In the short term, domestic prices and domestic inflation in industrialized countries are relatively

slow to change (or sticky). This means that private-sector inflation expectations for the short term
are also relatively sticky. This further implies that central banks, by controlling the short nominal
interest rate, can also affect the short real interest rate: the difference between the short nominal
rate and short-term inflation expectations. Via market expectations of future real rates, longer real
rates are also affected. Thus, the lowering of the instrument rate normally lowers short and longer
real interest rates. This will increase asset prices and aggregate demand for goods and services.
Furthermore, a reduction in the short interest rate normally depreciates the domestic currency and
hence increases the nominal exchange rate (expressed as units of domestic currency per unit of
foreign currency). Since domestic prices in practice are sticky, the domestic currency also
depreciates in real terms. That is, the real exchange rate also rises (the real exchange rate can be
seen as the price of foreign goods and services in terms of domestic goods and services or,
alternatively, the price of tradable goods in terms of nontradable goods and services). The
depreciation of the currency implies that the domestic price of imported and exported final goods
increases. Since these goods enter the Consumer Price Index (CPI), this means that CPI inflation
increases, the extent of which depends on these goods' share in the CPI. This is the socalled direct
exchange-rate channel to CPI inflation. This effect on CPI inflation usually occurs within about a
year, or even quicker. 11 Some of this discussion builds on Svensson (1997, 2001). Norges Bank
Watch 2002 11 The fall in short and longer real interest rates mentioned above will stimulate
consumption and investment and thereby increase aggregate demand. Since output is demand-
determined in the short to medium run, higher aggregate demand will also raise output. This is the
so-called real-interest-rate channel to aggregate demand. The rise in the real exchange rate makes
domestically produced goods less expensive relative to foreign goods. This increases demand for
export and for import-competing goods, which also adds to aggregate demand. This is the
exchange rate channel to aggregate demand. The effects through these two channels usually occur
in about a year or so. The monetary-policy literature has also discussed a so-called credit channel
to aggregate demand. It works in the same direction as the pure real-interest-rate effect on
aggregate demand. For simplicity, we can therefore include the credit channel in the above real-
interest-rate channel to aggregate demand. The real-interest-rate channel also includes effects via
changes in wealth, for instance, changes in the stockmarket value due to interest-rate changes

Interest rate has connection with inflation rate

-exim
-competitiveness
-liqiudity
The key policy rate or sight deposit rate is the interest rate in controlling or manipulating Norway’s
economy. The interest(nominal) rate is the require interest rate on the bank’s reserve up to a
specific quota in the Norges bank, which was maintain at a constant 0.5% since September 2016
until now to achieve the objective or low and stable inflation. Therefore, changes in the interest
rate might have strong impact in the short market rate and have transmission mechanism of
monetary policy which affect the output and inflation through number of channels such as demand,
exchange rate, expectations and more.

In the perspective of Norway’s economy, due to price stickiness, the changes in nominal interest
rate will also have impact on the real interest rate. Although the right amount of inflation can
benefit the country in terms of development and growth but hyperinflation will put the country in
the dangerous state. Thus, in order to restrict inflation, contractionary monetary policy that
increase the interest rate is implement by the Norges bank to lower down the money supply and
demand in the market. By increasing the rates, the investment such as bonds and stocks will be
directly affected as the short and long real interest rate(functions) is increased and have impact
on the financial institutions and systems. Therefore, the investment inside-out of Norway might
potentially reduce as returns on investments has decrease and cost of capital has risen, which
naturally result in a drop of local exchange currency. Other than that, as the bank lending and
borrowing has increase, the fund that could be lent out and raise would decrease. As the allowed
loan amount decrease, the purchasing of assets such as houses and premises decrease and
interest rate charged on loan as main source of income for commercial banks would be deducted ,
the inflation would have slower down. Moreover, as interest rate increase, the amount of wages
will be lessen that causes the demand for consumer durables decrease due to weaken purchasing
power, leading to decline in output and rise in unemployment, causing the funds injected into the
financial system decrease.

-housing prices and demand for real estate

-business need loans ( discourage expansions and job employment t) –unaffordable
-riskier investment decrease –profitability

Furthermore, the attractiveness of Norwegian Krone tend to becomes more attractive if Norges
bank decide to increase the interest rate. The reason being higher interest rates increase the
value of the currency thus

-reflect financial condition

-attractiveness
-

Although interest rates can be a major factor influencing currency value and exchange
rates, the final determination of a currency's exchange rate with other currencies is the
result of a number of interrelated elements that reflect the overall financial condition of a
country in respect to other nations.

Generally, higher interest rates increase the value of a country's currency. Higher
interest rates tend to attract foreign investment, increasing the demand for and value of
the home country's currency. Conversely, lower interest rates tend to be unattractive for
foreign investment and decrease the currency's relative value.
This simple occurrence is complicated by a host of other factors that impact currency
value and exchange rates. One of the primary complicating factors is the relationship
that exists between higher interest rates and inflation. If a country can achieve a
successful balance of increased interest rates without an accompanying increase in
inflation, its currency's value and exchange rate is more likely to rise.

