FAQ Monetary policy, inflation and the key policy rate
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).
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 also Norges Bank's submission Modernisation of the Regulation on Monetary Policy (of 28 February 2018 to the Ministry of Finance)
The Government has defined an inflation target for monetary policy in Norway. The operational target is consumer price inflation of close to 2 percent over time.
The inflation targeting shall also be forward-looking and flexible so that it can contribute to high and stable output and employment and to counteracting the build-up of financial imbalances. See What is monetary policy? at the Knowledge bank.
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.
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 close to 2 percent over time.
The operational target of monetary policy shall be annual consumer price inflation of close to 2 percent over time. 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. In its conduct of monetary policy, Norges Bank will take into account indicators of underlying consumer price inflation. Different measures of underlying inflation are discussed in the Monetary Policy Report.
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.
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.
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.
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.
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.
The policy rate is set by the Monetary Policy and Financial Stability Committee. 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).
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.
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?
The minutes of the Monetary Policy and Financial Stability Committee's monetary policy meetings are published regularly. The content of the minutes is included in the Monetary policy assessment, which is published at the same time as the interest rate decision. See the policy rate decisions