Furthermore, central banks have more instruments than just interest rates, as was revealed during and after the financial crisis, and these instruments have some impact on financial stability. The interactions between monetary policy and financial stability are therefore important. The exchange rate and the foreign exchange markets have proven to be more disorderly than theory on the benefits of floating exchange rates has generally admitted. Some market intervention could therefore pay a role in improving outcomes. Of course, this topic is more complex than my broad paintbrush can capture, and at present, there is considerable discussion internationally of how the experience of the financial crisis and its aftermath should affect which policy instruments central banks should use and how, in order to preserve long-term price stability, conduct some short-term output stabilisation, and promote financial stability. The main points that I mentioned earlier concerning the efficacy of monetary policy and its possible objectives remain largely unchallenged by this experience, however. BIS central bankers’ speeches  3  These flaws were also present in Iceland’s economic policy framework. As a result, there was inadequate response to the excessive capital inflows that contributed to credit and asset price bubbles and domestic residents’ significant foreign exchange risk, which was to a large extent unhedged. Furthermore, monetary and fiscal policy were not well enough aligned, and the same can be said of other Government decisions that affected demand. The burden on monetary policy was therefore greater than it would have been otherwise, which further stimulated capital inflows.

In other words, monetary policy is always implemented under conditions of uncertainty – to varying degrees, of course. This is why we consider a large number of economic indicators and use several models. Furthermore, we do not put a single economist in front of a computer and assign that person the task of determining the monetary stance; instead, we have a committee that exchanges opinions and assesses the current situation and outlook at the time in question. The observations I have just made are general in nature and apply to large and small countries alike. But we know that monetary policy in small, open economies is accompanied by particular challenges – challenges that we must take into consideration when developing a monetary policy framework for Iceland. In this context, it should be noted, first of all, that smaller economies generally have a tendency to be more volatile than larger ones, owing both to less economic diversity and the greater relative weight of individual shocks. Second, the relative weight of the tradable sector is often greater than in larger economies. Because of this, economic developments are more dependent on the exchange rate, and pass-through from the exchange rate to inflation is generally stronger. Third, financial markets are shallower than in larger economies, other things being equal, and this contributes to greater volatility of financial prices. Fourth, in an environment of unrestricted capital flows and increasing international financial integration, the possibility for small economies to affect their own financial conditions through monetary policy diminishes.