Our estimates of the potential output level have increased in pace with the emergence of new information. Our best guess is nevertheless that the output gap is now positive and widening. Low inflation combined with high growth in output and employment is therefore a challenge to monetary policy. 2  BIS Review 49/2006  Even though economic growth has been strong over the past 15 years, business cycles have fluctuated. A pronounced upturn in the years from 1993 to 1998 was followed by a period of more moderate growth and a mild recession in 2002 and into 2003. Since summer 2003, there has again been a clear upturn in the Norwegian economy. Wage developments reflect and influence business cycles. Strong employment growth in the 1990s resulted in a rise in labour costs, which in turn had a dampening impact on growth. Moderate wage growth in recent years has been accompanied by a strong cyclical upturn. So far, the upturn has been marked by strong growth in output, with an ample supply of labour and unusually low inflation. For a longer period employment showed a smaller rise than in previous cyclical upturns, partly reflecting the decline in sickness absence since summer 2004 and solid growth in productivity. Employment showed a turnaround last autumn and the number of persons employed is now increasing sharply. Unemployment is falling rapidly.
It will always be difficult to know when and to what extent monetary policy should respond to a sharp rise in asset prices and a strong increase in credit growth. Our knowledge of the driving forces is incomplete. Our history is short and our experience with deregulated loan and housing markets is limited. It is difficult to determine to what extent the rise in house prices and growth in household debt can be accounted for by structural and long-lasting adaptation, by “normal” cyclical effects and by a short-term trend extension and speculative behaviour that may amplify the cyclical fluctuations when the bubbles burst. We have leaned towards the notion that debt and asset price developments may be a potential source of subsequent instability, but it is neither our ambition nor our conviction that monetary policy can control developments in these variables. Combined with the favourable supply-side developments in the economy, this has prompted us to extend the horizon for reaching the inflation target. In our communications, we have also clearly articulated that the interest rate has been unusually low and  BIS Review 49/2006  3  must gradually be increased to a more normal level. Since last autumn, this has been expressed in Norges Bank’s interest rate projections for the period ahead. From using technical assumptions or others’ assessments, we have now taken ownership of the interest rate path in our projections. This is also a means of seeking to influence household and business expectations.