Good morning, everyone. I would like to thank the Department of Economics at the University of Oslo for inviting me to give this year’s Schweigaard Lecture.

Choosing a theme was not difficult. Since inflation surged in spring 2022, and Norges Bank responded by raising the policy rate substantially and rapidly, monetary policy has been a subject of debate in Norway.

One view, put forward by the Norwegian Confederation of Trade Unions (LO), is that Norges Bank has placed too much weight on inflation and too little on employment when setting the policy rate. From parts of academia, on the other hand, we have been criticised for taking too long to tackle inflation. Former Deputy Director of the Norwegian Directorate of Health, Espen Rostrup Nakstad, has questioned whether the policy rate is even suited to bringing down inflation.

Monetary policy is also being debated internationally. In several countries, central banks’ monetary policy independence has been challenged in recent years, and in the US the new Federal Reserve Chair has rekindled the debate on how much central banks should, or should not, say about monetary policy.

It is not surprising that monetary policy generates debate. Interest rates matter greatly to people’s finances, not least here in Norway. Debate has its place in a democracy. The announcement last year that the Ministry of Finance would review the monetary policy mandate does not make the debate less relevant.

And let me stress that I am not saying that economists should be the only group participating in the debate about monetary policy. Doctors are also welcome.

I will use today’s lecture to answer some of the questions that have been raised. So let me begin:

1. Why is inflation at 2 percent so important?

This question goes to the very core of Norges Bank’s mission. It is now 25 years since inflation targeting was introduced in Norway. Since 2018, the target has been 2 percent.

Chart: “Inflation”

Most people would agree that low and stable inflation is a good thing. When prices suddenly rose sharply four or five years ago, the costs of high inflation were widely felt.

When prices rise quickly and unexpectedly, it becomes hard to plan and make good decisions. High inflation makes it difficult, for example, to know whether the price of a good or service is reasonable, and wage increases that look generous when they are agreed may after a few months be eroded by high inflation. The lowest income groups are most affected by rapid and unexpected price increases.

Low and stable inflation is a precondition for a well-functioning economy. At the same time, some inflation is good. It makes the economy more flexible and keeps deflation, a sustained fall in prices, at a distance. Historically, deflation is associated with economic stagnation and high unemployment.

It is therefore wise to aim for an inflation rate that is neither too high nor too low. In Norway, as in a number of other countries, we settled on an inflation target of 2 percent. This provides a reasonable balance between the two aims.

This does not mean that the economy would necessarily have performed substantially worse if we had chosen a slightly higher target. But those who might imagine that a higher inflation target would provide room for a permanently lower interest rate would be disappointed. Over time, what matters for how interest rates affect the economy is the real interest rate, that is, the interest rate less inflation. Had we chosen a higher inflation target, the policy rate would also have been higher on average.

2. Does Norges Bank give too little weight to the aim of keeping employment as high as possible?

In the debate this is what some people have opined, arguing that the policy rate increases in recent years have pushed up unemployment too much. So let me say a little more about the trade-offs we make when setting the policy rate.

Sustaining employment at the highest possible level is an overriding objective of economic policy, which Norges Bank is also mandated to promote. The mandate assigned to us by the political authorities provides for a flexible inflation targeting regime, so that monetary policy can also contribute to high employment and economic stability.

Over time, there is no conflict between the objectives of low and stable inflation and high employment. In the long run, we cannot trade off higher employment for higher inflation. Quite the contrary. Low and stable inflation is important for a well-functioning economy and provides the best possible basis for keeping employment as high as possible.

In the short term, however, a conflict may arise between the two aims. A higher policy rate will dampen inflation but also restrain economic activity, which may lead to higher unemployment.

When setting the policy rate, we seek to strike the right balance between these aims.

Chart: “Unemployment and inflation”

In recent years, the policy rate has helped cool the economy. Unemployment has edged up from a low level. Inflation has come down substantially from the peak but is still above target. With a higher policy rate, we could have brought inflation down faster. But we do not want to restrict the economy more than needed. We are therefore taking time to bring inflation back to target.

However, there is a limit to how much time we can take. Over time, high inflation can lead households and firms to begin planning for greater inflation persistence. For example, firms set their selling prices for a period ahead based on expected price and cost changes. If inflation has been high for a long time, firms may assume that it will remain so and raise their own selling prices. Such mechanisms entail a risk of greater inflation persistence, making it more difficult to bring inflation down again. In situations like the present, when inflation has remained above target for a long time, we are therefore particularly alert to signs of rising inflation pressures.

