As in Australia and Canada, by law the political authorities have the right to issue instructions to the central bank in matters of special importance. However, this right has never been exercised. The Norges Bank Act requires Norges Bank to inform the ministry when, in the opinion of the Bank, there is a need for measures to be taken by others than the Bank in the field of monetary, credit or foreign exchange policy. For example, in a scenario with a sharp and prolonged fall in oil prices, the krone exchange rate may remain outside the initial range for an extended period. If Norges Bank responds by raising interest rates in order to force the krone back to its initial range, monetary policy could trigger a recession of a type that will undermine confidence in the krone. Similarly, after an appreciation a situation may arise in which interest rates must be set at such a low level to return the krone exchange rate to the initial range that this results in higher inflation. The basis for exchange rate stability is weakened in both cases. Hence, Norges Bank cannot with open eyes orient policy instruments in such a way that they fuel inflation or lead to a deflationary recession.
The portion used by oil companies in Norway, partly to finance investment, also has an effect on the mainland economy. We can say that oil revenues enter the Norwegian economy through an external and an internal circular flow. The distinction between the external and internal circular flow is important for exchange rate stability. This means, among other things, that short-term changes in oil prices shall not influence the orientation of economic policy. If the distinction between the two circular flows were to break down, and the use of oil revenues were to fluctuate more in step with oil prices, we would have an unstable economy, and hence an unstable exchange rate. The Government Petroleum Fund thus has two objectives. It serves as a buffer for the mainland economy against fluctuations in oil revenues, and it manages a considerable portion of the government’s financial wealth. In addition to capital outflow from the Petroleum Fund, in recent years there have also been considerable capital outflows from various non-oil sectors. As in other Nordic countries, large asset managers such as life insurance companies and securities funds accumulated substantial holdings of foreign equities and bonds in the latter half of the 1990s. These portfolio investments abroad reflect a desire to diversify risk. The substantial net outflow of long-term capital from the private sector may partly reflect a thin Norwegian capital market. The Norwegian bond market is not very developed and the total value of equities in the Norwegian market in relation to GDP is very low.