By allowing greater flexibility with regard to the short-term achievement of goals, it is possible to achieve more stable developments in the real economy. But confidence in the nominal anchor must not be undermined. This may lead to a less favourable trade-off, as illustrated in the chart by the broken line. If there is insufficient confidence in monetary policy, economic agents may expect higher price and cost inflation to persist. This will be taken into account when setting wages and prices. The result will be a wage and price spiral. Experience shows that this in turn leads to slower growth and lower employment. A lack of confidence therefore entails a risk of higher unemployment. In consequence, monetary policy must also focus on movements in nominal variables when the economy is subjected to supply-side shocks in order to prevent the economy from entering a vicious circle. The building of confidence in nominal developments must be given sufficient priority. If there is confidence in monetary policy, economic agents will expect the rise in price and cost inflation to be of short duration. Higher prices will then not feed through to prices for other goods and to wages to the same extent, and there will be less risk of a recession. Confidence in monetary policy therefore results in a better trade-off between nominal fluctuations and fluctuations in production and employment. I have been talking about supply-side shocks to the economy.
It is nevertheless relevant to raise the question as to whether monetary policy in general has been too expansionary. I would, however, point out that monetary policy must be evaluated in relation to the decision-making basis that existed at the time the decisions were made. Given the decision-making basis prevailing in 1999, it seemed likely that the Norwegian economy would experience a growth pause and that price and cost inflation would fall. Moreover, the international financial market was fragile as a result of the many financial crises the previous year. As new information gradually pointed to higher growth in Norway and internationally, coupled with the prospect of higher-than-expected price and cost inflation, we raised the interest rate. It may be that the combination of the decline in interest rates in 1999 and the brighter international growth outlook, partly reflected in higher oil prices, had an impact on expectations formation that we underestimated. Today, the krone exchange rate is approximately in the initial range, while inflation is higher than the level aimed at by the ECB. However, the interest rate is oriented towards bringing price and cost inflation down towards this level. If price and cost inflation remains too high, this will translate into a weak and unstable krone exchange rate sooner or later. 12  BIS Review 7/2001  Conclusion In the conduct of monetary policy we have two objectives. First, we have a long-term perspective where building confidence and credibility is important for ensuring nominal stability.