Interest rate expectations for the next few years largely depend on the economic outlook and market expectations concerning monetary policy. In the long term, up to ten years, market participants are unlikely to have any particular expectations concerning cyclical fluctuations. The forward rate may then be interpreted as the sum of the expected real interest rate and expected inflation when the economy is in balance. Without limitations on capital movements, the real interest rate must be expected to develop approximately the same across countries over time. If there are no systematic differences in the risk premium between countries, differences in forward rates may be interpreted as differences in inflation expectations between countries. In the euro area, the inflation target is below, but close to 2 per cent. This results in an inflation differential of ½ - 1 percentage point against Norway. An investor must therefore have an interest rate in Norway that is ½ - 1 percentage point higher than in Germany in order to achieve the same expected real return in the two countries. Following the introduction of the inflation target, the difference between German and Norwegian forward rates was about 1 percentage point for a long time. So far in 2003, this differential has been somewhat lower. This interest rate differential indicates that the market is confident that we will achieve the inflation target. This line of reasoning can also be reversed. Given stable inflation expectations of 2½ per cent, i.e.
Income from employment normally varies in the course of a lifetime. Earnings are low when we are young, rising in our middle years, before falling again as we reach retirement age. Many people raise loans in early adulthood, repay their loan and build up positive net wealth as they reach middle age, then draw on their savings towards the end of their lives. This results in consumption that is more evenly spread over a lifetime than implied by the flow of annual income. A company’s investment choices also involve the choice between present and future consumption. Owners may give priority to present consumption by taking out dividends, or they can invest profits in the company and thereby lay the basis for larger profits later. By placing capital at the disposal of others, in other words by saving, one’s own consumption is postponed. People require compensation for this, both because human beings are impatient and because there is a certain probability we may not live to see the future. The interest rate provides this compensation. If we want to use our money for consumption now or to finance investments by raising loans, the interest rate is the price we must pay in order to do so. The interest rate is therefore a key variable in our choice between consumption now or in the future. Interest rates are the terms at which money or goods today may be traded off for money or goods at a future date. The interest rate is also the price of money.