This has played a major role in the ongoing reduction in Iceland’s foreign debt, as I will touch on later. Inflation has been at or below target for two full years. This is the longest such period since inflation targeting was adopted 15 years ago this Easter. And it has happened in spite of steep wage increases, which under typical conditions would have generated much higher inflation. But it so happens that conditions are far from being typical. Iceland’s terms of trade have improved markedly with the decline in oil and commodity prices, and tendencies towards deflation can be seen widely abroad. This has worked to counteract domestic inflationary pressures. At the same time, exports of goods and services have grown strongly, not least because of the booming tourism industry. According to newly published figures from Statistics Iceland, national income grew by nearly 8% in real terms in 2015, looking through the failed banks’ estates. When national income is measured, GDP is adjusted for income that reverts to non-residents and for changes in terms of trade. This tells us more about purchasing power in the economy as a whole than GDP does, and it explains in part why the recent wage increases have thus far generated much more real wage growth than inflation. There has been a substantial change recently in Iceland’s net external debt. According to newly published figures, external debt amounted to 14½% of GDP at the end of 2015.
It can be argued that such policy instruments should be on the law books by the time the auction of offshore krónur takes place because, if the auction is as successful as we intend, it is possible that confidence in Iceland will grow still further and capital inflows will increase. BIS central bankers’ speeches  3  Why do we need all of these additional tools and contingency measures? An important reason is the risk to financial stability that accompanies excessive and volatile capital movements that are unconnected to economic fundamentals. Another important reason is that in an increasingly financially integrated world, it is more difficult for small countries to deviate too far from the monetary policy pursued in the larger countries that determine global financial conditions. We saw this before the financial crisis, in New Zealand and here in Iceland. And we have seen it more recently, in countries like Switzerland and Sweden. We can better understand why this is so if we consider a situation where cross-border financial integration is nearly perfect, so that capital movements very quickly even out the difference in risk-adjusted real returns on assets in different countries. The interest rate channel of monetary policy transmission then becomes clogged up in small, open, and financially integrated economies, where long-term interest rates are determined by rates in large countries and transmission takes place largely through the exchange rate channel.