FAQ - Monetary policy, inflation and interest rates
What is monetary policy? Monetary policy in Norway is conducted by Norges Bank on behalf of the Government. Monetary policy is the component of economic policy that deals with influencing interest rates and liquidity in the market for NOK. The most important monetary policy instrument is the interest rate on banks' deposits in Norges Bank (the sight deposit rate).
Who is responsible for monetary policy? The objective of monetary policy has been laid down by the Government and submitted to the Storting. The responsibility for the conduct of monetary policy is delegated to Norges Bank pursuant to the Norges Bank Act and appurtenant regulation. Norges Bank reports on the conduct of monetary policy in its Annual Report See the Guidelines for monetary policy (Norges Bank's submission of 27 March 2001 to the Ministry of Finance)
What is inflation? Inflation is a sustained rise in the overall price level. Inflation is the same as a decline in the value of money, i.e. a certain amount of money buys you less than previously. Inflation is usually measured in terms of the rise in consumer prices, as measured in Statistics Norway's consumer price index. According to the Monetary Policy Regulation, the objective of monetary policy is annual consumer price inflation of approximately 2½ per cent over time.
How does inflation affect my personal finances? The higher inflation becomes, the less your savings are worth. You get less for your money than before. High inflation also makes it more difficult to compare prices for different goods and services because prices are constantly being increased. When inflation is high, it tends to be variable. Variable inflation creates uncertainty regarding future income and expenses. In isolation, low and stable inflation means that there is less uncertainty associated with your financial decisions than if inflation is high. See the price calculator on our website
Where can I find inflation figures? Statistics Norway prepares and publishes the official figures for inflation, the consumer price index (CPI). Substantial changes in the CPI may occur at times as a result of extraordinary fluctuations in certain product prices or changes in direct and indirect taxes. One version of the CPI adjusted for tax changes and excluding energy products, the CPI-ATE, is a measure of underlying price inflation. See Statistics Norway's website for more information about the CPI and different versions of the CPI.
Why is low and stable inflation an objective? High inflation means that storing money is expensive since the real value of the money is constantly falling. High inflation can also result in an unnecessary use of resources if many people spend a lot of time and energy on reducing the adverse effects of high inflation. There are also costs involved for businesses when they continually have to alter their prices.
When inflation is high, it tends to be variable. Variable inflation creates uncertainty as households and firms become unsure of their future income and expenses. This makes it difficult to take the right decisions and gives rise to unsound investments, which in turn contribute to fluctuations in the economy. Uncertainty can also result in economic agents becoming less willing to enter into long-term contracts. Considerable resources can be used to hedge against substantial changes in prices. Substantial and unexpected changes in prices also result in an arbitrary redistribution of income and wealth, for example from small savers to professional agents, and from tenants to owners of real estate.
In addition, high and variable inflation makes it difficult to differentiate between a change in prices for a good or service and a change in the overall price level. As a result, it is more difficult to determine which markets have shortages and which have excess supply. Making the right decisions becomes more demanding and may contribute to price instability in financial and property markets.
Other costs of inflation are related to the taxation system. Many tax boundaries are set in nominal terms for one year at a time (surtax for example). High inflation implies rising real taxes through the year. Higher real taxes may result in a widening gap between behaviour that profits the national economy and behaviour that is profitable in terms of personal finances (rising tax wedges).
In this sense, it may be said that low and stable inflation contributes to an efficient distribution of resources in a market economy. Inflation should not, however, fall to a level that is too low. This is partly because the structure of the economy evolves over time and rigidity in nominal terms may make it difficult to lower nominal prices and wages. With some inflation, relative wages can change without a fall in nominal prices and wages.
Why do we want to avoid deflation? Deflation - a persistent decline in prices - often accompanies, and may amplify, an economic downturn. Deflation can in itself contribute to a fall in demand, thereby having a negative influence on the economy. For example, prospects of a fall in prices can result in the postponement of consumption and investment in expectation of even lower prices. Deflation can also result in an increase in the real value of debt and a decline in household demand. Corporate profitability can also deteriorate, leading to a rise in unemployment.
Which measure of inflation does Norges Bank emphasise? In general, direct effects on consumer prices resulting from changes in interest rates, taxes, excise duties and extraordinary temporary disturbances shall not be taken into account. In real time it will always be difficult to determine which price movements are permanent and those which only have short-term effects on the CPI. There is no one indicator that provides a precise picture of underlying inflationary pressures in all situations. Different measures of underlying inflation are discussed in Monetary Policy Report. The Regulation on Monetary Policy
What are the monetary policy instruments? Norges Bank influences economic developments by setting the interest rate on banks' deposits in Norges Bank. This interest rate, known as the sight deposit rate, is Norges Bank's key rate. The banks’ deposit to the sight deposit rate is limited by a quota, see The liquidity management system. In addition, Norges Bank can undertake foreign exchange market interventions. Foreign exchange market interventions are the buying or selling of NOK in the foreign exchange market in order to influence the krone exchange rate.
What is the key rate? The key rate is the central bank's main interest rate in the conduct of monetary policy. The key rate in Norway is the interest rate on banks' deposits up to a quota in Norges Bank and is known as the sight deposit rate. What is Norges Bank's discount rate? Norges Bank's discount rate was historically the rate banks had to pay for rediscounting bills of exchange in the central bank, and changes in the discount rate influenced the general level of interest rates in Norway. In 1986, the arrangement for the central bank's liquidity loans to commercial and savings banks, where the interest terms were linked to the discount rate, was reorganised because the discount rate eventually lost its status as a key rate as a result of credit market developments. The discount rate has therefore no longer any significance for monetary policy. The Executive Board decided that with effect from 1 January 1987, Norges Bank would no longer set a discount rate. Historical overview of Norges Bank's discount rate
How does Norges Bank set the key rate? Norges Bank's Executive Board sets the key rate - i.e. the sight deposit rate. The analyses and the monetary policy strategy presented in Norges Bank's Monetary Policy Report, together with assessments of price and cost developments and conditions in the money and foreign exchange markets, form a basis for monetary policy decisions. Norges Bank gives weight to both variability in inflation and variability in output and employment when setting interest rates (flexible inflation targeting).
What is flexible inflation targeting? Flexible inflation targeting means that the central bank gives weight to variability in output and employment, as well as inflation. Under a strict inflation targeting regime, the central bank only focuses on inflation.
The choice of horizon for monetary policy implicitly sheds light on monetary policy trade-offs. A central bank that places considerable emphasis on stable developments in the real economy will choose a long horizon. Monetary policy influences the economy with long and variable lags. Norges Bank sets the interest rate with a view to stabilising inflation close to the target in the medium term. The relevant horizon will depend on disturbances to which the economy is exposed, and how they will affect the path for inflation and the real economy ahead.
How does a change in the interest rate affect the economy? It may be useful to distinguish between three channels through which monetary policy operates: the demand channel, the foreign exchange channel and the expectations channel. For more details on how interest rate changes affect the economy, see: What are the effects of an interest rate change?
What is Norges Bank's Executive Board? Norges Bank's Executive Board has executive and advisory authority in connection with Norges Bank's core tasks of price stability, financial stability and added value in investment management. Matters laid down in legislation and matters of principle are dealt with by the Executive Board.
Are the minutes of the Executive Board meetings published? The minutes of the Executive Board's monetary policy meetings are published regularly. The content of the minutes is included in the Executive Board's assessment, which is published at the same time as the interest rate decision. Previously, the minutes were subject to a duty of confidentiality for 12 years prior to publication. See the list of all interest rate decisions.