This is why the sovereign has been able to tap international capital markets twice so far since the crisis struck, and why its five-year CDS spread is currently below 180 points. Why did the Government give a verbal blanket guarantee for domestic deposits only and not for deposits in the banks’ foreign branches? After all, this distinction probably added fuel to the fire of the so-called Icesave dispute about the settlement of deposit guarantees in Landsbanki’s Dutch and British branches. The short answer is that such a guarantee would never have been credible. As a result, it would not have stopped the run on these deposits and, if attempted, might have bankrupted the Government. At the time, the Central Bank of Iceland’s FX reserves amounted to 2½ billion euros, while the foreign currency deposits in Landsbanki’s Dutch and British branches totalled 11½ billion euros and payment of the EU minimum deposit insurance would have required 4½ billion euros. The sovereign was completely closed off from foreign capital markets at that point. Furthermore, in economic terms, given that these deposits were used to a significant degree to finance illiquid assets in these same countries, such a payment, if possible, would have amounted to a net transfer of resources from Iceland to these countries at a time when Iceland was going through its deepest financial and economic crisis in the post-war period! That made no sense.
This was the result of weaker cyclical developments in the world economy and a sharp drop in interest rates internationally. In addition, the Norwegian business sector has felt the effects of the high Norwegian cost level. The weak prospects at home and abroad have in turn had an impact on the Norwegian labour market and the outlook for wage growth and inflation in the years ahead. The mandate implies that the interest rate must be adapted to the outlook for the Norwegian economy. If it appears that inflation will be higher than 2½ per cent with unchanged interest rates, the interest rate will be increased. If it appears that inflation will be lower than 2½ per cent with unchanged interest rates, the interest rate will be reduced. This orientation of monetary policy will normally also contribute to stabilising output and employment. The impact of monetary policy occurs with a lag. The current inflation rate does not provide sufficient information to determine the level at which interest rates should be set now. Our analyses indicate that a substantial share of the effects of an interest rate change will occur within two years. Thus, two years is normally a reasonable time horizon for reaching the inflation target. The interest rate influences inflation indirectly via domestic demand for goods and services and via its effect on the exchange rate. When interest rates rise, it becomes more profitable for households to save, and they will therefore postpone consumption. Borrowing also becomes more costly, with an associated decline in investment.