Interest rate developments abroad may have a considerable influence on movements in the krone exchange rate. The inflation outlook in Norway implies that Norway will not be the frontrunner when other countries increase interest rates. As mentioned earlier, themes shift in foreign exchange markets. Norges Bank does not have the instruments for fine-tuning the exchange rate. Normally, Norges Bank will not intervene in the foreign exchange market in order to influence the exchange rate. Foreign exchange market intervention, irrespective of whether foreign exchange is bought or sold, is not an appropriate instrument for influencing the krone over a longer period. We do not wish to act in a way that may trigger a game situation in the foreign exchange market. Foreign exchange intervention rather than a change in the interest rate may give ambiguous signals to foreign exchange operators and a game situation may arise. However, interventions may be appropriate if the krone deviates substantially from the level that the Bank judges to be reasonable in relation to fundamentals, and if exchange rate developments weaken the prospect of achieving the inflation target. Interventions may also be appropriate in response to pronounced short-term fluctuations in the krone when liquidity in the foreign exchange market falls to a very low level. Although the krone may fluctuate in the short term, when inflation is low and stable, the exchange rate will generally stabilise over time. When inflation has been higher in Norway than among our trading partners for a longer period, the krone has generally depreciated.
When inflation in Norway is expected to be broadly in line with that of other countries, the exchange rate will usually also return to its normal range following periods when the krone has been particularly strong or particularly weak. The advantage of a flexible exchange rate is perhaps most evident when the economy is sluggish. If the krone were to remain at a level that is too strong, nominal wages would have to remain unchanged over a longer period or fall in order to bolster companies and jobs. This only occurs when unemployment is very high. With a flexible exchange rate, a depreciation of the krone can also boost competitiveness. A flexible exchange rate can reduce fluctuations in employment and output. 4  BIS Review 34/2004  Empirical studies2 have also suggested that economic growth in industrialised countries with floating exchange rates has been as strong as, and often stronger than, growth in countries with a stable exchange rate. A precondition is that there is an economic policy framework so that inflation does not spin out of control. The real exchange rate The chart shows developments in two measures of the real krone exchange rate, i.e. consumer prices and relative labour costs in Norway relative to trading partners, measured in a common currency. The real exchange rate measured by relative labour costs in a common currency is an expression of the cost competitiveness of Norwegian companies.