A weaker króna would have a multiple impact in the form of higher inflation, not least in the climate of overheating which has prevailed in Iceland recently, a resulting fall in living standards and difficulties for companies and credit institutions. Exchange rate policy reforms For quite some time now the Central Bank has been examining the option of abolishing the formal fluctuation bands for exchange rate policy and adopting instead direct inflation targeting as the basis of monetary policy. Articles on this topic have appeared in the Bank's publications in recent times and international agencies have recommended serious consideration of inflation targeting as the main monetary policy goal. The fixed exchange rate framework has gradually been eased and the fluctuation bands have been extended in phases, as I mentioned earlier. Indeed, the extension of the bands in autumn 1995 can be claimed to represent the first step towards instituting a new foreign exchange framework, with the next step taken in February last year. The Central Bank sees many factors in favour of adopting inflation targeting, which is a logical continuation of the flexible exchange rate policy that has been pursued. Monetary policy based on formal inflation targeting enjoys growing support and has been adopted by an increasing number of countries. Industrialised nations which have done so include Australia, the UK, Canada, New Zealand, Switzerland and Sweden.
BIS Review 51/1999  2