inflation and a considerably negative output gap – might, under criteria 1 and 2, indicate in isolation that the interest rate should be set very low and even be negative towards the end of 2009. this is illustrated by the green line. however, the executive board chose to take a less drastic course of action on the basis of the other criteria taken into consideration. criterion 3 states that previous methods of operation should be taken into account and that the interest rate should normally only be changed gradually. with emphasis on interest rate smoothing in the loss function ( i. e. criteria 1 + 2 + 3 ), the result is the black line. this interest rate path is still low, and lower than the path that was in fact chosen. criterion 4 states that monetary policy should be robust and criterion 5 that cross - checking should be carried out. in a turbulent economic situation, we were uncertain whether our model was the right one for the norwegian economy and wanted to guard against model misspecifications. in an economy where unemployment is around 3 per cent and inflation is on target, setting the interest rate as low as zero was regarded as going too far. a practical approach to model uncertainty is to cross - check using simple monetary policy rules such as the taylor rule ( criterion 5 ). in addition to the basic taylor rule, we usually employ a variation of this rule involving external interest rates, and a rule where the output gap is replaced by gdp growth. a mechanical application of the taylor rule would have resulted in a forecast approximately as indicated by the blue line in the diagram, i. e. considerably higher than the interest rate path that was chosen. a higher interest rate path would also have resulted in more negative output and inflation gaps. achieving the inflation target would have taken ten years. see holmsen et al. ( 2008 ) for a discussion of the implementation and communication of optimal monetary policy. an interval for the interest rate is determined based on the criteria, where optimal policy ( with interest rate smoothing ) defines the lower boundary and the taylor rule yields the upper boundary. after an overall assessment, the interest rate forecast indicated by the red line was selected. the interest rate decision, in norway as elsewhere, is based on discussion by a board. criteria 3, 4 and 5 introduce conditions that cannot easily be observed. we have to apply judgement. the criteria contribute to consistency and structure the discussion. the riksbank also applies judgement when selecting the interest rate path. but svensson does not discuss possible shortcoming

are the same as those of the previous report. and once preferences have been formalised in a loss function, it is relatively simple to find the optimal interest rate path for a given model. the choice of path will then depend on policymakers ’ preferences. a policymaker ’ s preferences may of course change over time, but i am in favour of basing the analysis on the same set of preferences as previously. this approach will contribute to consistency in communication over time. cf. woodford ’ s ( 2005 ) formulation : ” for not only do expectations matter, [ … ] very little else matters. ” criteria for a “ good ” interest rate path inspired by svensson, norges bank has developed a set of criteria for a “ good ” interest rate path. the intention is to make it easier for others to understand how we think, although the criteria also define the agenda for the internal discussion. 2 the first criterion for a good interest rate path is to set the interest rate with a view to bringing inflation back to target in the medium term following a shock. the primary objective is to achieve the inflation target. the second criterion reflects the flexibility of inflation targeting. there are many routes to the objective. which one should we choose? according to the criteria, emphasis should be placed on finding an interest rate path that also stabilises output and employment. so far, our approach tracks svensson ’ s theoretical approach fairly closely, with some deviation from the analytical method he presents in his article. the most important difference is that we have chosen to focus directly on the target, using a loss function to describe monetary policy. the approach proposed in the article primarily relies on a description of policy under different rules followed by calculation of the loss using the loss function. because the model is primarily a model and reality is primarily reality, some tailoring is required to connect model and reality. some additional criteria have therefore been formulated. these criteria are necessary because our models are uncertain and because confidence in monetary policy cannot always be taken for granted. the criteria do not conflict with svensson ’ s monetary policy research, but can be regarded as a bridge between the model and reality. allow me to show you how the criteria were used in the work on the march monetary policy report by outlining the thought process involved. although the charts i will be presenting are a simplification, they serve to illustrate our working methods. norges bank ’ s assessment of the current situation and the forecasts – with below - target