With our decision to keep the three-month Libor rate on hold, we are adhering to our current monetary policy course: we are making use of our monetary policy leeway to support growth without jeopardising long-term price stability. Every forecast and every decision is fraught with uncertainty. Should unexpected events delay economic recovery or push up the Swiss franc sharply, we shall take appropriate action. For such cases, the Swiss National Bank keeps all its options open. 2/3  Observed inflation December 2004  Inflation forecast on September 2004 with Libor at 0.75% and of December 2004 with Libor at 0.75%  3/3
But the effect of monetary tightening on domestic demand is limited through the processes I have described, where long rates react weakly to the increase in the policy rate. In addition, firms and households increasingly borrow in foreign currency in order to avoid even those limited increases in domestic borrowing costs that take place. This foreign currency borrowing is intermediated by the domestic banking system, where the financing is more short-term than the lending. Thus the banking system has a growing balance sheet in FX, with a maturity mismatch but limited LOLR facilities to backstop it. In short, financial risks are accumulating, both in the financial sector and among firms and households. At the same time, the economy is increasingly in an unsustainable position, with an overvalued currency and big current account deficit. The  2  BIS central bankers’ speeches  whole thing then comes crashing down when foreign financing comes to a sudden stop, heralding a currency crisis and even a banking crisis as well. Before I go further, let me warn you, though, that this is only part of the explanation of the financial crisis in Iceland. The offshore activities of the banks and old-fashioned macroeconomic mismanagement were equally important, if not more so. On this topic, I refer you to other speeches and publications by myself and others. 2 What can and should be done about the problems I have laid out?