Monetary policy has little or no ability to influence most of these separate goals in the long term. It is therefore sensible to specify monetary policy’s long-term goals in terms of factors monetary policy can affect. Introducing money into an economy and establishing a credible monetary policy that ensures low and stable inflation will have a positive effect on the real economy. Similarly, monetary policy that ceases to function could result in a dramatic deterioration in welfare, as we have seen on numerous occasions. However, apart from this, monetary policy will not have lasting effects on the growth potential or the level of welfare in the economy. It is the supply of economic resources - labour and  2  BIS Review 49/2002  capital and our ability to utilize them efficiently in production - that is decisive. We cannot use monetary policy to pull ourselves up by our bootstraps. It also seems intuitively unreasonable that it should be possible to influence output potential or average growth in the economy through monetary policy. I think this is fairly obvious if we imagine the effects of monetary policy in a “Robinson and Friday” economy. i)  The long-term objectives of monetary policy  In the long term, monetary policy determines the average level of inflation. Output is determined by the supply of labour, capital and technology and by productivity changes. It is important to stress the essential difference between the target of a high level of economic growth (output target) and the inflation target.
The line in the chart will therefore move further down and to the left with a more credible monetary policy. 3. Norwegian monetary policy and cyclical fluctuations  In the long term, we cannot influence growth potential or prosperity by means of monetary policy - not even in Norway. But we can influence the fluctuations in the economy, the short-term cyclical movements. Norges Bank also takes into account that monetary policy should not cause unreasonably sharp fluctuations in output by setting a relatively long-term horizon for the attainment of the inflation target, and allowing deviations in the intervening period. It would probably be possible by a very aggressive use of instruments to force inflation back to the target within a time frame of 3-4 quarters - perhaps even less if the foreign exchange channel is strong. This would cause very pronounced fluctuations in the real economy, however. In this sense, variations in output enter our “loss function”. The thinking that follows from the theoretical research is to a large degree present in the actual setting of interest rates. For practical purposes, we, and other central banks with inflation targeting, make estimates of future price inflation. Our instruments are oriented in such a way that there are prospects of attaining the inflation target two years ahead. The theoretical literature has given us useful knowledge as to how far forward in time this horizon should be set. The result of using too short a horizon will be considerable instability in output and in nominal and real interest rates.