BIS Review 6/2003  1  Interest rates influence inflation throught their impact on domestic demand and on the market for NOK. When interest rates rise, it becomes more profitable to save and more costly to borrow. This dampens consumption and investment and thereby aggregate demand. Lower demand in turn curbs the rise in prices and wages. Higher interest rates make it more attractive to invest in NOK and borrow in foreign currency. Therefore, higher interest rates normally lead to an appreciation of the krone. This makes imported goods cheaper. In addition, a strong krone reduces activity, profitability and the ability to pay in the internationally exposed sector. It is important to be aware of the relationships between employment, output and inflation. If there is a shortage of labour and other economic resources, a tight monetary policy stance will reduce inflation by affecting aggregate demand. Conversely, when unemployment is high, low interest rates will stimulate demand and contribute to stable wages and prices. A monetary policy stance that is aimed at stabilising inflation will thus also contribute to stabilising aggregate output and employment. 1  The time it takes for a change in interest rates to affect demand and inflation will vary. Our analyses indicate that an interest rate increase of 1 percentage point over two years reduced mainland GDP by ¾ -1 percentage point after two years. The effect is thereafter reversed. The inflation rate is reduced by an estimated 0.20-0.35 percentage point after two years and 0.30-0.40 percentage point after three years.
Svein Gjedrem: Monetary policy and the outlook for the Norwegian economy Speech by Mr Svein Gjedrem, Governor of Norges Bank (Central Bank of Norway), to the Mid-Norway Chamber of Commerce and Industry, Trondheim, 13 November 2003. The speech is based on the assessments presented at Norges Bank’s press conference following the monetary policy meeting on 29 October, Norges Bank’s Inflation Report 3/03, the Report on Monetary Policy 2003 - the first eight months and on previous speeches. The text below may differ slightly from the actual presentation. The Charts in pdf can be found on the Norges Bank’s website. *  *  *  I would like to thank the Mid-Norway Chamber of Commerce and Industry for inviting me to speak to you today on monetary policy and the outlook for the Norwegian economy. The operational target of monetary policy as defined by the Government is inflation of close to 2.5 per cent over time. It is equally important to avoid an inflation rate that is too low as it is to avoid an inflation rate that is too high. The inflation target provides economic agents with an anchor for their decisions concerning saving, investment, budgets and wages. The inflation target also provides a framework for monetary policy’s contribution to stabilising output and employment. This intention is also expressed in the Regulation on Monetary Policy. Normally, Norges Bank sets the interest rate with a view to achieving inflation of 2½ per cent at the two-year horizon.