Birgir Ísleifur Gunnarsson: Update on Iceland’s economy Address by Birgir Ísleifur Gunnarsson, Chairman of the Board of Governors of the Central Bank of Iceland, at its Annual General Meeting, Reykjavík, 27 March 2001. *  *  *  On behalf of the Board of Governors of the Central Bank of Iceland I welcome you all to the Bank's 40th annual meeting. This year marks the Bank's fortieth anniversary after it was made completely separate from Landsbanki and transformed into an independent institution. The Bank's financial statements for the year 2000 have been ratified today by the Prime Minister. The Bank's annual report has also been published. As usual 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 and financial markets, and the main features of economic developments in the course of last year. I shall now address several aspects of economic issues and the present prospects, in particular those most closely connected with the Central Bank's field of activities. Overheating of the economy Iceland has distinguished itself from most other industrialised countries in recent years by the strong economic growth it has enjoyed, or 4-5% per year. The closest comparison in this respect is with the USA, where growth is in fact on a downward path now.
This prediction did not materialise in full. During the second half of the year it seemed clear that there would be some lag between the depreciation and its effect on the price level. This prompts questions about the correlation between prices and exchange rate developments. The short-term relationship of these factors appears to have weakened, which is undoubtedly explained in part by market competition. A more flexible exchange rate policy is also unquestionably at work. In earlier times, when devaluations were made amid extensive announcements, the change was in general rapidly reflected in the price level, since it was fairly certain that it would be permanent. After the exchange rate was made more flexible, it can be assumed that uncertainty about the permanence of changes has led buyers and sellers of goods to take more short-term exchange rate risk than before,  2  BIS Review 27/2001  since high costs are involved in making frequent alterations to prices. However, it is imprudent to ignore the eventual impact of a depreciation on prices, since research offers no support for such a view. This is one of the assumptions on which the Bank bases its forecast from this February, where inflation is expected to run at 4.3% between 2000 and 2001 and 4.6% from the beginning to the end of the year. Next year it is forecast to slow down to 2.7% from the beginning to the end of the year.