But, while significant progress has been made since the end of the recession, there remain a number of headwinds that have offset the improvement in the underlying fundamentals. As a result, we have yet to see any meaningful pickup in the economy’s forward momentum. The most notable recent headwind, of course, has been the large amount of fiscal drag this year from the payroll and income tax increases and the budget sequester. Also noteworthy is the tightening of financial market conditions that has occurred since May. As we move into 2014, the fiscal headwinds should abate somewhat. As that occurs, the improving underlying fundamentals of the economy should begin to dominate, pushing up the overall growth rate. But this is just a forecast, it has not been realized yet. That is one reason why I supported the FOMC’s decision last week to maintain the current pace of our Treasury and mortgagebacked security purchases. In my view, the economy still needs the support of a very accommodative monetary policy. Adjustments to that policy need to be anchored in an assessment of how the economy is actually performing, how financial conditions are evolving, and how this affects the longer-term outlook and the risks around it. Our decisions on how to adjust our policy tools – for example, the pace of asset purchases and forward guidance with respect to the level of short-term rates – must be rooted in the ongoing flow of information that informs our judgments about the prospects for a sustainable recovery.
Credit institutions are now proceeding more cautiously in their lending to this sector and interest rate terms are changing. Oil prices seem to be stabilising, and in spite of mounting labour market pressures, wage drift has been contained. The Central Bank’s policy rate hike is beginning to spread through the economy; monetary policy is transmitted with an inherent lag in all cases, and this has even been exaggerated by Iceland’s unique economic conditions at present. The most important change in the wake of the September policy hike, however, was that indexed bond yields began to rise at last. It was vital for monetary policy to begin to have an effect in the parts of the economy which showed the clearest signs of overheating, i.e. soaring private consumption growth. Although all these points represent an interesting and positive development, on their own they do not justify changing the policy that the Central Bank has been pursuing. Substantial pressures still exist in the economy, demand is buoyant and there are undeniably sizeable imbalances. These factors must be seen in context. While recent information on the short-term outlook should obviously be observed, it is even more vital to look at indicators for longer-term developments. In effect the Central Bank has no other option – like God’s mills, the Bank’s instruments grind slowly, but grind exceedingly well, if patience and foresightedness guide the way. The Central Bank has made no secret that the current strength of the króna is not sustainable in the long run.