the euro area, the inflation target is below, but close to 2 per cent. this results in an inflation differential of ½ - 1 percentage point against norway. an investor must therefore have an interest rate in norway that is ½ - 1 percentage point higher than in germany in order to achieve the same expected real return in the two countries. following the introduction of the inflation target, the difference between german and norwegian forward rates was about 1 percentage point for a long time. so far in 2003, this differential has been somewhat lower. this interest rate differential indicates that the market is confident that we will achieve the inflation target. this line of reasoning can also be reversed. given stable inflation expectations of 2½ per cent, i. e. that monetary policy is credible, an estimate of the expected equilibrium real interest rate can be derived from the long - term forward rate. about ten years ahead, market participants expect a short - term nominal interest rate in norway of about 5¾ per cent. with expected inflation corresponding to the inflation target of 2½ per cent, we can estimate the market ’ s expected real interest rate in the long term at about 3¼ per cent. this is approximately the same level for long - term real interest rates as in the period 1997 - 2002, but higher than the long historical average from 1870 to 2003. deflation tendencies in a number of countries inflation has declined in a number of countries. this indicates that the global shift in monetary policy, with a greater focus on inflation, has been effective. however, other factors have also played a role. fiscal policy is being used to a lesser extent in demand management. structural reforms have been adopted in order to improve the growth potential of the economy. financial markets have been liberalised and the markets for both financial services and products have been globalised. deflation, i. e. a sustained fall in prices, has again become a subject of economic debate in the last few years. this is naturally due to the fall in consumer prices in a number of countries in asia and the very low rate of inflation in many countries. deflation can have a destabilising effect. if market participants expect prices to continue to fall, the real interest rate may be high since the nominal interest rate cannot fall below zero. households and enterprises may then find it profitable to increase saving pending a decline in prices, which leads to further fall in demand. the real debt burden increases as a result of the fall in prices. this curbs demand. def

those who experienced the banking crisis in the 1990s have a clear perception of this. financial instability is characterised by wide fluctuations in prices for assets, such as dwellings, commercial property and securities or failure in the functioning of financial institutions ( a “ run ” on banks ) or financial markets. financial instability is also characterised by disturbances in credit availability or the flow of capital. this may have consequences for output, employment and for inflation. financial stability therefore promotes price stability. in tandem with the trend towards lower inflation since the mid - 1980s, asset prices have shown wider variations and financial crises have become more frequent. in the short term, a conflict may arise between achieving the inflation target and financial stability. in japan, equity and property prices increased sharply in the 1980s, while inflation was subdued. in the us, household and corporate debt rose fairly sharply and equity prices trebled between 1994 and 1999, while inflation was moderate. this has prompted a debate as to whether monetary policy must take financial stability into account to a greater extent. low interest rates and low inflation may contribute to a rise in asset prices and debt build - up ( financial bubbles ) through several channels. with confidence in the inflation target, inflation may be less affected by changes in the economic situation. increased international competition and imports from low - cost countries can keep inflation at a low level even during a period of strong expansion in the domestic economy. high productivity growth contributes to low inflation, but also to high earnings. banks will then record low losses and may increase their lending. investments financed by loans may push up property prices. when the bubbles burst, either in the housing market or in the stock market, asset prices fall and many will want to reduce their debt. this reduces demand and may lead to a fall in prices. deflation in japan is clearly related to the property and stock market bubble that burst in the early part of the 1990s. the build - up of financial bubbles may make the financial sector more vulnerable to any disturbances in the economy at a later stage. a sharp rise in asset prices and debt build - up may pose a risk to economic stability. in order to reduce this risk it will in certain situations be appropriate to apply a somewhat longer horizon than the normal time horizon of two years for achieving the inflation target. this presupposes that financial market participants are confident that inflation will be low and stable over time. norges bank has stated that if it is necessary to deviate from the normal response pattern in order to promote financial stability,