expectations are now well anchored at a low level. we have been able to say that, as a result, we expect that smaller adjustments in interest rates will be required to maintain price stability, and of course this is good news. it would be a tragedy if sloppy thinking by price setters, and a return to an indexation mentality, meant that the benefits of those lower inflationary expectations were lost. the impact of the exchange rate on inflation the second point i want to reiterate is the relevance of the exchange rate to inflation. the exchange rate has two effects on the inflation rate. first, there is the more or less immediate impact of movements in the exchange rate on the prices of goods and services which are traded internationally, or which could be traded internationally. we know, for example, that when the new zealand dollar depreciates the new zealand dollar price of oil goes up, and the price of petrol goes up with it, quite apart from any impact of an increase in the international price of oil measured in us dollars. similarly, the price of milk goes up, even though milk is not imported, because the new zealand dollar price of milk on the international market goes up with the depreciation of the new zealand dollar. these so - called “ direct price effects ” of a movement in the exchange rate typically affect new zealand ’ s inflation rate quite quickly, usually within six to 12 months. we used to think that a 1 per cent depreciation in the exchange rate would produce an increase in the inflation rate of about 0. 3 per cent within 12 months as a result of these more or less immediate direct effects. but for some years now, the impact of a change in the exchange rate seems to