The model must provide some indication of how the interest rate is working. We assume that Norway with its own national currency can determine inflation over time. One of our model requirements is therefore that monetary policy anchors inflation expectations. We must also take into account that economic agents look ahead when they make decisions concerning consumption, investment, wages and prices and base these decisions not only on today's economic policy, but also their expectations as to future policy. In addition, we build on theory and experience of the 1970s and 1980s indicating that in the medium and long term unemployment could not be reduced if we were only willing to accept somewhat higher inflation. At a given point in time, we can on the basis of current statistics and anecdotal information provide some indication of how the economy has evolved up to a few months ago. But even this basis is uncertain. Statistics are prone to substantial revisions and data from different sources can provide different profiles for the same variable. For example, financial market statistics and national accounts statistics now show, as on many previous occasions, different profiles for household net lending. In order to obtain a more accurate picture of today’s situation and developments over the next few quarters, we rely to a large extent on various statistical forecasting techniques. Such techniques and models can capture time series properties in data and correlations that in many cases feature a fairly high degree of accuracy without the model relationships following from economic theory.
We had to abandon our fixed exchange rate policy in December 1992. One important reason for this was the inherent weaknesses in the fixed exchange rate system in an environment of free capital flows and deep financial markets. When the fixed exchange rate policy was formally abandoned, there was a risk that the Norwegian economy could again lose its nominal anchor. However, the krone exchange rate showed little movement and soon found a new range. Fiscal policy had a stabilising effect. The exchange rate remained stable until autumn 1996. This was partly due to low wage growth and a level of total demand that did not generate pressures in the economy. After a period, the krone began to show wider fluctuations. The experience of the latter half of the 1990s demonstrated that monetary policy cannot fine-tune the exchange rate. Developments in the international financial markets led to greater fluctuations. And more fundamentally – exchange rate developments no longer sent signals back to wage formation and fiscal policy when labour market pressures mounted and incomes policy failed. High petroleum revenues, fiscal slippage and expectations of increased use of petroleum revenues contributed to this. The exchange rate was therefore no longer suitable as a nominal anchor. As a result, Norges Bank gradually placed increasing emphasis on low and stable inflation. In 2001, the Norwegian authorities decided that monetary policy in Norway was to be oriented towards low and stable inflation through a numerical target for inflation, as was the case in many other countries later in the 1990s.