In the recent period of expansion, inflation rose to 3 per cent in 2008, but was restrained without raising the key rate to a high level. 5 The advantages of economic agents anticipating low and stable inflation are now clearly evident. They can be quite sure that inflation over time will be close to 2.5 per cent. This enables interest rate setting to be more effective. When the nominal interest rate is reduced, the real interest rate falls accordingly, and it is this rate that influences decisions made by households and enterprises. Interest rate setting still provides some scope for stimulus. When inflation is anchored, economic agents do not expect inflation to accelerate over a period in Norway even if the krone depreciates. The krone can then decrease in value without monetary policy having to be tightened. This will curb the decline in our export industry. In bad times, a marked krone depreciation might even be necessary to hold up inflation close to 2.5 per cent. In the downturns in 1990 and 1998, the opposite action was taken: the interest rate had to be increased in order to stabilise the krone and keep inflation in check. Even though fiscal policy and monetary policy have had the intended effect, there have been fluctuations in output and employment. We have experienced a period of strong credit growth. During the upturn, the housing market was increasingly marked by the belief that house prices would always rise.
Owner-occupiers can thereby deduct expenses in connection with earning income but are not taxed on the benefit. With this tax wedge, the interest rate level that is right for households is too high for firms. It shields borrowers from a higher interest rate in upturns and thus has a stronger impact on house prices. It would not be appropriate to increase housing taxation now, but a reform is to be recommended when the turnaround occurs. 5  Different indicators of underlying inflation were close to 3 per cent in 2008, while the rise in total consumer prices was 3.8 per cent. BIS Review 16/2009  15  Economic agents can be myopic. It is short-sighted to base assessments of sustainable levels of debt on today’s variable interest rates. Long-term, fixed interest rates provide a far better guideline in this context. Homebuyers, and the banks providing their mortgages, must take into account that variable rates over time will be around 6 per cent, sometimes higher. There are also other sources of fluctuations in credit and property prices. Banking is procyclical. In upturns, loan losses are low, increasing banks’ profits. Access to equity capital is ample, providing the basis for strong lending growth. Losses increase in downturns, and the supply of equity capital can dry up, compelling banks to restrict their lending. The impact is stronger since the value of property used as collateral fluctuates in step with cyclical developments. At the same time, counterparties and rating agencies may require higher capital levels.