Interest rates alone do not determine the value of a currency. Two other factors
– political and economic stability and the demand for a country's goods and services
– are often of greater importance. Factors such as a country's balance of
trade between imports and exports can be a crucial factor in determining currency
value. That is because greater demand for a country's products means greater demand
for the country's currency as well. Favorable numbers, such as the gross domestic
product (GDP) and balance of trade are also key figures that analysts and investors
consider in assessing a given currency.

Another important factor is a country's level of debt. High levels of debt, while
manageable for shorter time periods, eventually lead to higher inflation rates and may
ultimately trigger an official devaluation of a country's currency.

The recent history of the U.S. clearly illustrates the critical importance of a country's
overall perceived political and economic stability in relation to its currency valuations. As
U.S. government and consumer debt has risen, the Federal Reserve has moved to
maintain interest rates near zero in an attempt to stimulate the U.S. economy. The Fed
has since moved to incrementally raise interest rates to 1.50% (as of February 2018) in
response to a recovering economy, but rates are still very low compared to pre-financial
crisis levels.

Even with historically low interest rates, the U.S. dollar has enjoyed favorable exchange
rates in relation to the currencies of most other nations. This is partially due to the fact
that the U.S. retains, at least to some extent, the position of being the reserve
currency for much of the world. Also, the U.S. dollar is still perceived as a safe haven in
an economically uncertain world. This factor, even more so than interest rates, inflation
or other considerations, has proven to be significant for maintaining the relative value of
the U.S. dollar.

Read more: How do national interest rates affect a currency's value and exchange rate?
| Investopedia https://www.investopedia.com/ask/answers/040315/how-do-changes-
national-interest-rates-affect-currencys-value-and-exchange-rate.asp#ixzz5F4nbQPzB
Follow us: Investopedia on Facebook

https://www.investopedia.com/ask/answers/040315/how-do-changes-national-interest-rates-
affect-currencys-value-and-exchange-rate.asp
would decrease, which causes the purchasing of assets such as
-liqiudity
-savings, investments and
-the amount that could be injected into the financial system has deceras
Aggregate demand of goods and services decreas
Purchasing power

This will increase the cost of capital of investment as the returns are decreased

Thus, the lowering of the instrument rate normally lowers short and longer real interest rates. This will
increase asset prices and aggregate demand for goods and services. Furthermore, a reduction in the short
interest rate normally depreciates the domestic currency and hence increases the nominal exchange rate
(expressed as units of domestic currency per unit of foreign currency). Since domestic prices in practice
are sticky, the domestic currency also depreciates in real terms. That is, the real exchange rate also rises
(the real exchange rate can be seen as the price of foreign goods and services in terms of domestic goods
and services or, alternatively, the price of tradable goods in terms of nontradable goods and services)

A period of low interest rates can engender financial imbalances. There is a risk that growth in property prices
and debt will become unsustainably high over time. With high debt ratios, households are more vulnerable to
cyclical downturns. In the event of a reduction in household income, debt burdens may become heavy to bear,
forcing households to reduce spending on consumption, with a deeper downturn as a result. For Norges Bank,
the consideration of restraining the build-up of financial imbalances has long been an element of a robust
monetary policy. The aim is to mitigate the risk of particularly adverse economic outcomes further ahead.

Chart: Estimated path for consumption during recessions

A recently published study by Norges Bank examines developments in private consumption during recessions.
The analysis is based on data from 61 international recessions in the past four decades (Hansen et al (2015)).
An important outcome is shown in this chart. The chart compares two different paths for consumption during a
recession. The blue line shows the average path, while the yellow line shows the path following a period of
high debt growth. The results confirm that high debt growth ahead of a recession leads to a deeper downturn. It
also takes longer for the economy to recover.

Chart: Monetary policy and financial stability

When financial imbalances are building up, the probability of a deep recession may increase. This is illustrated
in this chart by the blue lines. The uncertainty bands around inflation and the output gap are highly
assymetrical. Monetary policy can dampen vulnerabilities by keeping the interest rate somewhat higher than
would otherwise have been the case – in other words, by “leaning against the wind”. This policy is illustrated
by the red lines. By keeping the interest rate higher, the risk of a deep economic downturn is reduced. The
uncertainty bands are more narrow and symmetric. But this policy also entails a short-term cost: capacity
utilisation is lower, and inflation may stay below target.
The aim of “leaning against the wind” is to achieve an improved path for inflation, output and employment
over time. This is in line with our central bank mandate. Flexible inflation targeting with a sufficiently long
horizon should take financial stability into account if the situation so allows and so warrants.

At the same time, it should be stressed that regulation and surveillance of financial institutions are the first line
of defence against shocks to the financial system. And in the years following the financial crisis, the regulatory
framework has been strengthened. But that does not mean that our work is done. The financial system is in
constant flux. Economic agents in search of yield will seek out new opportunities. Today’s regulations are not
necessarily well suited to meet tomorrow’s challenges. We still need more knowledge about the use of
macroprudential tools. The prospect of a persistently low neutral interest rate has made this work even more
important.

-currency ( attract if interest rate increase )

https://www.norges-bank.no/en/Monetary-policy/Key-policy-rate/Key-policy-rate-Monetary-
policy-meetings-and-changes-in-the-key-policy-rate/

Monetary policy affects real and nominal variables through a number of channels, together referred
to as the transmission mechanism of monetary policy

- Monetary policy can only affect the inflation in short tern with limited ext\

-transparency