With a somewhat tighter labour market in the years ahead and rising inflation, wage growth may pick up. Over the past year, low consumer price inflation has probably contributed to keeping nominal wage increases lower than implied by labour market tightness in isolation. Low inflation has resulted in high growth in household purchasing power, even with moderate pay increases. With a path for the interest rate and the krone exchange rate in line with the baseline scenario in Inflation Report 1/05, inflation may increase gradually from less that 1 per cent today to close to 2 per cent in mid-2006. Under these assumptions, inflation may stabilise at around 2½ per cent at the threeyear horizon. However, continued shifts in trade patterns, with higher imports from Asia and intensified competition in retail trade, may prolong the period of low inflation. Developments in the krone exchange rate are uncertain. The real krone exchange rate measured by relative labour costs is strong. Historically, the real krone exchange rate has tended to return to an average measured over a longer period. Should this occur in today’s situation, through a depreciation of the nominal krone exchange rate, inflation will pick up somewhat faster than projected. If the krone appreciates, on the other hand, there is a risk that inflation will not move up as quickly as projected. Developments in line with the projections imply that the output gap will increase to about 1¼ per cent in 2006.
Given our highly open economy, we may have to accept somewhat wider variations in inflation than some other countries. The last time I was here, almost exactly a year ago, Norges Bank’s Executive Board had just decided to reduce the key rate by 0.25 percentage point to 1.75 per cent. Since then, the key rate has remained at this historically low level. Real interest rates are also low. From December 2002 to March 2004, the key rate was reduced by a total of 5.25 percentage points. The interest rate decline can be ascribed to a number of factors. In late autumn 2002, inflation started to fall. The inflation projections were also revised down. Gradually new information about the outlook for other countries and the Norwegian economy indicated that inflation might be very low. Short-term interest rates fell by close to 4 percentage points. It would seem that it is not only changes in the real interest rate that have an influence, but also the level of real interest rates. Between December 2002 and March 2004, the interest rate has moved from a high to a low level. The real interest rate is now lower than a neutral interest rate. A real interest rate that is lower than the neutral rate will stimulate activity even after the effects of the interest rate fall itself have been exhausted. Calculations seem to indicate that the neutral real interest rate for Norway is between 2½ and 3½ per cent, and it has probably fallen somewhat in recent years.