Today’s flexible inflation targeting regime establishes a firm framework for monetary policy and provides clear guidelines on how monetary policy is to respond in different situations. The fiscal policy authorities can thus internalise the monetary policy response pattern. This is only natural, since the mandate for monetary policy was laid down by the Government and the Storting. In other words, the proper framework is in place for delegating interest rate decisions, but the central bank’s response pattern must be known, so that the fiscal authorities can take this into account. Game situations that may arise with an independent central bank with an inflation target are further discussed in Leitemo (2000) and in Steigum (2000). Norges Bank analyses the inflation outlook three times a year in its Inflation Report. The Executive Board discusses the economic outlook at a separate meeting three weeks before the Inflation Report is presented. The following day, the Executive Board summarises its discussions and assesses the consequences for monetary policy for the next four months. This assessment constitutes an important internal reference when the Executive Board later makes a decision regarding the interest rate. It will also provide the basis for our external communication through speeches and the media. The key rate is assessed by the Executive Board every sixth week. Monetary policy decisions are announced in a press release followed by a press conference.
Against this backdrop, consumer price inflation, with an unchanged key rate of 6.5 per cent and an unchanged krone exchange rate from the average exchange rate for the second quarter, was projected at 2¾ per cent from the summer of 2004. 1  Cf. Cournot-Nash equilibrium in game theory  2  2 Cf. Stackelberg equilibrium in game theory  4  BIS Review 59/2002  Projections showed that price inflation could be lower than 2½ per cent in the short run. If we had tried to reach the inflation target in the short term, i.e. strict inflation targeting, we would have lowered the key rate. We know that would probably imply a weaker krone and higher inflation. A more pronounced increase in interest rates than the increase we actually implemented would then probably have been necessary in a year’s time. This would have led to unnecessary fluctuations in output and employment. Nor did concerns about stabilising output and employment warrant an easing of monetary policy. Had we placed greater emphasis on these variables, i.e. a strict output target, monetary policy should have been tighter and the interest rate higher to prevent a borrowing and spending spree, resulting in wider variations in the inflation. On the basis of an overall assessment, the key rate was raised by 0.5 percentage point to 7 per cent at the monetary policy meeting that same day.