For example, if the one-year interest rate was 2 percentage points higher in Sweden than in the United States, this would be compatible with a 2-per cent weakening of the Swedish krona against the US dollar during the year. The logic behind this is that “risk-free” investments in different currencies ought to have largely the same expected return. According to uncovered interest rate parity, a higher interest rate in Sweden than abroad should thus be linked with an expected future weakening of the krona. So how is this connected to my claim that the krona would become stronger as a consequence of an increased interest rate differential in relation to other countries? The answer lies in expectations and in what has already been priced on the market. This can be explained by a simplified example. Assume that the interest rate is originally as high in Sweden as in the rest of the world. In that case, uncovered interest rate parity says that the anticipated future exchange rate will be the same as the current exchange rate. If this expectation of the future exchange rate is taken for granted, an unexpected interest rate increase in Sweden would lead to an inflow of capital and an appreciation of the krona. The krona would now be expected to weaken in the period ahead, as the present rate is stronger than the anticipated future rate. Note that, on average, the krona will be stronger during the period in question due to the rise in interest rates in this example.
The economy has experienced a soft landing after the long period of high cost inflation in Norway and sluggish external activity. •  Output has returned to trend and is now showing a marked rise. •  Employment has returned to trend and is rising. •  Unemployment is at the 1996-level, and is at the average for the 1990s. •  Wage growth is broadly in line with a level that is consistent with the inflation target given nomal productivity growth. •  Overall credit growth is balanced. Credit is expanding broadly in line with trend growth in nominal GDP. •  Labour costs in Norway relative to our trading partners are now broadly in line with a long-term average. •  The nominal krone exchange rate is in line with the average for the 1990s. •  The interest rate level is near the level prevailing among our trading partners. •  Inflation expectations are approximately consistent with the target. In that respect, there is equilibrium in the Norwegian economy. But the current inflation rate is low, and external and domestic interest rates are low. Lagged effects of the strong krone in 2002 are exerting downward pressure on inflation. At the same time, a change in trade patterns and external economic conditions are pushing down import prices, even when measured in terms of what Norwegian importers pay in foreign currency. In Norway, intensified competition appears to be resulting in high productivity growth, which is probably contributing to low inflation.