In addition, the reduction in the interest rate has probably contributed to holding up expectations of future inflation even when inflation is low. If there is confidence in monetary policy, economic agents will expect inflation to be close to target over time. Companies will draw up their budgets on this basis. This will then contribute to stabilising inflation. Many companies change their prices only once or twice a year. When they change prices, they probably take into account the expected rise in other prices. It has been important to prevent inflation expectations from falling and becoming entrenched at a low level. Surveys of inflation expectations nevertheless indicate that expectations are well anchored around the inflation target in the long term. The first signs of the effects of the interest rate cuts appeared in the foreign exchange market. The interest rate differential against other countries narrowed. It became more attractive to borrow and less profitable to invest in the Norwegian krone. The movement in the krone exchange rate was reversed and the krone depreciated through 2003 and into 2004. However, the impact on the krone exchange  2  BIS Review 27/2005  rate has been considerably dampened because external interest rates have remained low. High prices for oil and gas and other export goods also contributed to an appreciation of the krone last year. The depreciation of the krone in 2003 contributed to restraining the fall in prices for imported goods. The effect occurred gradually.
The interaction here came into clear evidence when employment in the general government sector fell after the expensive wage settlement in 2002. The authorities can achieve better economic policy results if they can commit in advance to a set of credible policy rules. Households, enterprises and capital market participants are forward-looking in their decision-making. It is therefore important that the authorities do not sow doubt, but on the contrary act in a long-term and predictable manner. There must be consistency between plans and actions. Monetary policy’s role is to ensure low and stable inflation. Experience shows that we cannot reduce unemployment over time by simply accepting somewhat higher inflation. In many countries, including Norway, confidence that inflation will be held at bay has increased because interest rate setting has been delegated to the central bank. BIS Review 27/2005  1  For monetary policy to contribute to stabilising developments in output and employment, economic agents must be confident that the inflation target will be reached. Inflation targeting has proved to be a sound system and particularly well suited to small, open economies. Normally, interest rate setting under an inflation targeting regime will also contribute to stabilising output and employment. In downturns, with prospects of low and falling inflation, the interest rate will be reduced to boost demand and prevent an inflation level that is too low. During an upturn when there are prospects of high inflation, the interest rate will be increased.