The search for yield that prompted excessive risk-taking was the result of low long-term interest rates around the world, not simply rates in the UK. So what would have happened had we adopted the counter-factual policy of higher levels of Bank rate? Of course, it is impossible to know with certainty. And much depends on what would have happened to the exchange rate. On the MPC, two views were discussed. One was that by setting interest rates at a much higher level, so dampening domestic demand and output growth, expectations of the long-run exchange rate consistent with a sustainable path of domestic demand might be dislodged and “jolted” down to a lower equilibrium level – from A to B in Chart 8. Certainly, there seemed good reason at the time to imagine that slower growth at home might mean that hot money would return to countries experiencing stronger growth. As a result, the current exchange rate would have fallen from O to P in Chart 8 and then been expected to follow the path PB consistent with uncovered interest rate parity. The result would have been higher external demand to offset weaker domestic demand. After a time, we might have attained “one-speed” growth, so avoiding the unpalatable choice between “two-speed” and no growth.
At the same time, the rule made fiscal policy more robust: By decoupling spending from current petroleum revenues, the fiscal rule provides for a gradual and sustainable phasing-in of petroleum revenue spending. The guidelines ensure the necessary flexibility to allow automatic stabilisers to work, and they allow for careful countercyclical policy. The savings plan has remained intact and the Fund has now reached a size of nearly NOK 4 trillion, or 130 percent of GDP. When the fiscal rule was introduced in 2001, Norges Bank was charged with the task of keeping inflation low and stable. Thus, our traditional fixed exchange rate policy was abandoned. A clear division of responsibilities between monetary and fiscal policy was now established. Norges Bank’s conduct of monetary policy is geared towards low and stable inflation. The operational target of monetary policy is consumer price inflation of close to 2.5 per cent over time. When setting the key policy rate, we also take into account the impact of the interest rate on output and employment. In addition we give weight to the risk that a prolonged period of low interest rates can lead to elevated risk-taking and excessive debt accumulation in the household and business sectors. Inflation targeting has become more flexible. The present economic situation in much of the rest of Europe stands in contrast to ours. In Norway, domestic activity is high, and particularly so in the oil industry and the construction sector. Unemployment remains low and stable. But the Norwegian economy is not unaffected by the turbulence abroad.