The operational target of monetary policy as defined by the Government is inflation of close to 2.5 per cent over time. The inflation target provides an anchor for economic agents’ choices concerning saving, investment, budgets and wages. Households, businesses, public entities, employees and employers can base decisions on the assumption that inflation in Norway will be 2.5 per cent over time. High oil prices have a different impact in Norway than in oil-importing countries. When oil prices increase, the value of Norway’s national wealth rises. The idea behind the Petroleum Fund is that the cash flow from an increase in oil prices should accrue to the Fund and be invested abroad and should not be included directly in the government budget. As a result, the increase in the cash flow will not affect the domestic economy. Likewise, a fall in oil prices will not have an immediate impact on the domestic economy, but result in a lower accumulation of foreign assets. Even though the Petroleum Fund and the fiscal rule shield the Norwegian economy to a certain extent from fluctuations in the oil market, the Norwegian economy will still be affected by developments in oil prices. If changes in oil prices influence growth in the global economy, this will in turn impact Norwegian exports of traditional goods and services. Petroleum investment on the Norwegian continental shelf is another important channel. Fluctuating oil prices contribute to substantial variations in petroleum investment. This has spillover effects on the mainland economy.
As a personal reflection I can say that explaining the importance of low inflation is much easier - not least for a central bank governor - than the task of selling the advantages of a stable currency. This is particularly true as the latter task becomes increasingly pressing if the economy has been hit by problems with costs and is facing speculative attacks. Some of you may remember that for a few days in the autumn of 1992 the instrumental rate in Sweden was raised to as much as 500 per cent. In my view, this is probably one important explanation why Sweden is not a member of the ERM system - at least not at this stage. The challenge during the 1990s for the inflation targeting countries has been to build a rigorous framework around the new regime. Answers have been needed in particular to questions like the following: What rate of inflation should be targeted, what index should be used, are bands around the target necessary, the degree of transparency, etc. It has also been important to formulate a monetary policy reaction function, that is, to define the balance between inflation variability and output variability. The reason why central banks do not aim for maximum short-term stability in either inflation or output is that attaining only one of the targets would be costly.