Indeed, such was the surprise that the market immediately revised up its expectations for future interest rates. And there was a measurable increase in uncertainty, as different interpretations of the Committee’s unusual action were debated across the wires. This episode highlights the difficult balance which the mature Committee needs to strike between innovation and predictability. Today’s Committee members – only one of whom has been there since the beginning – quite reasonably do not want to be unduly constrained by the habits of their predecessors. But the passage of time has given ‘the Committee’ a collective personality. So changing established patterns of behaviour requires at least as much care and explanation as in the early days of the framework. Second, even if we have not changed our procedures very much over the past decade, other central banks have. They have become much more transparent. And the debate about how much central banks should communicate – and how – has moved on, among academics, central bankers and central bank watchers. For example, a long-standing issue is how much central banks should say about their expectations of future interest rates. The traditional concern has been that commentators would mistake a projection for a commitment, the risk being that when interest rates did not change as projected this would be damaging to credibility. However, in recent years other central banks have moved increasingly towards giving indications about the likely path of interest rates, given their forecast for the economy.
The chart shows the actual trade-weighted exchange rate (TWI) and expected TWI one year ahead as from 1998.3 When the krone is “weak”, the expected exchange rate one year ahead tends to be stronger than the actual rate. Likewise, the expected exchange rate one year ahead tends to be weaker than the actual exchange rate when the krone is strong. In the period 2002-2003, the krone exchange rate varied considerably. Movements in exchange rate expectations, however, were less  3  4  Consensus Forecast data were not available earlier. BIS Review 25/2004  volatile. When the krone was at its strongest in the second half of 2002, the expected exchange rate one year ahead was 4-5 per cent weaker. This illustrates that exchange rate expectations seem to be more stable than actual exchange rate movements and that after moving markedly beyond a long-term equilibrium level, the krone exchange rate is expected to revert to around this level. The equilibrium level for the nominal exchange rate is not, however, constant over time, but partly depends on price and cost developments in Norway relative to our trading partners. The advantage of a flexible exchange rate is perhaps most evident when the economy is sluggish. If the krone were to remain at a level that is too strong, nominal wages would have to remain unchanged over a longer period or fall in order to bolster companies and jobs. This only occurs when unemployment is very high.