svein gjedrem : monetary policy and wage growth address by mr svein gjedrem, governor of norges bank ( central bank of norway ), to the general assembly of the employers ’ organisation navo, 11 june 2002. the address is based on the assessments presented at norges bank ’ s press conference following the executive board ’ s monetary policy meeting on 22 may and on previous speeches. please note that the text below may differ slightly from the actual presentation. * * * norway ’ s economic policy is based on the guidelines for fiscal and monetary policy. the guideline for fiscal policy states that the use of petroleum revenues over the central government budget shall be equivalent to the expected real return on the government petroleum fund. this means that all the capital in the fund is being utilised. monetary policy is oriented towards low and stable inflation. historically, periods of high inflation have always been followed by a downturn. low and stable inflation therefore fosters stability in the economy. establishing guidelines for economic policy is not new. both fiscal and monetary policy have been subject to a rules - based framework throughout the post - war period, with the exception of the last half of the 1970s and the first half of the 1980s. monetary policy has had a clear anchor since 1986. the phasing in of petroleum revenues in the central government budget shall be equivalent to the expected return on the petroleum fund. most of the phasing in of petroleum revenues will take place over the next ten years. with a four per cent return on the petroleum fund, the use of petroleum revenues will rise to almost five per cent of mainland gdp in 2010. the inflation target provides an anchor for expectations concerning future inflation and interest rates. the inflation target is set at 2½ per cent. monetary policy affects the economy with a lag. the current level of inflation does not provide an adequate basis for determining the level at which interest rates should be set today. our analyses indicate that a substantial share of the effects of an interest rate change will occur within two years. two years is thus a reasonable time horizon for achieving the inflation target. economic agents can act on the assumption that the inflation rate will be 2½ per cent. if it appears that inflation will be higher than 2½ per cent with unchanged interest rates, the interest rate will be increased. if it appears that inflation will be lower than 2½ per cent with unchanged interest rates, the interest rate will be reduced. there is symmetry here. it is

equally important to avoid an inflation rate that is too low, as it is to avoid an inflation rate that is too high. the interest rate is the most important monetary policy instrument. it affects price inflation through two channels : demand for domestic goods and services and the krone exchange rate. changes in labour costs influence the rise in prices for domestically produced goods and services. the tighter the labour market is, the higher wage growth will be. demand for goods and services determines to a great extent how tight the labour market will be. high levels of private and public consumption, investment and exports will sustain the demand for labour. when the supply of labour is limited, the competition for labour pushes up wages. a tight monetary policy stance with a high real interest rate will curb domestic demand. in many countries, low and stable consumer price inflation is the goal of monetary policy. consequently, we can assume that imported price inflation will remain subdued. however, price inflation will nonetheless vary in pace with global economic developments. the krone exchange rate also plays an important role in determining import prices. a strong krone exchange rate will curb prices for imported goods, while a weak krone exchange rate will result in higher prices. when there is a rise in the interest rate in norway and a widening differential between domestic and foreign interest rates, investments in nok will increase, and the krone exchange rate will rise. price inflation may vary considerably from month to month. this variation may be due to random or temporary conditions, such as fluctuations in electricity prices or petrol prices, or the effects of changes in real taxes. when we assess the interest rate, we disregard these effects. statistics norway has constructed an indicator for adjusted price inflation - cpi - ate - which is the measure we use to examine the results of monetary policy performance. a sharp rise in labour costs is currently fuelling brisk growth in the prices of goods and services produced in norway. inflation is being kept at bay because the rise in prices for imported goods is close to zero. a stronger krone exchange rate, increased trade with china and eastern european countries, a reduction in tariffs and the global downturn have kept import prices low. if the krone exchange rate remains at today ’ s level, imported price inflation will remain subdued. wage growth has remained at between five and seven per cent every year since 1998. it appears that this year ’ s wage settlement will result in a similar outcome. strong wage growth is the result of a tight labour market. the interest rate