Our experience, as well as that of other countries, shows that a temporary slowdown is often an unavoidable consequence of strict economic management, aimed at controlling over-expansion and holding inflation in check. This is one reason why it is so important to prevent such waves from becoming too high. It is, however, an oversimplification to claim that monetary policy alone makes the decisive difference. Interest rates primarily affect demand in the economy. There are, on the other hand, many other factors which affect both demand and supply in the economy. These include, for instance, fishing quotas, public finances and public investment, foreign investment, e.g. in heavy industry, and the wage policy of the social partners. People who make these decisions control important economic instruments which are beyond the reach of the Central Bank. There are thus many parties involved in managing economic affairs and the Central Bank is far from the only party responsible here. Actions to boost economic growth and reduce unemployment Recently a number of actions have been announced to relax restraint in the economy. The full effect of major interest rate cuts in recent months has yet to be felt. The Central Bank has also announced imminent relaxation of reserve requirements, which will release funds in the banking system and should lead to interest rate decreases there. Each day the Central Bank has puchased foreign currency, in so doing placing some ISK 11 billion in circulation since September, which has certainly slowed the exchange rate rise.
The Central Bank’s tight monetary stance has, on the other hand, brought results, as last November inflation dropped below the target of 2½ %. Old theories reappear Recently there has been extensive discussion concerning the Central Bank of Iceland, its policy and objectives. Now that inflation has been subdued, old theories to the effect that the Central Bank should pursue multiple objectives have once more come to the fore. The Bank is to ensure full employment, it should have specific exchange rate objectives and ensure economic growth. These views reflect considerable over-estimation of the power of the Central Bank and the instruments at its disposal. It is also an oversimplification to focus exclusively on interest rates, as many people do, and expect that further interest rate reduction will solve all the problems. The Central Bank has, over the past two years, cut its rates thirteen times, and the bank’s policy rate is currently 5.3%. While this is naturally a higher rate than in the Euro zone, the problems which have to be grappled with there include long-term economic stagnation and high unemployment, and the future is by no means bright. In Norway, on the other hand, the Central Bank rate is 6%, to take an example of a neighbouring industrialised country. The Central Bank of Iceland’s real policy rate is currently around 2¾% considering future prospects, which is slightly under current estimates of the equilibrium interest rate.