The line in the chart will therefore move further down and to the left with a more credible monetary policy. 3. Norwegian monetary policy and cyclical fluctuations  In the long term, we cannot influence growth potential or prosperity by means of monetary policy - not even in Norway. But we can influence the fluctuations in the economy, the short-term cyclical movements. Norges Bank also takes into account that monetary policy should not cause unreasonably sharp fluctuations in output by setting a relatively long-term horizon for the attainment of the inflation target, and allowing deviations in the intervening period. It would probably be possible by a very aggressive use of instruments to force inflation back to the target within a time frame of 3-4 quarters - perhaps even less if the foreign exchange channel is strong. This would cause very pronounced fluctuations in the real economy, however. In this sense, variations in output enter our “loss function”. The thinking that follows from the theoretical research is to a large degree present in the actual setting of interest rates. For practical purposes, we, and other central banks with inflation targeting, make estimates of future price inflation. Our instruments are oriented in such a way that there are prospects of attaining the inflation target two years ahead. The theoretical literature has given us useful knowledge as to how far forward in time this horizon should be set. The result of using too short a horizon will be considerable instability in output and in nominal and real interest rates.
But Beauty comes in a package along with the Beast, and the Beast in this case is the single monetary policy - the single, one-size-fits-all, interest rate. The trouble is that it may not in the event suit the domestic monetary policy needs of the different individual Euro-area countries. And if you don’t find that instantly repulsive I suggest you ask yourself how, at this particular juncture, we could keep the economic porridge - if I may mix my fairy stories - at just the right temperature if we were obliged now to have German-level interest rates. Now you can’t just hope the Beast will never appear. I don’t know of any serious analysis that doesn’t acknowledge that tensions could arise between the domestic policy needs of BIS Review 14/1997  -2-  the different member countries - as a result of different cyclical positions, or different fiscal policies, or as a result of external shocks which affect some member countries more than others, or as a result of structural changes in one member country as against another. The risks, like the potential benefits, are, as I say, real. You might more reasonably hope that Beauty’s Beast will turn into Prince Charming - and that all their problems turn out to be little ones. But I have to tell you that it was always at this point in the story that I began to wonder if my mother was making it all up!