A persistently high rate of increase in house prices can in isolation engender expectations of a further rise and can thus prove to be self-reinforcing for a period and push up credit demand. At the same time, the switch to a flexible inflation targeting regime reduces the possibility of exposing households to a double shock in the form of higher unemployment and higher interest rates, as was the case prior to the banking crisis in the beginning of the 1990s. If the economy is exposed to disturbances that may lead to higher unemployment, inflation will normally decline and interest rates will be lowered. High debt growth increases the vulnerability of households to economic disturbances. As a result of low interest rates, the household interest burden will remain fairly low in spite of high debt growth. It may prove to be particularly challenging for borrowers to assess their debt-servicing  4  BIS Review 53/2004  capacity over time in a period when the interest rate is abnormally low. Such a low interest rate also places particular demands on banks in assessing the creditworthiness of borrowers. The interest rate can be used to reduce credit demand. At present - with low interest rates abroad and a close link between domestic interest rates and the krone - a tighter monetary policy would restrain credit demand primarily because job security would be reduced as a result of a stronger krone. Summary of the situation in the Norwegian economy A turnaround in the Norwegian economy has occurred.
The economy has experienced a soft landing after the long period of high cost inflation in Norway and sluggish external activity. •  Output has returned to trend and is now showing a marked rise. •  Employment has returned to trend and is rising. •  Unemployment is at the 1996-level, and is at the average for the 1990s. •  Wage growth is broadly in line with a level that is consistent with the inflation target given nomal productivity growth. •  Overall credit growth is balanced. Credit is expanding broadly in line with trend growth in nominal GDP. •  Labour costs in Norway relative to our trading partners are now broadly in line with a long-term average. •  The nominal krone exchange rate is in line with the average for the 1990s. •  The interest rate level is near the level prevailing among our trading partners. •  Inflation expectations are approximately consistent with the target. In that respect, there is equilibrium in the Norwegian economy. But the current inflation rate is low, and external and domestic interest rates are low. Lagged effects of the strong krone in 2002 are exerting downward pressure on inflation. At the same time, a change in trade patterns and external economic conditions are pushing down import prices, even when measured in terms of what Norwegian importers pay in foreign currency. In Norway, intensified competition appears to be resulting in high productivity growth, which is probably contributing to low inflation.