Furthermore, in some cases housing prices did go up high, with clear indications that there was a bubble. However, their financial systems made it through and remained stable and,  1  A flexible inflation targeting regime balances the cost of output fluctuations with those of inflation instability, and the result should be a decline in both, output and inflation volatility. For an exposition of this framework and how it relates to the definition of the inflation target parameters see De Gregorio (2009a). BIS Review 113/2009  1  despite the current difficulties, have avoided acute financial crises. This is the case of, for example, Australia and Spain. Naturally, when facing disproportionate increases in housing prices, both the increase in credit and the boom in construction are symptoms that the downturn will be severe. Still, this need not result in a systemic financial meltdown. In any case, monetary policy can and does help in the creation of bubbles, although not so much by the level of the interest rate but by the monetary policy strategy with which financial turmoil is dealt with. In the United States, the strategy of turning a blind eye to the period of soaring asset prices and then, when the bubble burst, reducing aggressively interest rates used to be the Fed’s strategy (the “mop-up strategy” according to Blinder and Reis, 2005). This approach was first used on the “Black Monday” of October 1987, then with the breakdown of Long-Term Capital Management (LTCM) and later with the bursting of the high-tech bubble.
But perhaps it has been equally important that it has been possible to adjust workforces and wage growth at a local level. First, companies can adapt the use of labour to production by using overtime, part-time positions or contract labour. Moreover, the supply of labour is highly flexible. When demand rises, the number of job-seekers increases. Those who are already employed work more. During an upturn, we have in particular observed an increase in labour force participation among young people. Along the same lines, the number of persons in education tends to rise when unemployment is rising. When labour demand increases, we see an influx of job-seekers from our neighbouring countries. In addition, close to 30 000 persons had some form of employment in Norway throughout or during parts of 2001, but resided in Sweden. With the enlargement of the EU Norway has become part of a larger labour market. Enlargement also provides scope for increased trade in services. This increases the production capacity of the Norwegian economy. For example, it seems that capacity in the construction industry has increased. The activity level is now very high, and there are still no signs of rising wage growth. Hence, labour mobility can eliminate bottlenecks in the labour market. Employment is also strengthened by local wage negotiations. Some of the newer industries apply performance-related pay to a greater extent, allowing firms to reduce costs more easily while retaining employees when earnings decline. There also seems to be wage flexibility in more traditional industries.