This was the result of weaker cyclical developments in the world economy and a sharp drop in interest rates internationally. In addition, the Norwegian business sector has felt the effects of the high Norwegian cost level and the strong krone exchange rate. Public agencies have also had to adapt activities as a result of last year’s wage settlement. The weak prospects abroad and at home have in turn had an impact on the Norwegian labour market and the outlook for wage growth and inflation in the years ahead. The mandate implies that the interest rate must be adapted to the outlook for the Norwegian economy. If it appears that inflation will be higher than 2½ per cent with an unchanged interest rate, the interest rate will be increased. If it appears that inflation will be lower than 2½ per cent with an unchanged interest rate, the interest rate will be reduced. Normally, this orientation of monetary policy will also contribute to stabilising output and employment. The impact of monetary policy occurs with a lag. The current inflation rate does not provide sufficient information to determine the level at which interest rates should be set now. Our analyses indicate that a substantial share of the effects of an interest rate change will occur within two years. Thus, two years is normally a reasonable time horizon for reaching the inflation target. The interest rate influences inflation indirectly via domestic demand for goods and services and via its effect on the exchange rate.
Jarle Bergo: Monetary policy and business cycles Speech by Mr Jarle Bergo, Deputy Governor of Norges Bank (Central Bank of Norway), at Kunnskapsparken Bodø, 25 September 2003. The text below may differ slightly from the actual presentation. The address is based on the assessments presented at Norges Bank’s press conference following the Executive Board’s monetary policy meeting on 17 September and on previous speeches. The Charts in pdf can also be found on the website of the Norges Bank. *  *  *  The operational target of monetary policy as defined by the Government is inflation of close to 2.5 per cent over time. 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. This intention is also expressed in the Regulation on Monetary Policy. High demand for goods and services and labour shortages normally point to higher inflation. When interest rates are increased, demand falls and inflation is kept at bay. When demand is low and unemployment rises, inflation will tend to slow. Interest rates will then be reduced. Norges Bank sets the interest rate so that future inflation will be equal to the inflation target of 2½ per cent. The interest rate has been reduced since December last year in response to the change in the inflation outlook.