3) Wider inflation differential against trading partners The Asian crisis has resulted in reduced international consumer price inflation. General pressures in the economy have had only a marginal impact on price inflation in Norway. Consumer price inflation hovered around 2.5 per cent throughout 1998, which was well below the level anticipated by most observers. The fall in import prices has been the main factor restraining the rise in prices. The Asian crisis has probably had a dampening impact on international price inflation. The direct effect of the crisis has been a fall in the prices of goods produced in Asian countries and the indirect effect has been a slowdown in global demand and intensified price competition across countries. As a result, commodity and producer prices have also fallen. The widening of the inflation differential projected by Norges Bank has occurred as result of reduced inflation in other countries. Wide sectoral differences in price developments Although inflation has remained stable in Norway, there are wide differences in price developments among various sectors. Services prices have shown the sharpest rise, moving up by BIS Review 10/1999  –4–  as much as 7 per cent in 1998. The main explanatory factor is that the high level of wage growth has a greater impact on this sector as labour costs account for a substantial share of total costs. The rise in the consumer price index is being restrained by subdued or zero import price inflation.
This means that heavy and prolonged interventions may be self-reinforcing over time, steadily increasing the necessary volume of intervention purchases required to maintain the krone exchange rate. The foremost example of such a game situation in Norway’s exchange rate policy history was Friday, 20 November 1992, when we made intervention purchases for NOK 37 billion from the time the market opened until the market closed. Norges Bank does not want to intervene in such a way that this type of game situation arises. However, the Bank will use interventions if the krone moves substantially out of line with what we consider to be reasonable based on fundamentals or in the event of exceptional short-term volatility. It may also be appropriate to reinforce a desired development in the exchange rate that has already been observed in the market. In such a situation, it is assumed that the risk of ending up in a game situation against exchange market players is marginal. However, we must take into account that the krone exchange rate cannot in the long run deviate substantially from the level implied by economic fundamentals. The instrument available to Norges Bank for influencing economic fundamentals is the interest rate. Over time, therefore, the interest rate is the most important instrument of monetary and BIS Review 10/1999  –8–  exchange rate policy. This is also recognised in the formulation of the guidelines for monetary policy. According to the National Budget for 1999, “Interest rates must be adjusted in order to avoid persistent and large-scale interventions”.