Taking into consideration innovations in central bank legislation in other countries, this Act consolidated the new inflation targeting policy. The most significant change from the earlier legislation was to set a single, principal objective for the Central Bank, i.e. to promote price stability. The Bank was also granted the independence to apply its instruments in order to achieve this objective. Furthermore, it was assigned the task of maintaining Iceland’s foreign exchange reserve and fostering an efficient and reliable financial system, i.e. financial stability. The Act also stipulated that the treasury may not borrow from the Central Bank. Specific requirements were set out concerning transparency and accountability towards both the government and the public. For example, the Bank is now obliged to publicly account for its monetary policy and for monetary and exchange rate developments and its actions in these areas at least quarterly. The principal objective of current Central Bank monetary policy, as stated in the joint declaration issued by the Bank and the government in March 2001, is to keep inflation as close as possible to 2½%. Should inflation deviate from this target by more than 1½ percentage points in either direction, the Bank is to provide the government with a written public account explaining what has caused this deviation, how the Bank intends to respond and how long it expects that it will take for inflation to once again return to within the targeted inflation limits. The Central Bank has only one instrument at its disposal to achieve this objective: interest rates.
When this decision was announced, it was stated that the Bank intended to purchase the equivalent of ISK 20 billion of currency by the end of 2003. To start with the Bank purchased USD 1.5 million on Mondays and Wednesdays each week. This January the Bank also began to purchase this same amount on Fridays as well, and in February purchases were added on Tuesdays and Thursdays. Currently the Bank thus purchases USD 7.5 million each week, or the equivalent of USD 390 million on a yearly basis. Even though the impact of these purchases on the exchange rate will likely be slight in the long term, as is generally the case with such intervention on the foreign exchange market, the króna rate will be somewhat lower for a while than would have otherwise been the case. 1  Aluminium smelter and related power plants. As was previously pointed out, the Central Bank spent the equivalent of ISK 40 billion to try and shore up the falling króna in the years 2000 and 2001. As a result, the Bank’s net external position worsened significantly and since that time its currency reserves have to a considerable extent been maintained with foreign short-term loans. The Bank’s plans to purchase the equivalent of ISK 20 billion in foreign currency, announced last autumn, involved paying off at least a major portion of short-term debt. This was also the primary purpose of the purchases.