Monetary policy The operational target of monetary policy as defined by the Government is inflation of close to 2.5 per cent over time. It is just as important to avoid an inflation rate that is too low as it is to avoid an inflation rate that is too high. The inflation target provides economic agents with an anchor for their decisions concerning saving, investment, budgets and wages. The inflation target also provides a framework for monetary policy’s contribution to stabilising output and employment. The economy grows thanks to increases in the supply of labour and capital and technological progress. Average growth over time is referred to as trend growth. Owing to shocks to the economy, actual growth fluctuates around trend growth. The chart shows actual mainland GDP growth and trend GDP growth. BIS Review 16/2004  3  Normally, Norges Bank sets the interest rate with a view to achieving inflation of 2½ per cent two years ahead. A two-year horizon is applied because it takes approximately two years for an interest rate change to have a full impact. A flexible exchange rate Norway is a small open economy with a floating exchange rate. The Norwegian krone does not stand out as particularly volatile. On the contrary, in countries like Sweden, the UK, Switzerland, Australia, Canada and New Zealand, the exchange rate fluctuates just as much - or more - than the Norwegian krone. There is a cost involved for businesses in hedging against fluctuations in the krone.
The key interest rate has been reduced by 5¼ percentage points and is now approximately the same as among our trading partners. The krone has depreciated over the past year, and is in line with the average for the 1990s. Monetary policy is expansionary. This is reflected in low after-tax real interest rates as shown in the chart. The low interest rate level has reduced household net interest expenses. This has increased household purchasing power considerably. Household demand will probably be the most important driving force in the Norwegian economy in the period ahead. Private consumption has a considerable impact on overall demand and activity and accounts for 60 per cent of mainland GDP. Low inflation and reduced interest expenses will support strong growth in household real income. Even with a moderate wage settlement, real income growth may reach about 5%. In addition, improved labour market conditions will strengthen job security and lead to expectations of higher income growth. Against the background of high real income growth, improved job security and expectations of continued low interest rates ahead, household consumption is expected to exhibit strong growth. Growth in private consumption is projected at 5¼% between 2003 and 2004. Given this path, consumption will grow at a pace that is broadly in line with real income, with little change in the saving ratio. After falling last year, house prices edged up in autumn. At the end of 2003, house price inflation was high.