I point this out because some of those who developed a sudden interest in the Icelandic economy overlooked the background to the depreciation of the króna so far this year which is important to keep in mind. The Central Bank’s main objective is to contribute to a twelve-month rate of inflation as close as possible to 2½%. For various reasons this target has proved difficult to attain recently. Probably the most important factor has been the structural changes in the mortgage loan market in 2004, with the easing of the Housing Financing Fund’s lending rules and the subsequent entry of commercial banks and savings banks into the market. These changes caused real estate prices and private consumption to surge. In the recent term, house price inflation has accounted for the lion’s share of the increase in the CPI. The Central Bank had hoped that house price inflation would slow down or stop before the króna began to weaken. If housing prices had risen by little or nothing, they could have offset the effects of the eventual depreciation. Regrettably the outcome was as I described, i.e. the króna fell sooner and faster than had been expected, and before real estate price inflation began to come down to a sufficient degree. Inflation will therefore clearly remain some way above target over the months to come. BIS Review 46/2006  1  A necessary economic adjustment lies ahead. One of the chief characteristics of the Icelandic economy is its high degree of flexibility and adaptability.
The reasons are large year-classes approaching retirement age, increased longevity and a lower birth rate. Conditions are quite different in Iceland, where age distribution is changing more slowly than in most countries with similar economies. Iceland’s retirement pension system is based on all working persons saving a proportion of their wages in a fund which is then used to pay their pension. Taxes therefore does not need to be raised even if there is a proportional rise in the number of pensioners. In addition to pension funds, some pensions are paid through the national insurance benefit system and there are also voluntary supplementary pension savings schemes. Iceland’s pension system thereby fulfils what has been considered international best practice in this field [the three-pillar system]. Total assets of Icelandic pension funds were equivalent to 120% of GDP at the end of 2005. No other pension system in the world is on such a strong footing. At the end of 2004, when total assets of Icelandic pension funds corresponded to more than 100% of GDP, the figure for the Netherlands was just over 100% and for the US 80-90%. In the overwhelming number of industrial countries, total assets of pension funds were equivalent to less than 20% of GDP, and the ratio was even lower than 10% in many countries, including Germany, Italy, Belgium, Austria, Sweden and Finland. By comparison, assets of Norway’s Government Pension Fund (Petroleum Fund) last year were equivalent to 60% of GDP.