Norway has adopted flexible inflation targeting regime in achieving monetary policy objectives where weight is not only given to variability in inflation but also to variability in employment and output. Under inflation targeting the main objective and priorities of the central bank is to attain and maintain price stability beside other objective which includes economic growth and reducing unemployment (Walsh, 2003). The main characteristic of an inflation targeting regime that differentiates it from other monetary policy regime include: 1.
The central bank set their inflation target numerically and announces the same to the general public and is obligated to achieve that target. In case the central bank fails to achieve their target then they are accountable to the public and must give a good reason for such failure. Norge bank expects inflation of close to 2. 5% over time. 2. The main aim of the central bank is to control future inflation rather than focusing on present inflation. Therefore the central bank forecast future inflation and make them public which have led the inflation targeting regime being also known as inflation forecasting regime.
3. Price stability as a primary goal – the central bank is committed to achieving stable and low level of inflation both in the short-run and in the long-run. 2 The central bank is allowed to pursue other goals subject to he condition that price remain low and stable. 4. Transparency and accountability – with this regime communication to financial market and general public is important. Effective communication is achieved through press releases after the meeting which includes minutes of the meeting and publication of inflation reports. Where the central bank upholds transparency then accountability is enhanced.
Where a comparison of inflation against the target indicate a breach of target then the central bank must give a public explanation which is in contrast to previous practice adopted by the bank. The reason why Norway has adopted inflation targeting is that it anchors inflation expectation. In addition it make it easy to understand the objective of central bank and increase accountability since the CPI figures are produced by an independent statistical office therefore cannot be manipulated by the central bank to create a favorable performance.
Furthermore it influences the behavior of wage and price setting and has the effect of lowering long-run inflation expectation (Bain & Howell, 2003) Norges bank uses the key rate (interest rate on bank deposit in norges bank) as the main monetary policy instrument (appendix A). The key rates have an impact on short term money market rate and future expectation on bond yields and banks lending and deposits rate. Due to a decline in global economic activities the bank has reacted by lowering interest rate. A fall in interest rate causes local government and household consumption to increase. 3
Furthermore the fall in interest rate has caused an increase in investment. A fall in interest rate means that the household will have more money left after servicing their debt. The increase in disposable income will ultimately lead to increase in aggregate demand. This forces supplies to increase output and in turn will require more input in term of labor, material and capital and as a result reducing the rate of unemployment. As the cost of borrowing becomes less expensive, investments becomes more attractive and through the multiplier effect increase in investment causes increase in national income and output.
As national income increase wage growth can pick up and together with higher profit margin it may result to higher inflation (Clarida & gali, 2005). Interest rate also has some impact on krone exchange rate and lowering interest rate will lead to depreciation of krone. As a result imported goods become more expensive and this will accelerate the rate of inflation. However a weaker krone is beneficial to businesses in Norway as it boost export therefore improving profitability. As businesses grow they will absorb more work force and thereby reducing unemployment (bofinger, 2001).
In 2008 the Norwegian central bank to reduce to reduce the key policy rate by 1. 75% to 3% with effect from 18 December 2008 and the main strategy of the bank is to maintain the rate between 2-3 % unless the economy experience major shock. This was due to a considerable decline in growth of both domestic and international market. Inflation was also subsiding faster than the board expected and therefore it was appropriate to lower the key policy rate.
As the global economy is experiencing a cyclical downturn combined with falling oil prices then the economic growth in Norway is 4 expected to be lower than anticipated and therefore production and employment are anticipated to fall in 2009. However the krone exchange rate has been weaker than expected and this has helped in mitigating the impact of international downturn on Norwegian economy. Thus the risk of economic downturn has increased while the risk of inflation has reduced. Therefore low interest rate is aimed to achieve stability of inflation as well as stabilizing development in employment and output. 5 References: BAIN, K & HOWELLS, P. Monetary Economics: Policy and its Theoretical Basis,
Palgrave Macmillan, 2003. BOFINGER, P. Monetary Policy: Goals, Institutions, Strategies and Instruments, Oxford University Press, 2001. CLARIDA, R and GALI, J (2005). The Science of Monetary Policy: A New Keynesian Perspective, Journal of Economic Literature 37, pp1661-1707. International monetary fund, 2007. Norway: 2007 Article IV consultation: staff report, Staff supplements, public information notice on the Executive Board discussion, And statement by the Executive Director for Norway. Washington, D. C: International monetary fund. WALSH, C. E. Monetary Theory and Policy, MIT Press, 2003.Sample Essay of Custom-Writing