The Norges Bank is contemplating a series of hikes to its key policy rate to rein in domestic demand as capacity utilization nears its peak.
A senior economist at the central bank, Birgit Nygaard, noted that rising wage growth coupled with high household consumption could entrench inflation if left unchecked. Currently, the policy rate stands at 1.5%, which is considered highly stimulatory given the current inflation target.
However, the recent sharp appreciation of the Norwegian Krone (NOK), driven by elevated European demand for natural gas, is expected to cool some of these domestic pressures. The Governor of Norges Bank commented that "the appreciating Krone is already acting as a headwind for our traditional mainland export sectors, denting their international price competitiveness."
Nygaard added, "While the strong NOK will lower import costs and help anchor inflation expectations in the short term, the subsequent deterioration in our net trade balance will naturally damp aggregate demand. If this exchange rate channel proves persistent, it may reduce the need for aggressive interest rate hikes later this year."
With reference to Extract B, explain the likely effect of a rise in the value of the Norwegian Krone (NOK) on aggregate demand.
