An inflation target of 2½ per cent and trend productivity growth of around 2 per cent, according to updated national accounts figures, imply annual nominal wage growth of about 4½ per cent. These figures are consistent with developments in the 1990s, when wage growth averaged 4½ per cent. This resulted in inflation of 2½ per cent. The krone exchange rate was stable. In general, an unexpected upward shift in labour costs will prompt an increase in interest rates in order to avoid higher inflation. With a floating exchange rate and unchanged interest rates, an increase in wage growth of one percentage point will eventually translate into a comparable increase in price inflation, unless this increase is based on higher productivity. The magnitude of the interest rate increase must be adapted to this. First, the nominal interest rate must be increased to maintain the real interest rate. Second, the real interest rate must also be increased in order to prevent inflation from accelerating.
Financial stability does not mean that bank insolvencies should be excluded or that stock markets should develop smoothly. We are concerned about financial stability because of the macroeconomic implications of financial turmoil. First, financial stability is a prerequisite for the successful implementation of monetary policy. Second, a stable financial sector is necessary for the smooth functioning of the economy as a whole. Third, central banks have an interest in financial stability because they know that in the event of financial crisis their role as ultimate liquidity provider could interfere severely with their traditional objective of price stability. 1  Greenspan, 1998. BIS Review 74/2007  1  1. The HLI industry  In order to assess whether HLIs constitute a major risk to financial stability, it may be helpful to discuss the exact meaning of the terms “highly leveraged institution” and “hedge fund”. Legal – or any other generally accepted – definitions do not exist yet. However, there are several characteristics that such institutions have in common. They are privately offered investment vehicles that pool the investments of high-net-worth individuals and family businesses, the HLI managers themselves and, increasingly, institutional investors. Often there are minimum investment requirements that restrict access to HLIs. Thus retail investors are mainly indirectly exposed to HLIs: actively through investments in funds of funds or passively through pension funds. HLIs deploy active investment strategies to pursue superior absolute return. Usually HLIs also employ leverage. HLIs are only lightly regulated and are not subject to supervision.