Jarle Bergo: The basis for inflation targeting Speech by Mr Jarle Bergo, Deputy Governor of Norges Bank (Central Bank of Norway), at the Foreign Exchange Seminar of the Association of Norwegian Economists, Sanderstølen, 21 January 2005. Please note that the text below may differ slightly from the actual presentation. The speech does not contain new assessments of the economic situation or of current interest rate setting. The references and the  Charts in pdf-format can also be found on the website of the Norges Bank. *  *  *  In 2004, the Norwegian Finn Kydland and the American Edward Prescott were awarded the Nobel Prize in economic sciences. They received the prize for their theoretical studies in the 1970s on economic policy rules and the importance of anchoring economic agents’ expectations. Norway’s current economic policy, with an inflation target for monetary policy and a fiscal policy rule, is partly based on the insights of Kydland and Prescott. But it is not just theory that has brought us here. Practice and experience over the last 30 to 40 years have perhaps been just as important. In his book “Doctrines and economic management in retrospect”, Hermod Skånland, former Governor of Norges Bank, points out that until the 1980s, the perception that government had to assume responsibility for employment and that borrowing should be inexpensive contributed to both the currency crisis and the banking crisis.1 Today’s economic policy can be seen as a result of a long learning process where academicians and the authorities have contributed.
Kydland and Prescott showed that room for manoeuvre in economic policy may have a price. The insight they provided was that economic policy can achieve better results if the authorities can commit themselves to a pre-established set of credible policy rules, rather than give themselves the possibility of changing policy at any given time in the future. This was a fundamentally new insight compared with the belief that the authorities had unlimited possibilities for managing the economy, a view that had dominated economic policy in previous decades. 1  Skånland, Hermod (2004): “Doktriner og økonomisk styring. Et tilbakeblikk”, Norges Banks skriftserie nr. 36 (“Doctrines and economic management in retrospect”, Norges Bank’s Occasional Papers, no. 36) (in Norwegian only). 2  See Kydland, F. E. and E. C. Prescott (1977): “Rules rather than discretion: the inconsistency of optimal plans”, Journal of Political Economy 85, 473-490. 3  Lucas, R. E. (1976): “Econometric Policy Evaluation: A Critique” Carnegie-Rochester Conference Series on Public Policy 1, 19-46. BIS Review 4/2005  1  One example used by Kydland and Prescott is what can happen when the authorities impose heavy taxes on capital today at the same time as they promise to lower taxes in the future. If firms believe this, they will increase investment now. However, when the increased real capital stock becomes a fact, the authorities may be tempted to disregard their promise of lower taxes. The purpose of reducing taxes has already been achieved. A breach of promise may be accepted once.