Given how widespread this phenomenon is, and given that it is in some respects independent of domestic conditions and economic policy, there are a number of indications that global factors such as increased cross-border mobility of labour and other production factors, international value chains, and the existence of a large excess labour force in some emerging market economies play an important role in it. An underestimated slack in the labour market is hardly a factor in Iceland, as the labour participation rate is at a historical high and wage rises are substantial. Labour importation and indirect pressures from an unutilised lower-income labour force in other countries have clearly had a dampening effect on wage increases, however. Even so, inflation is low. This is true of 4  other economies as well. But it is less of a puzzle than wage developments in industrialised countries overall: global trends have been favourable to them, as can be seen in improved terms of trade and rising exchange rates. It is well known that this can create conditions where strong GDP growth and sizeable pay rises can coincide for a time with low inflation. And one difference between Iceland and many other industrialised economies is that in other countries there have been concerns that inflation expectations would fall too steeply and become anchored below target. In order to place Iceland in this context, let us look at Chart 4, which gives some relevant metrics for several small and medium-sized inflation-targeting countries.
In the long run, monetary policy can deliver price stability, and in the short run it can also mitigate the effects of shocks and reduce fluctuations in output and employment. But monetary policy cannot have a long-term impact on the real exchange rate. As such, it can do little to mitigate the crowding-out effect of strong growth in a new export sector. If it tried to, the effect would be only temporary, and it would come at the expense of sacrificing the objectives with which monetary policy has been entrusted – objectives that it can achieve. Industrial and fiscal policies can have such a real impact over the long term, however, and it is to them that concerned parties should turn. 9  But it is possible to choose from among various options on the spectrum between a rigid peg and a free-floating exchange rate. And it is possible to adopt another currency, either unilaterally or in bilateral or multilateral cooperation. These were the options explored in the Central Bank’s 2012 report. 4 The conclusion was that a unilateral peg with unrestricted capital flows could run aground, as it did in so many economies after capital movements were liberalised further in the 1980s and 1990s. A firmer peg such as a currency board could pose risks to financial stability, and the same was considered true of unilateral adoption of another currency. It was deemed highly uncertain – and actually unlikely – that bilateral adoption of another currency would be on offer anywhere.