It is true that business investment excluding energy-intensive industry and ships and aircraft is strengthening and, according to the forecast, will grow by 8% this year, while total business investment as a share of GDP will rise over the forecast horizon, to about 11% in 2014. It will still be below the 30-year average of 12½%, however. On the other hand, exports of goods and services will grow by about 2½% this year and by an average of just under 2% per year in 2012 and 2013. This is not a very cheery prospect, given that the real exchange rate of the króna is currently over 20% below the historical average. It is important to bear in mind that low investment levels and weak export growth are related phenomena. A large share of Iceland’s exports (marine products and aluminium) are subject to capacity constraints, and in some instances, increased export levels would require substantial investment. Thus it is important to facilitate investment in export sectors. Those who believe that monetary policy has been a critical factor after the real policy rate fell to the current –1% are mistaken, however. Much more important are risk aversion in the markets, limited access to foreign credit, an uncertain operational environment, and impaired corporate balance sheets.
But the Taylor rule is a good test because, other things being equal, the policy rate should be reasonably well in line with it unless there are convincing reasons for a deviation. With this in mind, let us turn to the November interest rate decision. The Monetary Policy Committee decided to raise interest rates by 0.25 percentage points. That decision, of course, was based on the most recent statistics and the indications in the Bank’s forecast. First of all, inflation is far above target and is forecast to continue rising until early in 2012 before tapering off as the year progresses. Second, available measures of inflation expectations indicate that longer-term expectations are considerably above target. These measures of inflation expectations are flawed, of course – perhaps especially so at this time. Survey measures have a tendency to take excessive account of recent inflation, and bond market measures of inflation expectations are skewed by a variety of market imperfections at present. But flawed though they may be, these are the only measures we have, and it would be irresponsible simply to ignore them. Third, indicators suggest that domestic demand was strong in Q3 in spite of the global situation, and that the economic recovery is strong enough not to be derailed by resistance to inflationary pressures through modest rate interest hikes. Fourth, we have the global situation, which is mainly a risk factor at this juncture and has not yet had a measurable impact on domestic economic developments. But we did not merely raise interest rates.