But experience showed that this was not an available option. An attempt to increase output beyond the level that is consistent with stable inflation will over time lead to steadily rising inflation. Economic agents will eventually incorporate higher inflation into their inflation expectations. In the long run, the result will only be higher inflation, not higher employment. Output and employment will return to their potential level. Another important lesson from the 1970s and 1980s was that economic agents look to the future when they make decisions about consumption and investments, wages and prices. They will take into account not only current economy policy, but their expectations of future economic policy. If economic agents expect that tomorrow’s policy will result in high inflation, the cost of reducing inflation may be high in terms of increased unemployment. Therefore, it is important to establish confidence in monetary policy and the objective of price stability. There must be consistency between the stated objectives of economic policy and what is actually done to achieve these objectives. This is the most important reason why the implementation of monetary policy has been delegated to the central bank in Norway, as has been the case in other comparable countries. In Norway, responsibility for interest rate decisions was delegated to Norges Bank through the 1985 Norges Bank Act and through adaptations in practice in 1986. However, confidence in the inflation target also requires that government finances are in order.
Norway has had room for manoeuvre because solid state finances secure credibility and because inflation expectations are firmly anchored. Even though oil prices fell from close to USD 150 per barrel in summer 2008 to almost USD 30 at the end of the year, Norway’s state finances were not called into question. In addition, oil prices increased markedly as early as spring last year. The oil fund mechanism curbs the effects of oil price fluctuations on demand and output – as well as on inflation and the krone exchange rate. The Government Pension Fund Global is also an important source of funding for public spending in the next decades. Reductions in government welfare spending, which will probably be a matter of necessity with an increasingly ageing population, will be smaller than would have been the case without the fund. 10  BIS Review 69/2010  5. Challenges to the Norwegian economy  In the period 1992–2008 the Norwegian economy experienced a long upturn. In the 2000s, the cost level started to rise, partly reflecting a sharp improvement in our terms of trade. Prices for Norwegian goods, such as oil, gas, metals, minerals and fish increased sharply while import prices fell. Looking ahead, the impact of these driving forces cannot be expected to be as favourable. It is hardly likely that export prices will show a renewed surge. Moreover, our economy has become vulnerable. Norwegian labour has never been as costly as today.