The central bank alone cannot, with the instruments at its disposal, steer the exchange rate. During the years when a fixed or stable exchange rate was the objective of monetary policy, fiscal policy was responsible for smoothing fluctuations in the economy. At the same time, incomes policy’s role was to keep wage growth in line with wage growth abroad. The objective of exchange rate stability therefore provided a framework for economic policy. When foreign interest rates moved up, the interest rate in Norway also had to be raised in order to prevent a weakening of the krone. Conversely, interest rates in Norway were often reduced following a reduction in interest rates abroad. One can imagine how this division of responsibility would have been implemented in the face of the disturbances to the Norwegian economy which occurred in 2001 and 2002. The upward tendency of the krone would have led to reductions in the interest rate down to the international level. As a result, interest rates would also have reached a historical low in Norway. Low interest rates would have fuelled lending growth, pushed up house prices and intensified the shortage of labour. In order to prevent another bubble of this type in the Norwegian economy, substantial fiscal policy tightening would have been required in 2001, 2002 and 2003. The fiscal rule stipulates that the central government budget deficit shall over time be equivalent to the expected real return on the Government Petroleum Fund.
However, towards the end of the upturn the economy was facing labour shortages, higher wage growth and a sharp increase in household consumption and debt. Interest rates had to be kept at a high level in Norway. Chart 9. Cyclical divergence Short-term interest rates in the US and Norway 10  10 8  Norway  8 6  6  4  4  US 2  2  0  0 1995  1996  1997  1998  1999  2000  2001  2002  2003  Source: EcoWin  The turnaround abroad took place two years ago, but the Norwegian economy continued to show a high level of activity. This led to a widening of the interest rate differential against other countries. The main explanation for the wide interest rate differential is not that interest rates are high in Norway, but that interest rates are at a historic low abroad. Interest rates in the US have not been at such a low level since the 1960s. 1  Measured by the monthly average of the import-weighted exchange rate against 44 countries, the krone was at its weakest level in May 2000 since May 1994. Measured by the monthly average of the trade-weighted exchange rate index, the krone was at its weakest level in May 2002 since the series was started in January 1971. Measured by both indices, there were a few days in autumn and winter 1998 when the krone was weaker than in May 2000.