A flexible exchange rate can reduce fluctuations in employment and output. Empirical studies do not provide any evidence that floating exchange rates have reduced growth in industrial countries. Rather, they suggest that industrial countries with floating exchange rates have fared well, and often better, than countries with an exchange rate target. A precondition is that there is an economic policy framework so that inflation does not spin out of control. Economic developments and prospects External cyclical developments and events have had considerable implications for developments in the Norwegian economy. BIS Review 11/2004  9  Chart 12. a. Output gap  b. Inflation  Deviation from trend BNP. Per cent  Per cent  5  4  4  US  2  Euro area  3  0 2  -2  1  Euro area  -4 1992  1996  2000  US  2004  0 1992  1996  2000  2004  Sources: OECD and EcoWin  The US fuelled the international upswing in the 1990s, with strong growth in private consumption, rising equity prices and a high level of investment. Inflation was low because productivity increased. In Continental Europe, the upturn started later and was weaker. Capacity utilisation in Germany and France was low through most of the 1990s. Chart 13.
An economic turnaround has occurred, with a soft landing after the long period of high cost inflation in Norway and a low level of activity in other countries. But inflation is too low. As mentioned, there are three main factors that have contributed to this. First, the global downturn had considerable implications for the impact of interest-rate setting in Norway. A strong krone contributed to the decline in inflation. The krone has now returned to its previous level so that the effect will be reversed. Second, low inflation in other countries and rapid changes in the international division of labour have resulted in a fall in prices for imported goods and services, even when measured in terms of what Norwegian importers pay in foreign currency. Third, intensified domestic competition also appears to have exerted downward pressure on prices. As a result of both changes in the international division of labour and increased domestic competition, there is idle labour and available real capital in Norway. We cannot rule out that adjustments will be made over a period of time and that these adjustments will encompass a large portion of the domestic economy. Thus, it is possible that the level of output that is consistent with stable inflation will increase. Inflation will remain low in 2004. However, the easing of monetary policy will gradually push up inflation. As mentioned, it may take some time before interest rates in other countries are increased to a considerable extent.