Still, the services component of inflation continues to be the largest contributor to its increase, so medium-term risks remain present, due to the closing of output gaps and the tight labor market (figure 2). Market inflation expectations have moderated for the short term and remain around 3 percent over the projection horizon. The baseline scenario foresees GDP growing this year between 4 and 5 percent, which is the same range forecast in March. Although the economy outgrew forecasts in the first quarter, the worsened external conditions will result in output slowing down more deeply than  BIS central bankers’ speeches  3  forecast in March. Still, GDP growth will not drift substantially away from the trend, which the Board estimates at 5 percent. This projection also considers that y-o-y growth in consumption will moderate further, in line with decelerating labor income and less expansionary lending conditions than some months ago. Interest rates on consumer loans have risen lately, coinciding with a decline in the y-o-y growth of these credits. In addition, the Survey on Lending Conditions of the first quarter revealed greater constraints in the supply of consumer loans by some financial institutions. Demand for consumer loans continued to rise, according to this survey. For investment, the more persistent construction and infrastructure component – largely associated to the execution of mining and energy projects – suggests that it will remain strong in the coming quarters.
These criteria are necessary because our models are uncertain and because confidence in monetary policy cannot always be taken for granted. The criteria do not conflict with Svensson’s monetary policy research, but can be regarded as a bridge between the model and reality. Allow me to show you how the criteria were used in the work on the March Monetary Policy Report by outlining the thought process involved. Although the charts I will be presenting are a simplification , they serve to illustrate our working methods. Norges Bank’s assessment of the current situation and the forecasts – with below-target inflation and a considerably negative output gap – might, under criteria 1 and 2, indicate in isolation that the interest rate should be set very low and even be negative towards the end of 2009. This is illustrated by the green line. However, the Executive Board chose to take a less drastic course of action on the basis of the other criteria taken into consideration. Criterion 3 states that previous methods of operation should be taken into account and that the interest rate should normally only be changed gradually. With emphasis on interest rate smoothing in the loss function (i.e. criteria 1+2+3), the result is the black line. This interest rate path is still low, and lower than the path that was in fact chosen. Criterion 4 states that monetary policy should be robust and criterion 5 that cross-checking should be carried out.