Financial market participants generally assume that we will react to an elevated inflation outlook by tightening monetary policy. That confidence in the inflation target is valuable and helps us keep inflation low and stable. If we over time do not react to an elevated inflation outlook, we could risk eroding confidence in the inflation target. The krone could then weaken markedly, and prices continue to rise rapidly. Should that happen, a sharp increase in the policy rate would be needed to bring inflation down again, with potentially high costs in the form of job losses.

3. Should the green transition become a monetary policy objective?

So, when setting the policy rate we must give weight to keeping employment as high as possible. Economic policy must also take other important considerations into account such as equitable distribution and sustainable development. It has been argued that Norges Bank should use the policy rate to promote more objectives than those set out in the current mandate. A concrete question that has been raised is whether Norges Bank should use the policy rate to promote the green transition.

In my view, the answer to this question should be no. We also expressed this view in our submission on the review of the monetary policy mandate earlier this year.

And this is not because I consider the objective to be unimportant. One of the greatest challenges of our time is to succeed in the transition to a low-carbon economy. The objective of low and stable inflation may perhaps seem trivial in that context.

The economy is increasingly affected by climate change and measures to reduce greenhouse gas emissions. This summer, we have once again seen how heatwaves, droughts and fires in Europe cause extensive damage. Such events can have consequences for inflation, output and employment, which we must take into account when setting the policy rate. However, I would caution against using monetary policy to address climate challenges.

First and foremost, this is because monetary policy is ill-suited to the task. The policy rate is not an effective instrument for reducing greenhouse gas emissions. Other components of economic policy have far more targeted instruments, such as carbon taxes, emissions trading systems and regulation.

In our view, monetary policy’s most important contribution to the climate transition is to ensure low and stable inflation over time. Low and stable inflation provides a safer environment for making needed climate-related investments. When inflation is low, it is also easier to distinguish changes in individual prices from general inflation, strengthening the signal from, for example, higher carbon taxes.

4. Why is a handful of economists allowed to decide the price of borrowing money?

Interest rates have a substantial impact on the finances of both households and firms. Nevertheless, politicians have entrusted policy rate setting to five economists.

The five Committee members are me, the two Deputy Governors, Pål Longva and Øystein Børsum, and the two external members, Steinar Holden and Hilde C. Bjørnland, both professors of economics. Together, we constitute the Monetary Policy and Financial Stability Committee.

If we go far back in time, the monetary system was controlled by the king. During the Napoleonic Wars, the system failed. To finance the war, the king printed ever more money. Inflation spiralled out of control, and people lost confidence in money.

With these experiences still fresh in mind, the authors of the Norwegian Constitution adopted at Eidsvoll decided that the Storting should be responsible for the country’s monetary system. However, elected representatives may also find it difficult to adhere to a policy that safeguards the value of money over time. Policy rate increases to keep inflation down may be unpopular and may conflict with other more short-term objectives and a desire to maximise electoral support.

In many countries, the political authorities have therefore chosen to delegate the conduct of monetary policy to the central bank and provide it with statutory protection so that policy rates can be set without political influence, thus affording the objective of price stability special protection.

This does not mean that elected representatives have abdicated. Even though the Committee sets the policy rate, politicians decide our aims and objectives.

The debate in Norway shows that politicians are attentive to interest rate developments. Nevertheless, during my time as Governor, I have not experienced Norwegian politicians challenging the central bank’s monetary policy independence, as has occurred in other countries.

Let me emphasise that when we at Norges Bank highlight the importance of central bank independence, it is not for our own sake, but because delegating the conduct of monetary policy to an independent central bank has proved to be the most effective way of ensuring price stability. International experience also indicates that if doubts arise about central bank independence, investors may adjust their inflation expectations and demand higher risk premiums.

Now to a rather different question that I have been asked many times in recent years.

5. Does Norges Bank believe that higher interest rates can bring down prices abroad?

The answer is no, and I doubt there are many people who actually believe that we believe so. But some have argued that we should not raise the policy rate when part of the reason for high inflation is that prices for oil and other international commodities have risen as a result of Russia’s invasion of Ukraine and the conflict in the Middle East.

We cannot, of course, influence prices abroad, but that does not mean we should disregard them when setting the policy rate.

Although we cannot influence prices abroad, we can influence spillovers to domestic prices and counteract the onset of a rise in prices for a broad range of goods and services due to higher commodity prices. A higher policy rate will normally lead to a stronger krone, which will reduce the prices of imports measured in Norwegian kroner. A stronger krone will also reduce export profitability and may thereby help dampen wage growth.

We will respond with the policy rate to an elevated inflation outlook. High inflation imposes costs no matter what caused it. But the causes of inflation matter for how strongly we respond. We will normally respond less forcefully with the policy rate when inflation is caused by an imported cost shock that also dampens economic activity than when inflation is driven by high demand and strong pressures in the economy.

