9  BIS Review 121/1999  Chart 10 How interest rates affect the economy  Exchange rate  NBs interest rates  •Market interest rates •Lending and deposit rates  •Demand & production •Loans, investment, share prices •Wages and prices •External balance  Legg inn filadresse her  8. Exercising discretion in monetary policy  The mandate stipulates the objective of monetary policy, but Norges Bank has to choose how to achieve the objective. As shown, the krone exchange rate has fluctuated in recent years in spite of Norges Bank’s active use of instruments, indicating that Norges Bank cannot fine-tune movements in the krone exchange rate. The exchange rate will also in the future be influenced by factors that are not under the control of Norges Bank, like fluctuations in international financial markets, the evolution of the price of oil, fiscal policy, and developments in domestic prices and costs. Thus, in its use of the interest rate Norges Bank focuses on the preconditions for stability of the krone exchange rate over time. The interest rate affects the exchange rate directly through returns on holding kroner, but also indirectly through the effects of the interest rate on inflation and output. More specifically, stability of the exchange rate requires that: •  Price and cost inflation must be brought down to the level aimed at by euro countries. •  Monetary policy must not in itself contribute to deflationary recessions, as this would undermine confidence in the krone. Let me explain in more detail.
It is under such circumstances that output and employment have tended to suffer severely, leading to actual deflation. That, of course, is what prompted the Swedish political system’s resolute intervention at the time of the bank crisis here about a decade ago. It was a matter, not of protecting the banks as such or their owners from losses, but of safeguarding the banks’ central function in our economy. Maintaining a modern market economy would be virtually impossible/ without an efficient credit supply and payment system. In the present context it is positive that the banking sector is functioning well even though stock markets around the world have fallen steeply in recent years. There are also many signs that the banking sector has learnt a good deal from the financial problems in the last few decades. As regards general economic policy, we know that focusing on low and stable inflation creates a better and securer environment for economic policy decisions on the whole. A credible long-term commitment to low inflation does away with some of the uncertainty about future income streams,  BIS Review 50/2002  3  which are what ultimately determine the fundamental value of various kinds of asset. Such a commitment should also provide better conditions for financial decisions. But there is more to it than that. As representatives of the Austrian School pointed out, business cycles are not exactly alike.