The sharp depreciation of the krona left many borrowers with foreign currency loans facing higher debt. For a time, exchanging Icelandic krona for another currency was impossible. Nonetheless, the decisive factor was the collapse of Iceland’s oversized banks. Although they were taken over by the Icelandic authorities, there was no confidence that Iceland’s finances would be able to cope with the accompanying high level of debt. Iceland was obliged to seek aid from other countries and from the International Monetary Fund (IMF). Output is now expected to fall by 10 per cent this year, and private consumption to drop by  2  BIS Review 16/2009  35 per cent over the next three years. At the same time, the Icelandic state will be bearing a debt burden equivalent to more than NOK 1 million per family. The global crisis soon affected Norway. Our banks and the flow of credit and money are closely interconnected with global markets. Banks’ foreign financing became expensive and almost came to a halt. Banks responded by raising interest rates on corporate and household loans and restricting lending. As the autumn progressed, an increasing number of business sector segments were feeling the impact of contraction. In August 2008, manufacturing enterprises in our regional network reported that they expected growth to remain high. In November, they described the turnaround as a “heart attack”. Manufacturers of automotive parts in Farsund, Høyanger, Raufoss, Kongsvinger, Kongsberg, Hvittingfoss and Rollag felt the impact of the slump in car sales.

In an open economy, such policy may be ineffective in controlling asset price growth and may even worsen the prospects for financial stability. I will tackle this further in my coming discussion of capital flows. The same criticism applies to the use of regulation to achieve macro stability. It could be possible to use bank capital requirements to control inflation through the supply of credit and real activity, but it would raise the cost of capital and would hit especially hard bankdependent firms and consumers while other borrowers would turn to other sources of financing. Furthermore, the relatively high-frequency changes that managing macro  2  BIS central bankers’ speeches  conditions may require may create unnecessary policy-driven volatility in financial markets. All this indicates that it is more appropriate to tackle each goal with its own type of tool. The separation of the instruments does not necessarily mean that the achievement of the goals can be separated operationally. Because of the dual causality of price and financial stability, monetary and financial policies should be explicitly coordinated. How this coordination is achieved varies across countries. At the very least, instances to monitor global risks to financial stability should exist. Central Banks should be involved in these monitoring instances (or should centralize the monitoring and supervision functions) because of their relative advantages in providing a macro view of the economy and their market contacts, due to the implementation of monetary operations. In addition regulation that could have systemic implications should be discussed in these instances.