6. Is the policy rate the right medicine for bringing inflation down?

Everything I have said so far rests on a fundamental premise: that a higher policy rate actually helps bring inflation down.

But can a high policy rate be the wrong medicine for bringing inflation down? May it even be that a lower policy rate would have resulted in lower inflation? These questions were raised in the debate earlier this year.

Chart: “Policy rate and inflation”

The chart shows developments in inflation and the policy rate in Norway over the past 25 years. At first glance, one might perhaps get the impression that these hypotheses are correct. We see that inflation is often high when the policy rate is high, but this does not mean that a higher policy rate leads to higher inflation. It could just as well be the case that the central bank raises the policy rate precisely because inflation is high.

The fact that high inflation leads to a high policy rate makes measuring the impact of rate changes challenging but not impossible. Our methods allow us to distinguish the policy rate’s response to inflation from the effect of the policy rate on inflation. When such methods are applied, the results are quite clear. Research consistently finds that higher interest rates contribute to lower inflation. At the same time, research shows that there is uncertainty about the magnitude of the effects.

This does not mean, however, that no prices rise when interest rates rise. Rents are a case in point. When interest rates rise, landlords’ costs increase and they may attempt to pass these costs on to tenants through higher rents. This mechanism is supported by research and is an example of what economists call the cost channel.

Yet, it is still the case that a higher policy rate dampens overall inflation. The reason is that there are other, stronger, channels from higher interest rates to inflation. Households tighten consumption and firms postpone investment in response to higher interest rates. This dampens economic activity, which in turn leads to lower wage and price inflation over time. A higher policy rate also strengthens the krone, which reduces prices for imported goods.

So, the answer to the question is yes, the policy rate is the right medicine for bringing inflation down. Our job at Norges Bank is to find the right dosage.

7. Why is the policy rate in Norway so much higher than in Sweden and Denmark?

In both Sweden and Denmark, interest rates have come down substantially from their peak in 2024. The policy rate in Norway is now more than 2 percentage points higher than in our closest neighbouring countries. This makes many people wonder why we could not have simply lowered our policy rate too.

Chart: “Policy rates in Norway, Sweden and Denmark”

There are many similarities across the Scandinavian countries, but in order to answer this question I will begin with an important distinction. While Norway and Sweden have a floating exchange rate, Denmark has chosen to peg its currency to the euro. A fixed exchange rate reduces uncertainty and makes it easier for Danish firms and households to trade with other countries in the euro area. With a fixed exchange rate, the Danish central bank must keep its policy rate close to the euro area interest rate. This means that the policy rate cannot be used to the same extent to smooth economic fluctuations. A floating exchange rate, as we have in Norway, provides leeway to set the policy rate based on conditions in the Norwegian economy. This has been particularly beneficial in periods when the Norwegian economy has not moved in line with trading partner economies. A floating krone exchange rate has also acted as a shock absorber during downturns and facilitated structural adjustments in the economy.

Then what about Sweden, which, like Norway, has a floating exchange rate? Just as we set the policy rate based on domestic conditions, the Riksbank sets its policy rate based on conditions in the Swedish economy. The policy rate is lower in Sweden than in Norway because inflation has been significantly lower. Higher inflation in Norway partly reflects higher wage growth, which in turn must be seen in the context of high prices for Norwegian commodity exports. This is why Norway also needs a higher policy rate than Sweden.

8. How much should central banks say about policy rates?

You are probably now thinking that I have said a lot. So how much should central banks actually say about policy rates? This question is once again high up on the agenda since Kevin Warsh took office as Chair of the Federal Reserve before summer. Warsh has moved towards saying less, both about the reasoning behind monetary policy decisions and about the monetary policy outlook. This shift has led some people in Norway to question Norges Bank’s communication practice.

The discussion about how transparent central banks should be is not new. A few decades ago, central banks could change policy rates without having to announce the fact, and the ability to speak in opaque terms was considered an important qualification for central bank governors. Alan Greenspan, who chaired the Federal Reserve from 1987 to 2006, is reported to have said:

If I seem unduly clear to you, you must have misunderstood what I said.

For a long period, Norges Bank, like the Fed, said little, and the intention was not necessarily that people should understand how monetary policy worked or what the central bank was thinking.

During the 1990s and 2000s, central banks took major steps towards greater transparency. Monetary policy meetings were announced well in advance, press conferences were held and rate decisions were explained. A number of central banks gradually began publishing minutes of monetary policy meetings. This year, we too have followed suit and started publishing a summary of the Committee’s discussions leading up to the monetary policy decisions.

In one area, Norges Bank has been among the central banks that has gone furthest in terms of transparency. For more than 20 years, we have published a policy rate forecast. The forecast is not a promise but shows what we consider to be the most likely policy rate path given our mandate and our assessment of economic developments.

