Monetary policy objectives and instruments
The Storting and Government define the objectives of monetary policy by law and regulation. Norges Bank's role is to contribute to achieving the objectives. The key instrument of monetary policy is the policy rate.
According to the Norges Bank Act and the Regulation on Monetary Policy, monetary policy shall maintain monetary stability by keeping inflation low and stable.
The operational target Norges Bank aims at in interest rate setting is inflation close to 2 percent over time. As the primary objective of monetary policy is low and stable inflation, it can be said that Norway has an inflation-targeting monetary policy regime.
Inflation targeting shall be forward-looking and flexible so that it can contribute to high and stable output and employment, and to counteracting financial imbalances.
When Norges Bank sets the policy rate, various monetary policy considerations are weighed against each other.
Monetary policy shall bring inflation to target:
The policy rate is set with a view to stabilising inflation at the target in the medium term. The time horizon will depend on the disturbances to which the economy is exposed and the effects on the outlook for inflation and for output and employment.
Monetary policy shall contribute to high and stable output and employment and to counteracting financial imbalances:
When shocks occur, a short-term trade-off may arise between reaching the inflation target and supporting high and stable output and employment. Monetary policy should achieve a reasonable trade-off between these considerations. As long as there is confidence that inflation will remain low and stable over time, monetary policy can contribute to smoothing fluctuations in output and employment. A flexible inflation targeting regime, where sufficient weight is given to the real economy, can prevent downturns from becoming deep and protracted. This can reduce the risk of unemployment becoming entrenched at a high level following an economic downturn. Nevertheless, monetary policy cannot assume primary responsibility for high output and employment.
To some extent, monetary policy can contribute to counteracting the build-up of financial imbalances and thereby reduce the risk of sharp economic downturns further ahead. If there are signs that financial imbalances are building up, the consideration of high and stable output and employment may in some situations suggest keeping the policy rate somewhat higher than would otherwise be the case. The regulation and supervision of financial institutions are the primary means of addressing shocks to the financial system.
The conduct of monetary policy takes account of uncertainty regarding the functioning of the economy. Uncertainty surrounding the effects of monetary policy normally suggests a cautious approach to interest rate setting. This may reduce the risk that monetary policy will have unintended consequences. The policy rate will normally be changed gradually so that the effects of interest rate changes and other new information about economic developments can be assessed.
In situations where the risk of particularly adverse outcomes is pronounced, or if there is no longer confidence that inflation will remain low and stable, it may in some cases be appropriate to react more strongly in interest rate setting than normal.
Instruments and implementation
The main monetary policy instrument is the policy rate, which is the interest rate on banks' deposits in Norges Bank up to a specified quota.
The policy rate is set by Norges Bank's Monetary Policy and Financial Stability Committee. Normally, the Committee sets the policy rate eight times a year. The Committee meetings where the policy rate is set are called monetary policy meetings.
For the level of the policy rate to reflect the level of other market rates, Norges Bank manages the total amount of banks' deposits in Norges Bank so that banks benefit from lending to one another at a rate close to the policy rate.
Norges Bank places emphasis on transparency in its monetary policy communication. The assessments on which interest rate setting is based are published regularly in the Monetary Policy Report and elsewhere.
The Monetary Policy Report is published four times a year in connection with four of the monetary policy meetings. Among other things, the Report contains an assessment of the outlook for the Norwegian economy and the Bank's policy rate forecast (also called the policy rate path). The analyses in the Report form the background for the Committee's monetary policy assessments and decisions.
The Report is published in March, June, September and December.
At the interim monetary policy meetings, the Committee's policy assessment is based on an updated picture of economic developments, but without new economic projections.
The Bank also reports on the conduct of monetary policy in the Annual Report.