The crucial task of valuing and disclosing the impact of losses on core banking institutions is still work in progress: important announcements are being made almost daily, and beyond them lies the equally important task of repairing banks’ balance sheets. The current shortage of liquidity makes the pricing of complex assets even more difficult. At the very least, this reinforces the need for transparency in providing estimates of losses, and descriptions of the best-efforts processes used to produce these estimates. The process of price discovery for many complex asset classes is unlikely to be completed quickly. For assets directly related to US sub-prime, this is unlikely to be before the US housing market stabilises. Other structured credit markets are likely to remain illiquid until confidence in the banking sector has been restored, and large financial institutions are willing to take more risk. Clearly the situation is still developing. And its impact on the wider economic outlook – global and domestic – will depend critically on what happens from now on. Here there are some major uncertainties.
Honoured guests: There is no doubt that inflation targeting is the future for monetary policy in Iceland, as it is for other countries with monetary independence, even though targets may be modified along with the tools used to attain them. There was a time when it was believed that central banks could achieve their objectives by wielding a single weapon: seven-day interest rates. It was also believed that central banks should think only about the transmission of monetary policy to the real economy and let the financial system alone in other respects. In the narrowest sense, the task in hand was inflation, not asset bubbles. But this narrow policy was doomed to crash and burn, here as well as elsewhere. Monetary policy has been reformed and strengthened since then, and is sometimes referred to as inflation targeting-plus. In May 2015, London Business School professor Hélène Rey published an influential paper bearing the title Dilemma not Trilemma: The Global Financial Cycle and Monetary Policy Independence. Rey argued that, because of financial integration, independent monetary policy was actually no longer an option for small currency areas unless it was possible to manage the capital account directly or indirectly, no matter what exchange rate regime was pursued.