The Central Bank of Iceland responded to the pandemic-induced recession with policy rate reductions totalling 2 percentage points. These rate cuts and other measures adopted by the Bank and the Government made it possible to safeguard purchasing power in Iceland, and we made it through the shock with a 7.2% drop in GDP. The tide turned quickly, however. In May 2021, the Central Bank of Iceland became the first central bank in the West to start ratcheting its policy rate upwards at the start of the recovery. It has now raised the policy rate a dozen times, by a total of 6.75 percentage points, to the current 7.5%. We admit freely that the Central Bank of Iceland underforecast inflation, as did its counterparts abroad. In retrospect, we could have raised interest rates faster. On the other hand, the impact of rate hikes can never be predicted with perfect accuracy, and prudence surely puts limits on how fast interest rates can be increased. Furthermore, policy makers must be careful not to take excessive macroeconomic risk. Nevertheless, appraisals by foreign experts have concluded unanimously that the Central Bank took the right action in a timely manner, both in response to the pandemic and in the effort to maintain price stability in its wake. Among these experts are the International Monetary  4/8  BIS - Central bankers' speeches  Fund and the appraisal committee appointed pursuant to Article 36 of the Central Bank Act.
The potentially large number or companies, SMEs in particular, that may be affected by these solvency problems in the current crisis plus the fact that the public sector can be an important creditor as well, given the generalised use of public guarantees during the crisis, introduce additional difficulties or specificities that should also be taken into account. In sum, withstanding the negative consequences of the COVID-19 crisis on the solvency of viable firms, is currently a major challenge for economic policymakers. Swift policy action taken since the start of the crisis allowed a liquidity crisis to be avoided and has helped translate the medical advances against the disease into more positive macroeconomic scenarios. However, we must now be ready to react to these solvency risks in order to prevent the current crisis from developing a financial component which, as we painfully know from recent experience, would only make the crisis more lasting and socially and economically more costly. Thank you for your attention. 2/2  BIS central bankers' speeches