The question then arises: should there be an exchange rate target or an inflation target? The answer is not always straightforward. Other things being equal, an inflation target is more appropriate because it stands closer to the factors important to economic well-being, and it is easier to decide what an inflation target should be than to estimate the “right” exchange rate target. In other respects, the answer is determined by the structure and cyclical behaviour of the economy in question, the maturity of its markets, and whether cross-border movement of capital is largely unrestricted or not. The more open an economy is, the stronger the arguments for an exchange rate target because inflation is determined to a greater degree by the exchange rate. On the other hand, the less correlated shocks and cycles are with those in trading partner countries, the stronger the arguments for an inflation target and a floating exchange rate. Therefore, the two characteristics of small economies that I mentioned earlier  2  BIS central bankers’ speeches  pull in opposite directions. This does not change the fact that, other things being equal, smaller economies are likelier than larger ones to have an exchange rate target. Underdeveloped financial markets can be obstacles to the pursuit of an inflation target and a floating exchange rate. An example of this is the conditions in Iceland before the 1990s, when we lacked a money market for krónur and an interbank foreign exchange market.
These tools would not be used against the regular flows that are a normal part of monetary policy transmission; instead, they would primarily be used when flows became too strong and there is the risk that monetary policy transmission along the interest rate channel would be weakened excessively In implementing monetary policy, the MPC takes into account the impact of monetary policy and its interactions with other aspects of economic and prudential policies, insofar as this is consistent with medium-term price stability. There will be reliable processes for exchange of information, discussion, and analysis of the interactions among these various factors. This will take place through consultations between the Ministry of Finance and the Central Bank; through the proposed macroeconomic council, where the interactions between economic policy and labour market decisions would be discussed; or in the Systemic Risk Committee and Financial Stability Council and joint meetings of the Monetary Policy Committee and the Systemic Risk Committee. The Central Bank plans to strengthen these processes still further by launching a new publication next year. The report, which will be issued at least once a year, will focus on the external position of the economy and its sustainability, the outlook for the balance of payments, and the exchange rate and signs of major deviations from the equilibrium exchange rate. Honoured guests: The revised monetary policy framework will be finalised in the next few months, before capital controls on residents are lifted.