MONETARY POLICY IN ICELAND:AN EVALUATIONbySEBASTIAN EDWARDSHenry Ford II Distinguished Professor
UCLAJune 2018

Table of Contents• Executive Summary• Introduction• Part One: Monetary Policy Options: Reflections based on Iceland• Part Two: An assessment of current monetary policy in Iceland’• Part Three: Conclusions and recommendations• Annex: Models for assessing exchange rate equilibrium: A brief
review and some reflections regarding Iceland

Introduction
5432
1Policy Rate
Core Inflation

0-1-2-3-4

Real policy rate
AustraliaChileCanada

New ZealandNorwaySwedenUKICELAND

PART ONE: MONETARY POLICY OPTIONS:REFLECTIONS BASED ON ICELAND
••
•
•••
•
•

Dilemmas, trilemmas and all of thatCredibility vs. flexibility
Does flexibility really means having a shock absorber?
The transmission mechanisms of monetary policy under flexible exchange
rates
Do flexible rates buy full monetary policy independence?
Capital controls and monetary policy
Currency intervention
Monetary regimes, monetary policy, fiscal policy and labor markets

Monetary policy independenceControls on inflows with intervention:Chile, 1991-1999

Foreign exchange market intervention,New Zealand, 2004-2017

Currency intervention model,New ZealandPART TWO: AN ASSESSMENT OF CURRENTMONETARY POLICY IN ICELAND•“Inflation has been at or below the Central Banks inflation target for over threeyears… Increased price stability has been achieved in spite of considerable domestic
inflationary pressures stemming from large pay increases, and this stability is due inno small part to a steep decline in import prices, which in turn is due to domestic
inflation and the appreciation of the króna.”•“As inflation has fallen in recent years, it has also grown less volatile.”•“Deviations from the inflation target have also diminished greatly.”••“Short- and long-term inflation expectations have gradually subsided to the targets
and have become less volatile.”“Inflation appears to be less persistent than before.”•“The inflation target has gained credibility.”•“Business cycle fluctuations have diminished.”•“Fluctuations in the exchange would have diminished… and there are signs that theircharacteristics have changed in recent years.”•“Exchange rate movement seemed increasingly to counteract the effects of aggregate
supply and demand shocks.”“Fluctuations in real interest rates have diminished as inflation expectations havebecome more firmly anchored.”•Transmission mechanisms• Is it the yieldcurve?
• Is it the exchangerate?

• Monetary policy and the yield curve• Monetary policy and the exchange rate
• Exchange rates and pass-through• Monetary policy and the housing sector• Taylor rules for a small open economy• Assessing the long term equilibrium value ofthe real exchange rate, the sustainable current
account balance, and sustainable NIIP
• The effectiveness of capital controls andcurrency intervention

Bilateral exchange rate volatility

Four main
conclusions/recommendations• It is important to realize that there is no “silverbullet” in terms of monetary regime/policy.
• At the current time the best monetary regime
for Iceland is “flexible inflation targeting.”• However, some improvements to policy can beundertaken. (Details below).
• Need for support policies: Labor market
flexibility, pension funds liberalization, fiscal
support.

ANNEX:
MODELS FOR ASSESSING EXCHANGE
RATE EQUILIBRIUM: A BRIEF REVIEWAND SOME REFLECTIONS REGARDINGICELAND