Transparency about the basis for our decisions is important for democratic oversight and for enabling the public to hold us to account. We also seek to be transparent about how monetary policy will react to changes in the economic outlook. The fact that our reaction pattern is well known can reduce uncertainty and enhance monetary policy effectiveness.

But this approach also implies some dilemmas. Greater transparency is not necessarily synonymous with better communication. In recent years, we have had to revise our policy rate forecasts substantially because economic developments have differed from what we envisaged. One argument against publishing a policy rate forecast is that it may be perceived as a promise, and that frequent revisions to the rate path can weaken confidence in the central bank.

The best suited approach to communication can vary across countries and change over time. We are following the international debate with great interest. We have no specific plans to implement any changes at present, but we are continuously working to enhance our communication of monetary policy and our response pattern.

In any event, we will continue to be transparent, continue to answer questions and continue to explain our rate decisions. I won’t become taciturn.

9. What are the implications of AI for monetary policy?

The world is undergoing an epochal shift in technology. Some people have asked me what the implications of AI will be for the monetary policy stance. The answer is that I do not know, and perhaps this is not the most important question to ask about the consequences of AI. But how new technology affects the economy is naturally a matter of interest to both Norges Bank and other central banks. AI can clearly perform many tasks faster and better and spur new ideas and solutions. However, the magnitude of productivity gains and how quickly they will materialise are uncertain. Researchers’ estimates vary widely. Some expect substantial gains. Others believe productivity may initially fall because new technology requires time, investment and adjustment before the gains are realised.

But if we assume that productivity will increase, will this result in higher or lower interest rates? The answer partly depends on the time horizon.

If AI boosts global productivity, growth opportunities will increase and the willingness to invest could pick up. The interest rate level could then become higher over time than it would otherwise have been, both globally and in Norway.

In the near term, higher productivity could reduce firms’ production costs and dampen inflation, which pulls in the direction of lower policy rates. However, if expectations of higher earnings and wage growth were to boost investment and consumption without the supply side keeping pace, both wage and price inflation could pick up. Policy rates could then rise – also in the near term.

AI may have far-reaching consequences for the economy and for Norges Bank’s tasks. It is precisely in the face of ever-changing economic conditions that it is sensible to conduct regular reviews of the mandate for monetary policy, as announced by the Ministry of Finance.

I believe that we currently have sound mandate. In my view, flexible inflation targeting has functioned well, and I cannot foresee a better alternative at the present time. Whether it will also be the best alternative in the future remains to be seen.

10. Where is the policy rate headed?

The final question I will answer today is also the question I am asked most often, which is how the policy rate will evolve ahead. The short answer is that it depends on economic developments. I also have a longer answer, which is based on the forecasts we presented in June and the assessments we made at our monetary policy meeting earlier this month.

Unemployment in Norway is now neither especially high nor unusually low. Inflation, however, is too high and has run above target for several years.

An important reason why inflation remains elevated is that firms’ labour costs have risen substantially in recent years. Wage growth has not been high relative to profitability in manufacturing. The principle of the Norwegian wage determination model is precisely that workers should receive their share of value added in manufacturing. But wage growth raises firms’ costs, and although wage growth is slowing, it will continue to keep inflation elevated.

It is our assessment that a restrictive monetary policy stance is needed to return inflation to target within a reasonable time horizon. Our June policy rate forecast indicated an increase in the policy rate from 4.25 percent to just above 4.5 percent by the end of the year. We envisaged raising the policy rate at one of the forthcoming monetary policy meetings.

Chart: “Policy rate forecasts since 2021”

But as this chart clearly shows, the policy rate forecast is neither a promise nor a definitive roadmap. As I already touched on, in recent years we have had to revise our policy rate forecasts substantially because the economic outlook has changed.

Inflation fell this summer and has been lower than projected. Slower inflation is welcome news, but inflation is still markedly above target, and it is too early to conclude that the inflation outlook has changed materially. It may thus still become necessary to raise the policy rate.

In about a month, we will present new forecasts. Experience suggests that they are unlikely to be identical to those we presented in June. What remains unchanged is that we will set the policy rate with the aim of returning inflation to target within a reasonable time horizon.

Many wonder when the policy rate will come down. If we look somewhat further ahead and with inflation moving towards target, it will probably be appropriate to begin a prudent easing of monetary policy. However, as the chart shows, we do not envisage that the policy rate will be significantly lower ahead. For borrowers, that may be one of the most important takeaways from this lecture.

Thank you for your attention. And to those of you who are just beginning your studies, I wish you the best of luck. There has rarely been a more interesting time to be a student. My advice is to use this unique time to learn, not only from your lecturers, but from one another. Be curious and dare to ask the big questions.