This is consistent with lower 12-month growth rates in the second half, which respond largely to a tighter comparison base. For 2019 and 2020, the forecast ranges are similar to those considered in June. Thus, GDP will grow between 3.25% and 4.25% next year, and between 2.75% and 3.75% in 2020 (Figure 4). The lower growth expected in 2020 stems from the economy closing the gaps somewhat faster than expected and, therefore, growing around potential. Moreover, the impulse from abroad will contribute somewhat less growth at that horizon. These projections represent a somewhat less favorable external scenario than in the previous Report, an MPR that will remain below its neutral level for several more quarters, investment outgrowing GDP, no major macroeconomic imbalances and the economy growing around its trend trajectory towards 2020. 3  Compared with June’s Report, the baseline scenario adjusts the gross fixed capital formation (GFCF) of 2018 upwards but maintains the same gradual reduction in its expansion rates over the rest of the projection horizon. On the consumption side, we expect private consumption to grow at a similar pace as GDP during 2018, 2019 and 2020. This assumes that the durable component—largely its imported part—will decelerate from the first half of the year, affected by the depreciation of the peso. The support that household spending receives in the baseline scenario from the recovery of the labor market should help offset this effect (Figure 5).
Early on, the Monetary Policy Committee had to focus on stabilising the exchange rate in order to stop the collapse of asset prices and the automatic increase in private sector debt, most of which was either exchange rate-linked or indexed to the CPI. The scope to cut interest rates in order to stimulate demand was therefore limited, although it began to develop over the course of 2009. The capital controls that were introduced in late 2008 provided some room for manoeuvre and enabled the Central Bank to allow real interest rates to fall faster than would otherwise have been possible. Inflation, which had skyrocketed after the currency collapsed, began to subside gradually, but the inflation spike caused by contractual wage increases and excessively high inflation expectations cut into that room for manoeuvre from mid-2011 onwards. In order to understand the economic recovery in the face of these headwinds, two points are important. The first point centres on the nature of the recession. To some extent, the recession represented the inevitable adjustment of domestic demand to the fact that it was no longer possible to fund the country’s massive current account deficit and to the abrupt contraction of two sectors – financial services and construction – that had grown exponentially during the upswing. When the dust settled, the domestic economy still rested on other sturdy foundations, and the low real exchange rate stimulated some of Iceland’s tradable sectors.