Birgir Isleifur Gunnarsson: Review of economic and financial development in Iceland in 2003 Address by Mr Birgir Isleifur Gunnarsson, Chairman of the Board of Governors of the Central Bank of Iceland, at the Bank's annual meeting, Reykjavík, 23 March 2004. *  *  *  On behalf of the Board of Governors of the Central Bank of Iceland I welcome you all to the Bank’s 43rd annual meeting. The Bank’s financial statements for the year 2003 have been ratified today by the Prime Minister. The Bank’s annual report has also been published. It includes a survey of the Bank’s activities and performance, along with a detailed report on the Bank’s monetary policy and actions, the financial system, financial stability and the financial markets, and the main features of economic developments in the course of last year. Price developments Three years have now passed since Iceland’s monetary policy framework was changed and a formal inflation target was adopted with a joint declaration by the Government and the Central Bank. Under this framework, the target of monetary policy is price stability. The Central Bank is obliged to aim at an average rate of inflation, measured as the annual 12-month increase in the CPI, of as close to 2½% as possible. Since monetary policy aims at maintaining price stability, it will not be applied to achieve other economic targets such as a balanced current account or a high level of employment, except insofar as these are compatible with the Bank’s inflation target. Prices were stable in 2003.
As a result they will not shift the underlying macroeconomically-relevant monetary trends in the economy, which ultimately pin down developments in the price level. They are not intended to cap or control longer-term interest rates or to offer more favourable underlying financing conditions to the institutions involved – or, for that matter, to the Government – than would have prevailed in an orderly market environment. In the spirit of the famous Bagehot rule addressing the threat of bank deposit runs, yesterday’s intervention is intended to prevent painful, adverse self-fulfilling market dynamics emerging. That is why yesterday’s intervention is a “temporary and targeted financial stability operation”. It is intended to allow the inevitable and necessary re-pricing of financial assets stemming from recent macroeconomic news – including last week’s fiscal announcements – to take place in an orderly way. So yesterday’s intervention was not a monetary policy operation. The temporary and targeted character of the Bank’s intervention is key to the distinction between financial stability and monetary policy that I have emphasised here. With that in mind, let me now turn to the responsibilities of the Monetary Policy Committee (MPC), of which I am a member. The MPC will make a comprehensive assessment of the macroeconomic and monetary situation ahead of our next meeting in early November, before coming to a decision on the monetary policy stance. Hopefully, what I am about to say is self-evident. But in current circumstances it bears saying nevertheless.