Nevertheless, the aim is to lift the special reserve requirement as soon as conditions warrant it and that it will not, as a general rule, be used under normal conditions. Even so, the Central Bank has considered it important to be able to activate it if the need arises. The special reserve requirement would then be a third line of defence, to support conventional economic policy and microand macroprudential tools. In order for this to be possible after the capital controls have been lifted in full, a new statutory foundation (other than the Foreign Exchange Act) must be found for the special reserve requirement, which is primarily a monetary and macroprudential policy instrument. Furthermore, the efficacy of the special reserve requirement must be ensured once speculative derivatives trading in krónur has been re-authorised, as full liberalisation implies. The Central Bank is currently reviewing the technical foundations for the special reserve requirement and preparing proposals for statutory amendments pertaining to its application. Exchange rate fluctuations The new issue of Monetary Bulletin contains a Box on fluctuations in the exchange rate of the króna in international context. That article presents several points that should be borne in mind in any discussion of monetary policy and possible modifications to the monetary policy framework, including exchange rate policy. They are as follows:        Short-term exchange rate volatility increased just after the capital controls were lifted, as had been expected and as the Monetary Policy Committee had pointed out in advance in its statements.

In short, monetary policy with a flexible exchange rate is much more successful now than it had been before 2012, when the Bank published its report entitled Iceland’s currency and exchange rate policy options.3 Chart 5  1  Special Publication no. 4, Monetary Policy in Iceland after capital controls. Report from the Central Bank of Iceland to the Minister of Economic Affairs, December 2010: https://www.sedlabanki.is/library/Skraarsafn/Serrit/Peningastefnan_eftir_hoft.pdf 2 Special Publication no. 11. Monetary policy based on inflation targeting: experience since 2001 and post-crisis changes, September 2017: https://www.sedlabanki.is/library/Skraarsafn/Serrit/Serrit_nr_%2011.pdf 3 Special Publication no. 7. Iceland’s currency and exchange rate policy options, September 2012: https://www.sedlabanki.is/library/Skraarsafn/EMUskýrsla/Valkostir%20Íslands%20í%20gjaldmiðils-%20og%20gengismálum.pdf  6  Capital flow management tool There have been proposals in the media recently to the effect that the special reserve requirement on foreign capital inflows for investment in the bond market and in high-yielding deposits be immediately reduced or even eliminated. In a Box in the newly published Monetary Bulletin, the Bank discusses this special reserve requirement. It does not agree with these proposals. The special reserve requirement has functioned as intended, and monetary policy transmission along the interest rate channel has improved, as can be seen at the right in Chart 6. Without it, monetary policy transmission would have been shifted in greater measure to the exchange rate channel, leading to a stronger appreciation and increased exchange rate volatility, which would not have been terribly popular under current conditions. Although the goal is to lift the special reserve requirement, conditions do not warrant it as yet.