As long as economic fundamentals do not support the krone exchange rate at the initial range, it is highly unlikely that this would persist. If monetary policy has contributed to a deflationary recession, it could not be characterised as successful even if the krone has been stable around the initial range for a period, because this would have created the basis for future fluctuations in the exchange rate. Similarly, a krone exchange rate around the initial range combined with high inflation will not be sustainable. Monetary policy could not be said to have been successful in relation to the guidelines because, also in this case, it must be assumed that it was partly responsible for creating the basis for an unstable krone exchange rate at a later stage. The Norwegian economy may be exposed to economic disturbances that contribute both to higher inflation and to a temporary appreciation of the krone exchange rate. In this situation, monetary policy should have attempted to counter a sustained higher level of inflation because higher inflation provides the basis for subsequent krone instability. However, Norges Bank should in advance have notified the government authorities, which should also have evaluated other measures for stabilising economic developments. The Norwegian economy may also be exposed to negative events that provide the prospect of a deflationary recession and a depreciation of the krone. For example, a fall in oil prices may influence the economy in this direction.
Trade unions base their wage negotiations on expectations regarding price inflation and developments in employment over the next few years. Expectations play an important part in financial markets. Equity prices and exchange rates may fluctuate widely as a result of changes in the expectations of market participants. Because expectations are of such importance to economic planning and decisions, it is essential that there is confidence in the nominal anchor. This makes it possible to achieve nominal stability with smaller disturbances in the real economy and lower unemployment. BIS Review 7/2001  1  Although nominal stability is a prerequisite for sound developments in the real economy over time, conflicts may develop in the short term. Such conflicts may occur if there are disturbances on the production or supply side of the economy which give rise to higher price and cost inflation that does not actually reflect increased pressures in the economy. Examples of such disturbances are cost-push shocks resulting from negotiations, or weaker productivity growth. When disturbances of this type occur on the supply side of the economy, there may be a trade-off between fluctuations in nominal prices and wages and fluctuations in production and employment. A trade-off of this kind is illustrated in Chart 2. The chart shows that using strong instruments to achieve an inflation target or exchange rate target in the short term results in more pronounced fluctuations in the real economy.