of higher inflation, which we are addressing by increasing the interest rate. consumer price inflation is still fairly low, but capacity utilisation is now at such a high level that inflation is projected to move up gradually to 2. 5 per cent. higher interest rates will contribute to a gradual decline in capacity utilisation, thereby preventing inflation from becoming too high. in the long term, monetary policy cannot influence real economic variables such as output and employment ; it can only influence nominal variables such as inflation, the nominal interest rate and the nominal exchange rate. when monetary policy serves as an anchor for inflation expectations, it allows the interplay between monetary policy and other components of the economy to function. a good result can be achieved if the social partners take the role of " leader " and the central bank the role of " follower ". wage growth can then be determined in the knowledge of the monetary policy response. flexible inflation targeting provides a fixed framework for monetary policy and gives a clear indication of how the central bank is to respond in different situations. the " leader " – the social partners – can internalise the monetary policy response and take the " follower ’ s " – norges bank ’ s – response to their actions into account. this approach is most relevant when wage setting is centralised. a number of studies2 have shown that countries with a relatively high degree of centralisation and coordination, such as norway, can achieve relatively low unemployment. when wage - setting is decentralised, monetary policy will instead influence wage growth via market mechanisms, by stabilising aggregate demand for goods, services and labour. monetary policy that is flexibly oriented towards low and stable inflation will function well whether wages are set at the central, local or individual level. 2 in the initial period after the introduction of the inflation target in 2001, it appeared that the social partners had not yet internalised the response pattern ensuing from the monetary policy mandate. we are now well into a cyclical phase with very high capacity utilisation and low unemployment. in this situation, there may be a risk that wage growth will again accelerate. on the other hand, the experience gained by the social partners that large pay rises push up interest rates may have the effect of curbing pay increases. in local wage negotiations at enterprise level, competition, the supply of foreign labour and the possibility of outsourcing or relocating activities may dampen the impact. low and stable inflation should not be taken for granted. norway ’ s and other countries ’

- long consequences for economic developments. all that said, however, the challenges facing banks today require a broader set of instruments than those used by the nordic authorities 20 years ago, for two main reasons : first, the situation for banks is more complex. the authorities have to distinguish more clearly between insolvent banks and banks that are solvent but in need of more capital in order to increase lending. the lessons from the nordic banking crisis can be drawn on for the insolvent banks. for the solvent banks, the challenge is to maintain their lending capacity. this is particularly important given that other credit markets are not functioning normally, so that it is difficult, or impossible, for businesses to acquire funding directly from bond markets. but without more capital, the banks are not willing to accept new loans on their balance sheets. the main challenge facing the authorities today therefore is to ensure that solvent banks increase their financial strength and thereby their lending capacity. at the same time, it is important to have an exit strategy so that capital injections today do not translate into an increase in state ownership when the crisis is over. second, cross - border banking has been increasing. twenty years ago, all the main nordic banks were national banks. today, for example, four of the five largest banks in norway are foreign - owned ( three branches and one subsidiary ). a national authority cannot be expected to bolster the financial strength of branches of foreign banks : indeed, it could be complicated to do this even for foreign - owned subsidiaries. while we were able to choose national solutions to the banking crisis 20 years ago, any effective solution to today ’ s situation will require an internationally harmonised approach. as today ’ s financial crisis progressively gets resolved, it will be necessary to start the process of preventing future crises. this will require substantial reform of the regulatory framework. banks will have to strengthen their capital and their liquidity buffers. and financial regulation must have a less pro - cyclical effect. the objective must be to enable the banks to curb the impact of shocks on the economy, rather than to amplify them, as is the case now, where negative spirals are generated between the financial system and the real economy. because of the global character of today ’ s financial crisis, the authorities must work in concert to find solutions, both in terms of recapitalisation of the banks and regulation of the financial sector.