Interest rates have been on the increase recently in most parts of the world and capital is not as cheap as before, although it can still be procured at very low rates. Conditions in capital markets in general are therefore more likely to tighten in the coming years. Influential as economic developments on both sides of the Atlantic may be for the Icelandic economy, the way we handle our own affairs is still important. The crucial consideration is to achieve a rapid reduction in macroeconomic imbalances and restore stability. To do so, domestic demand must be reduced. Part of this process will occur automatically with the completion of ongoing investments in the aluminium and power sectors. Much has changed since the meeting a year ago, some things for the better, and others not. The current account deficit run up last year will not be forgotten for a long time – it even managed to trump the most pessimistic forecasts. Fortunately, clear signs of a gradual contraction are now visible, but this improvement is likely to be slower than we had previously expected, especially on account of foreign debt service. The Board of Governors of the Central Bank decided yesterday to leave the Bank’s policy rate unchanged at 14.25%, at the level where it has been since December. By contrast, the day before last year’s annual meeting, the Board of Governors raised the policy rate by 0.75 percentage points.
Its strong fiscal position is exemplary, and the population is relatively young, well educated and quick to adapt to technological and scientific innovations of all kinds. A strong pension system has been built up and – unlike other countries that have great fears about the future of their pension systems and their sustainability – it is clear that Iceland’s pension system is becoming increasingly stronger. Admittedly it is still not mature enough to have begun to pay out a representative proportion of its owners’ lifetime earnings, but this proportion is growing every year and all the pointers indicate that, for the foreseeable future, it will be highly sustainable. Thus the pension system is going from strength to strength in Iceland, at the same time as significant weaknesses are coming to the fore in many comparable economies. Real incomes in Iceland rank with the highest in the world, and unemployment with the lowest. Large-scale investments have recently been made which will generate  BIS Review 42/2007  3  handsome export revenues. Traditional sectors currently enjoy secure markets and high product prices. Undeniably this picture looks very bright and many more positive signs could be cited. But this does not alter the fact that, as I said earlier, the foundation has been precarious in many areas and the medium term will have a decisive significance for the outcome. Uncertainties abound and many households in Iceland thread a narrow path of debt and wages, where if they lose their footing, the fall could be heavy.