The target is set at 2.5 per cent. In the euro area, monetary policy is oriented towards price stability, defined as inflation below but close to 2 per cent. Inflation targeting has proved to be a sound system and particularly well suited for small, open economies. Normally, interest rate setting under an inflation targeting regime will also contribute to stabilising output and employment. In periods of recession, with prospects of low and falling inflation, the interest rate will be reduced to boost demand and prevent an inflation level that is too low. During an upturn when there are prospects of high inflation, the interest rate will be increased. Inflation targeting is softer around the edges than the exchange rate regimes Norway and many other countries operated earlier. The system has proved fairly robust to disturbances. Nevertheless, the soft landing of the Norwegian economy after several years of high domestic cost inflation and a low level of activity abroad must not lead us to believe that output and employment cannot show pronounced fluctuations in the future. We cannot expect the interest rate to have the same impact from one period to the next. The economy is also exposed to unexpected disturbances. As a result, we cannot fine-tune economic developments using the interest rate, but avoid the largest effects when the economy is exposed to disturbances. Experience seems to indicate that inflation expectations remain stable even if inflation varies somewhat as long as the interest rate is used actively to curb effects.
A smooth functioning of the banking sector is therefore clearly an essential element in the resolution of Europe’s problems. As a central banker and supervisor, I see three major tools which can help to ensure appropriate financing of the economy and financial stability – both of which are essential financial conditions for sustainable growth. 1. Financial regulation and supervision must be tailored to the two objectives of strengthening the financial sector while ensuring an appropriate financing of the economy. Of course, after the 2008 financial crisis, the most urgent priority was to re-establish financial stability and bolster resilience to financial shocks. But in the implementation process of the new Basel 3 rules, we need to pay the utmost attention to their potential consequences for the financing of the economy, especially in view of the much shorter agenda. In particular, the new liquidity rules need to be adjusted. In addition, much more progress is now needed in the area of “shadow banking”. 2. Since the beginning of the crisis, the Eurosystem has constantly provided all possible support within the scope of its mandate to help the banking system overcome its difficulties. For instance, the idea of the two LTROs was to remove funding pressures in order to allow a smoother adaptation to the new rules and difficult environment. Simultaneously, this aimed to prevent a major credit crunch that would compromise both the financing of the economy and the maintenance of price stability in the area.