The recession after the credit bubble burst and oil prices fell in 1986 was deep. The recession was deeper than would have been the case if we had maintained a larger and competitive manufacturing sector. Norwegian industry lost export market shares in the late 1980s in spite of the booming conditions abroad and substantial capacity slack at home. It was recognised that a substantial revision of economic policy would be necessary and that the problems created by inflation had to be taken seriously. The exchange rate was chosen as the nominal anchor in 1986. A fixed exchange rate was an intermediate target for achieving low and stable inflation. Inflation fell gradually to 2-3 per cent in 1991-1992. We had to abandon the fixed exchange rate policy in 1992. An important reason was the weakness inherent in the fixed exchange rate regime in a world with free capital flows and deep financial markets. The krone exchange rate showed, however, little change to begin with and rapidly found a new range. A formal inflation target for monetary policy was introduced in the spring of 2001. The operational target of monetary policy as defined by the government is inflation of close to 2.5 per cent over time. Many countries had already gained many years’ experience in operating such a system. New Zealand was the first in line towards the end of the 1980s. Canada followed shortly thereafter.
This policy was at the root of many of the problems that followed in the 1970s and 1980s. Today’s formulation of economic policy reflects the experience gained and the lessons learned in these two decades. The economic policy contributed to wide fluctuations in the Norwegian economy. Inflation became high and variable. This was largely due to a perception in the 1960s and 1970s that strong growth and low unemployment could be achieved if we were only willing to accept somewhat higher inflation. But it was gradually recognised that there was no such trade-off. The absence of a nominal anchor was one of the main reasons behind the pronounced swings in the Norwegian economy. With a policy of low interest rates and devaluations, inflation took root. Nominal interest rates were kept at a low level even though inflation rose. Frequent devaluations from 1976 were unable in the long term to prevent a decline in the manufacturing sector. On the contrary, they proved to be self-reinforcing. The wide fluctuations culminated in a credit boom in the mid-1980s. The fluctuations were reinforced by oil price shocks and the use of expected revenues from oil production. The government began already in the 1970s to budget on the basis of future strong growth  2  BIS Review 22/2006  in petroleum revenues. The result was that we spent a large share of our petroleum wealth in the 1970s and 1980s. Welfare schemes were expanded significantly. Manufacturing industry was scaled back.