Monetary policy: achievements and review? Már Guðmundsson, Governor of the Central Bank of Iceland. Monetary policy meeting of the Iceland Chamber of Commerce, held at Harpa in Reykjavík on 17 November 2016  Madame Chairman, honoured guests, The Iceland Chamber of Commerce has a long-standing tradition of holding a meeting like this one on economic developments and prospects and monetary policy. The meeting is held following the publication of the Central Bank’s autumn forecast and, in latter years, the Monetary Policy Committee’s interest rate decision. In recent years, it has been the practice to select a particular topic for the meeting, and in keeping with this, today’s topic is: Is independent monetary policy too costly? This departs somewhat from the contents of the Central Bank’s Monetary Bulletin and current tasks of monetary policy, but I will touch on these towards the end of my speech today. Yesterday the Bank published Monetary Bulletin 2016/4, which contained the Bank’s new macroeconomic forecast, and announced the Monetary Policy Committee’s interest rate decision. The big picture of the current state of the economy is that things have seldom been better. Icelanders have received a significant boost from improved terms of trade and growing goods and services exports, particularly due to strong growth in the tourism sector. It is this that underlies the vast increase in Icelanders’ real income and the country’s high employment level. In addition, Icelanders have proven more cautious this time than often before during an economic boom.
Second, the longer we keep inflation expectations at target, maintain a current account surplus, and continue to pay down debt, the more the risk premium component of interest rates and the equilibrium real rate in Iceland will continue to fall. The current propensity to save, adjusted for the business cycle position, is much greater than it has been for quite a while, and over time, it will contribute to a reduction in the long-term equilibrium real rate. If inflation expectations remain at target, both nominal and real rates will decline accordingly. Exchange rate of the króna and Central Bank foreign currency purchases Responding to the recent strong inflows into the foreign exchange market is one of the Central Bank’s most complex tasks at present. The problem lies, among other things, in distinguishing between short-term inflows, which are only loosely connected to economic fundamentals and are much more likely to stop suddenly or even reverse, and inflows that reflect more lasting positive changes in fundamentals, although these can change for the worse as well. It can be argued that, other things being equal, there should be more foreign exchange market intervention in the former instance and less in the latter. While the foreign exchange reserves were being increased to the desired size during the prelude to general capital account liberalisation, this distinction was less important for policy responses than it is now, as the premises were in place to buy the inflows and top up the reserves, more or less irrespective of the origins of the inflows.