6  BIS Review 69/2010  Inflation targeting has served the Norwegian economy well in the run-up to the crisis and later. Inflation expectations are firmly anchored. This is partly because inflation has on average over time been close to, but somewhat lower than, the target of 2.5 per cent, and because annual variations have not been pronounced. Inflation measured by the CPI is now 3.3 per cent, but 2 per cent if the temporary increase in electricity prices is excluded. Inflation will fall later in the year. In the period of expansion in the Norwegian economy up to summer 2008, the increase in the interest rate contributed to keeping inflation low. During the crisis, we were able to reduce the interest rate markedly without an upward shift in inflation expectations. The real interest rate turned negative. The interest rate reduction rapidly stopped the fall in consumption and property prices. BIS Review 69/2010  7  The krone exchange rate has also by and large contributed to stabilising inflation and employment. In the short term, the krone exchange rate can fluctuate widely, and it depreciated in autumn 2008 because capital sought safe havens. This helped Norwegian manufacturing in the first phase of the downturn. Since then, the krone has appreciated considerably. This has dampened inflation prospects. Experience from the crisis in other countries indicates that monetary policy alone cannot ensure stable economic developments.
Monetary policy has only one instrument by which to achieve the objective of low and stable inflation, and the interest rate is a crude instrument. Hence, other objectives must be achieved by means of, for example, financial regulation and the tax system. In Norway, a number of arrangements functioned during the financial crisis. Banks’ capital adequacy ratios were at the outset fairly high, with high quality Tier 1 capital, and Norway had a bank guarantee fund financed, albeit only just, by capital paid in by banks. Norges Bank also holds ample foreign exchange reserves and was able to supply foreign exchange to banks. Norwegian banks felt the impact of the global financial crisis primarily as a result of reduced access to funding. Over time, banks have increasingly relied on fairly short-term funding in global markets to finance their lending. This is the main reason why Norwegian banks encountered problems when funding from foreign sources dried up in 2008. For Norwegian banks, the financial crisis essentially proved to be a funding and liquidity crisis. New and increased equity capital and liquidity requirements for banks can promote stability in the financial system. The requirements should probably be more stringent in Norway than the minimum requirement that is likely to be agreed internationally. It is also important to cooperate with the other Nordic countries to avoid a situation where more lightly regulated banks aggressively market loans in Norway.