Inflation targeting means setting the interest rate so as to achieve a numerical target for inflation. Norges Bank sets the interest rate with a view to stabilising inflation at 2.5 per cent within a reasonable time horizon, normally 1-3 years. The more precise horizon will depend on disturbances to which the economy is exposed, and how they affect the path for inflation and output. The inflation target represents a framework for, not an obstacle to, monetary policy’s contribution to stabilising output and employment. We have chosen flexible inflation targeting. Variability in output and employment as well as inflation is given weight. The objective of monetary policy is to safeguard the value of money in the long term, and seek to contribute to stabilising economic developments in the short and medium term. The objective of monetary policy is low and stable inflation. The instrument is the interest rate. The interest rate influences inflation with a lag and with varying intensity. As interest rates fall, household and local government consumption and investment tend to accelerate. Higher demand leads to higher output and employment. Wage growth may pick up. Higher wage growth combined with higher profit margins will result in higher inflation. BIS Review 61/2004  1  Lower interest rates normally lead to a depreciation of the krone. Imported goods then become more expensive and inflation accelerates. Expectations play a key role in price and wage formation, and they are influenced by the interest rate.
15 This means developments in the US have disproportionate influence on global economic and financial conditions. Indeed, our research suggests that the influence of US financial conditions on foreign GDP has increased by a third relative to its average from 1990 to 2005, despite the US’s rapidly declining share of global GDP. Capital Flows as a % of GDP 2 0 -2 -4 Average Capital Flows-at-Risk Contribution of pull factors Contribution of push factors Total Capital Flows-at-Risk 1996  1999  2002  2005  Gross Gross outflow inflows s  Chart 10: Capital-Flows-at-Risks in emerging market economies are growing again  -6 -8 2008  2011  2014  2017  Sources: IMF and Bank staff calculations. Notes: See chart 7 for notes. Push factors are proxied by the Bank of England’s global financial conditions index. 15  Ilzetzki, Ethan, Carmen M. Reinhart, and Kenneth S. Rogoff (2019), Exchange Arrangements Entering the 21st Century: Which Anchor Will Hold? Quarterly Journal of Economics 134 (2): 599-646. 11  All speeches are available online at www.bankofengland.co.uk/speeches  11  When the Fed responds to domestic developments (such as a loosening in fiscal policy) global financial conditions and activity react strongly. This was the case during both the 2013 ‘taper tantrum’ and over the past year, as Fed communications significantly shifted expectations for US monetary policy. During both periods, Capital Flows-at-Risk in EMEs spiked (Chart 10). Financial (in)stability in advanced economies has also influenced the sustainability of capital flows to EMEs.