It can be said that, apart from reserve requirements and other similar tools, which are seldom changed, the Bank’s interest rate decisions, foreign exchange market intervention, and capital controls are its chief monetary policy instruments. These instruments must be properly aligned, and consequently, interest rate decisions take account of capital controls. The controls provided some shelter for interest rate decisions for a while; however, as soon as they are relaxed, interest rates must be high enough to give investors an incentive to hold ISK assets. Just how high they must be is determined in part by the risk premium on the Republic of Iceland, which fortunately has declined significantly in the recent term. For example, the Republic’s CDS spread has fallen from around 1000 basis points at the beginning of the year to about 350 points. But what about foreign exchange market intervention? It is a tricky instrument and, if misapplied, yields nothing at best and generates enormous losses at worst. Refusing to use it at all, however, would be unnecessarily extreme. One of the lessons of the financial crisis is that the proper deployment of foreign exchange reserves can be of key importance in preserving monetary and financial stability under difficult circumstances. This is supported by innumerable examples from countries from Brazil to Korea. There is no benefit in amassing foreign exchange reserves during an economic upswing if one is chary of using them in times of need.
•  Financing restrictions – in the form of LTVs and caps on loan tenures – were imposed on housing loans and car loans to moderate demand and reduce price pressures. •  Over 2013–2014, inflation came down steadily as housing and car prices declined. So, monetary policy and macroprudential policy can potentially be complementary to help achieve both macroeconomic stability and financial stability. They can do this sometimes by acting in the same direction; sometimes in opposite directions. •  Charles Bean 7 gives a useful pedagogical exposition of how a restoration of price and financial stability could be achieved by a combination of instrument tightening and loosening, similar to employing an optimal mix of fiscal and monetary policies to influence the composition of aggregate demand. 7  Bean, C. (2015), Comment on Applying an Inflation-targeting Lens to Macroprudential Policy Institutions, International Journal of Central Banking, Vol 11, Supplement 1  BIS central bankers’ speeches  7  •  But we need to deepen our understanding of when to use monetary policy and when to use macroprudential policy and when to combine the two, if at all. Does tighter regulation weaken the efficacy of monetary policy? There is one other aspect of the interaction between monetary and regulatory policy that I would like to touch on. •  Just as monetary policy that is set to achieve macroeconomic stability can sometimes be inappropriate for financial stability, could there be a situation where regulatory policy weakens the transmission mechanism of monetary policy?