The recent fall in oil prices will ease the pressure on firms’ input costs allowing them to restore profit margins without an increase in output prices. Nevertheless, according to surveys, businesses are more likely to raise prices than during the NICE decade. And in their own survey, the Bank’s Agents found that half of those (largely manufacturing) firms which had experienced some erosion of margins were now intending to raise prices. 2  2  Not so bad: not of the same order but also desirable. Speech at the Eden Project, Cornwall, October 2004. BIS Review 94/2006  A change in oil prices does not in itself tell us where overall inflation is headed in the medium term. For that, we need to look at the balance between money spending and potential supply. The growth of total money spending in the economy has picked up in recent quarters – nominal domestic demand rose by 6% in the year to Q2. And the growth rate of broad money and credit in the economy is now higher than at any point since 1990. There is, however, great uncertainty about potential supply. The possibility of continuing migration from the new member countries of the European Union and elsewhere is likely to increase the potential labour force available to UK employers. And it appears that more people of pensionable age are choosing to continue to work.
Norges Bank has no set target for the level of the exchange rate. Nevertheless, developments in the krone are of considerable importance to interest-rate setting because the exchange rate has an impact on inflation and output. An important channel for monetary policy is the foreign exchange market and the krone exchange rate. Although the krone fluctuates, the krone exchange rate is not particularly unstable compared with other countries’ currencies. The krone exchange rate is the price of our currency measured in a foreign currency. Developments in other countries are just as important for the krone as developments in the Norwegian economy. Capital flows freely and flows can change rapidly. This can spill over to exchange rates and interest rates as well as output and employment. There is a cost involved for businesses in hedging against fluctuations in the krone. A krone that is stable - but too strong - also entails social costs in the form of low activity. Similarly, a krone that is stable - but too weak - is a source of high inflation. From spring 1999 to December 2002, the interest rate in Norway was fairly stable at between 5.5 per cent and 7 per cent. In other countries, the interest rate fell in 2000 and 2001 when the ICT and equity bubbles burst. The interest rate differential between Norway and other countries widened due to cyclical divergence. The period of high capacity utilisation continued for a longer period in Norway, with strong wage and cost inflation.