Monitoring the European Central Bank 3 ". CEPR London 2001 and Lars E. O. Svensson: Independent Review of the Operation of Monetary Policy in New Zealand: Report to the Minister of Finance. February 2001. BIS Review 51/2001  In Norges Bank, we have used both an unchanged interest rate and an interest rate scenario based on market expectations in our inflation reports. If Norges Bank projects price inflation as higher or lower than 2½ per cent, it is an indication that the Bank envisages an interest rate path that is higher or lower than the path on which the projection is based. There is uncertainty associated with all forecasts. This very uncertainty and the central bank’s assessment of the various risk factors constitute important supplementary information. In our Inflation Reports, the uncertainty associated with the projections is discussed explicitly. An account is given of which variables Norges Bank regards as particularly uncertain, which way this uncertainty points, and how a different scenario could influence price projections. In addition, a fan chart illustrating the uncertainty of the projections is presented. Calculations based on alternative assumptions are presented regularly. This illustrates the isolated effect on price inflation of changes in assumptions. It provides insight into the effect on price inflation of potential disturbances to the economy. We base our analyses and assessments of the inflation outlook and balance of risks on models. The RIMINI macroeconomic model, developed in Norges Bank’s Research Department, has been an important tool for the Bank’s analyses since 1994.
If it appears that inflation will be lower than 2½ per cent with unchanged interest rates, the interest rate will be reduced. There is symmetry here. It is equally important to avoid an inflation rate that is too low, or deflation, as it is to avoid an inflation rate that is too high. When the annual use of petroleum revenues is managed according to a long-term action plan, a policy for which there is currently fairly general political consensus, we should normally be able to use the interest rate as a policy instrument to prevent high inflation. Normally, monetary policy should also be a fairly effective means of countering a deflationary recession. Stagflation, ie stagnating output and rising unemployment combined with rapid inflation, which characterised economic developments in many countries in the 1970s and 1980s, originates in the supply and output side of the economy or in income determination. If the Norwegian economy should ever be threatened by stagflation tendencies, monetary policy must be directed towards maintaining low and stable inflation. At the same time, structural policy and incomes policy should contribute to improving the functioning of the economy, allowing economic growth and employment to pick up. A change in interest rates is not expected to have an immediate effect on inflation. Our analyses indicate that a substantial share of the effects of an interest rate change occurs within two years. Two years is thus a reasonable time horizon for achieving the inflation target of 2½ per cent.