If fiscal policy is systematically too expansionary during booms and when petroleum revenues are higher than expected, Norway will in periods experience pressures in the economy and rising price and cost inflation. This will often give rise to situations where the krone depreciates, thereby undermining the credibility of our monetary policy. There is a price to be paid for this. Market participants will lose confidence in the krone and demand a higher interest rate for maintaining krone positions rather than switching to other currencies. The result is a permanently higher interest rate level in Norway compared with other countries. Intricate relationships Earlier, monetary policy was based on extensive use of interventions – in other words, purchases and sales of foreign exchange in order to defend the krone exchange rate. Denmark has used this instrument with positive results. There are probably many reasons for this in addition to its stable terms of trade. For instance, fiscal policy in Denmark has on numerous occasions made a substantial contribution to exchange rate stability. Over time our experience of large-scale and persistent interventions has been mixed. When the central bank intervenes heavily to defend the krone, market participants may easily move into a game situation and perceive central bank intervention as an interesting opportunity to make a profit. Market operators know that a situation in which the krone is being propped up only because Norges Bank is buying kroner cannot continue. It is then tempting to take reverse positions in the foreign exchange market in relation to the central bank.
Over time, it should also reduce the risk of local and regional crises and their contagion effect on the rest of the world. There is still a long way to go. As far as Norway is concerned, we must act on the assumption that we will continue to live in an unstable world. The financial crises have shown that a small country is vulnerable to international turbulence. The Norwegian economy is fragile and vulnerable. Stability and buffer against financial shocks Norway has also experienced a banking crisis. If nothing else, we learned from it. Laws, regulations and supervision have been tightened. Financial institutions place greater emphasis on risk management. The debt burden of households is lower than in the 1980s, and for a long period the business sector was also more cautious about incurring new debt. BIS Review 20/1999  4  Losses at Norwegian financial institutions have been low since the banking crisis. There is greater uncertainty now as the economy is approaching a turning point. The sharp growth in fixed income business has led to a substantial increase in corporate debt, which has been reflected in the high level of credit growth in recent years. The rise in interest rates has made it more demanding for households and enterprises to service their debt in the short term, but has had a restraining effect on credit growth.