...in asset prices have often occurred when there are considerable imbalances in the economy. There have been episodes where bubbles have accumulated in the form of sharp increases in asset prices in the equity and housing markets while inflation has been low. Higher asset prices and increased optimism often contribute to high debt growth. Increased access to credit pushes up asset prices further. There is therefore an interaction between developments in debt and asset prices. When the bubbles burst, the result may be an economic down-turn and deflation. In this way, developments in asset prices may give rise to an unstable inflation environment. Developments of this kind may also threaten the stability of the financial system, cf. the banking crises in the Nordic countries around 1990. will discuss whether and how monetary policy should take the build-up of financial imbalances into account. I will also touch upon the driving forces in the foreign exchange market. The krone is affected by mechanisms similar to those found in other asset markets.

Finally, I would like to comment briefly on current economic developments. Internationally, developments are weaker than expected. Interest rate cuts are expected in a number of countries. The fall in international interest rate levels has dampened the effects of our interest rate reductions on inflation. Growth in Norway is likely to be fairly weak now, and with an unchanged interest rate, inflation is likely to remain below target in the period ahead. The easing of monetary policy will therefore continue. Norges Bank's Executive Board will also carefully consider changing the interest rate in larger steps.

Price stability and financial stability

Seeking to foster price stability and financial stability is often considered a natural task of central banks. In Norway, the Government has set an operational objective for monetary policy. This objective is low and stable inflation. Financial stability is often defined as the absence of financial instability (1). Financial instability is characterised by unduly wide fluctuations in prices for assets such as dwellings, commercial property and securities, or failure in the functioning of financial institutions or financial markets. Disturbances occur in the credit supply or the flow of capital. In most cases, this will have consequences for output, employment and inflation. Financial stability therefore fosters price stability.

In Norway, the authorities' work on financial stability is divided between the Ministry of Finance, the Banking, Insurance and Securities Commission and Norges Bank. The Ministry of Finance is responsible for establishing a framework which ensures that Norway has a financial industry that functions smoothly. The Banking, Insurance and Securities Commission is responsible for supervising the financial sector. Norges Bank shall foster robust and efficient payment systems and financial markets, i.e. foster financial stability. This is in accordance with the Norges Bank Act and the Payment Systems Act.

Primarily, we wish to avoid instability in the financial system. A number of instruments are available, including regulation of financial markets, surveillance and shaping the financial infrastructure. Norges Bank's instruments are primarily the interest rate, banks' borrowing facilities, including requirements for collateral that can be accepted to secure such lending, and its supervision of the payment systems. We are also obligated to alert the Ministry of Finance when we assess the situation as giving cause for concern. The Financial Stability reports are an important tool. Norges Bank can also serve as the lender of last resort. This is reserved for very special situations where financial stability may be threatened.

Without financial institutions and financial markets that function smoothly, the effects of interest rate changes on inflation and employment will be unstable and uncertain. Low and stable inflation provides households and enterprises with a clear indication of changes in relative prices. This makes it easier for economic agents to make the right decisions and contributes to price stability in financial and property markets. Low and stable inflation therefore provides the best foundation for financial stability. The two objectives normally underpin each other.

Previous financial crises in Norway

From history, we know about a number of financial crises in Norway. During the time of the silver and gold standard prior to 1914, banking crises occurred relatively frequently and were mainly regional. This is an indication that banks at that time were small and locally anchored. Therefore, the crises did not spread through the banking system. Many Norwegian banks experienced liquidity and solvency problems in 1857 following the collapse of the US railroad industry, in 1864 in Oppland, in 1886 in Arendal and in Kristiania (now Oslo) in 1899-1905. The Norwegian author Alexander Kielland depicts the local financial bubble in Stavanger in the 1880s in his book Fortuna. There was a surge in credit growth and speculation in commercial bills that did not represent actual values. Speculation formed the basis for quick gains and it all ended in bankruptcies and banks that failed.

A dramatic scene from Fortuna:

When the clock struck 1, Taraldsen...

NOTE: All illustrations and photos have been removed from this article.



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