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With the introduction of a new mandate for monetary policy on 29 March 2001, Norges Bank was given responsibility for ensuring low and stable inflation. Monetary policy shall also contribute to stabilising output and employment. In the long term, there is no conflict between low and stable inflation and stability in the real economy. On the contrary, price stability will be a precondition for high and stable output and employment over time. However, in some periods, there may be disturbances that create a conflict in the short term. A trade-off must be made between the inflation target and stability in the real economy. This is the core of flexible inflation targeting. This article will discuss Norges Bank's conduct of a flexible inflation targeting regime.
Price stability, or low and stable inflation, is the primary objective of monetary policy in most countries. Historical experience from Norway and other countries has shown that the absence of price stability has resulted in low and unstable production and employment. High inflation or deflation is both a cause and a symptom of systematic imbalances in resource allocation.
We have had four periods of high inflation over the past 100 years: during the two World Wars, the Korean War and a 15-year period from the first half of the 1970s to the second half of the 1980s. In Norway, high inflation is a wartime phenomenon and a 1970s and 1980s phenomenon.
In 1973, the western economies experienced a recession which would prove to be the start of a very long period of sluggish growth. For Western Europe as a whole, GDP increased by only 2.7 per cent annually from 1973 to 1979 compared with about 5 per cent in the preceding ten years. This negative shift in productivity growth was due to several factors. Many of the productivity gains that followed in the wake of the transition from primary industries to manufacturing from the Second World War until the 1970s had faded. The transition to a service economy eroded the growth potential since service industries had lower productivity growth than manufacturing. In addition, we experienced a cost shock as a result of the oil crisis in 1973.
In Norway, the recession in the 1970s was dealt with by means...