Although developments in Iceland showed many of the same characteristics as those in some of the other Nordic Countries during the post-liberalisation rapid expansion, such as credit expansion, current account deficit, exchange rate depreciation and so on, Iceland escaped the difficulties suffered by banking systems in some of the other countries. Icelandic bank credit grew very rapidly in the late 1990’s and into the year 2000 and a sizable portion of the credit expansion was financed with credit from abroad. The capital adequacy ratios of banks fell for a while but nevertheless remained comfortably above the minimum required and internationally recognised levels. The year 2001 also turned out to be quite favourable for the banks, a development which continued by and large into the current year. Consequently, the capital position of the banks has improved and all the major banking institutions have relatively strong capital adequacy ratios at present. Loan losses have increased, as was to be expected in the wake of the credit expansion, but nowhere on the scale experienced in some of the other Nordic Countries a decade ago and very much less than they did during the downturn in the Icelandic economy around and after 1990. The conclusion to be drawn is, therefore, that the Icelandic banking system weathered the relatively turbulent post-liberalization boom period of 2000 and 2001 pretty well and is well poised to meet new challenges, including continued rationalisation and intensified competition from foreign banking institutions. In the most recent decades, the Icelandic economy has also seen structural shifts.

in the EU, the US and Japan. Capital markets outside these areas are small. However, changes are also being made in monetary policy regimes in a number of emerging markets. One important tendency is that fewer countries operate an exchange rate policy regime where they are free to change the conversion rate to other currencies on their own initiative, so-called “crawling pegs”. A number of emerging markets have chosen inflation targeting instead: for example Israel, Chile, Brazil, Colombia, Korea, Thailand, Mexico og South Africa. Other countries, such as China, Hong Kong and the Baltic States, have chosen to continue to use a fixed exchange rate system. The operational target of monetary policy in Norway as defined by the Government is inflation of close to 2.5 per cent over time. The inflation target provides economic agents with an anchor for their decisions concerning saving, investment, budgets and wages. The inflation target is also a vehicle for allowing monetary policy to stabilise developments in output and employment. This objective is also expressed in the Regulation on Monetary Policy. High demand for goods and services and labour shortages normally point to higher inflation. When interest rates are increased, demand falls and inflation is kept at bay. When demand is low and unemployment rises, inflation will tend to slow. BIS Review 46/2003  5  Interest rates will then be reduced. This orientation of monetary policy will normally also contribute to stabilising output and employment. The impact of monetary policy occurs with a lag.