macroeconomic model. a landmark was reached this year when the bank began publishing its staff ’ s projection for the policy rate path that is compatible with attaining the inflation target within an acceptable timeframe. previous interest rate assumptions had proved unsatisfactory and even misleading. publication of the policy rate path has been welcomed and has facilitated the central bank in exerting the impact that it intends to have on market expectations. international agencies and foreign analysts who monitor economic developments in iceland have praised the central bank ’ s monetary policy implementation, transparency and professionalism. it is interesting to note that these assessments are at odds with widespread attitudes in iceland at the moment. in the climate that has prevailed recently, the central bank ’ s policy rate hikes have admittedly affected the exchange rate of the krona first, then demand much later. among the explanations is that policy rate hikes have not had what should have been their normal effect. this has complicated the bank in its efforts to constrain inflation in recent times. one factor has been the changes that took place in the mortgage loan market in autumn 2004 when the commercial and savings banks began competing with the housing financing fund ( hff ). the central bank ’ s policy rate hikes impact the interest rates of non - indexed lending by commercial banks and savings banks and the non - indexed end of the domestic bond market. however, for a long time they had little impact on long - term interest rates. some critics cite this as proof that the central bank of iceland ’ s measures do not have the same effect as those of other central banks. yet the development in iceland is by no means an isolated occurrence. the us experience offers an immediate example. the federal reserve began raising its federal funds rate early in 2005 in progressive steps until early this year, from 1 % to 5. 25 %. these hikes had no effect on long - term interest rates in the us, which have been broadly steady since 2005 apart with only minor fluctuations in either direction. us monetary authorities were puzzled by this development. i cite this example because it has been claimed that, unlike the central bank of iceland ’ s decisions, the impact of changes in the federal reserve ’ s rates is immediately transmitted in full to long - term interest rates. one reason for iceland ’ s limited success in keeping inflation in check has been precisely that the impact of the central bank ’ s policy rate hikes has not been transmitted in full to the mortgage loan market. in particular this is because one

are in play at any given time. the auction format also ensures that transfers of banking system liquidity will not be large enough to jeopardise the system ’ s stability. the foreign exchange reserves are protected as well by the requirement that investors bring foreign currency into the country and exchange it for kronur in the domestic market. this will offset the foreign exchange outflows that often accompany new investment. another important aim of the strategy is to ensure short - term treasury financing. even though significant progress has been made in controlling the fiscal deficit after the crash and halting the accumulation of unsustainable debt, it is important not to underestimate the current dependency of treasury financing on the capital controls. more than half – and, in some instances, as much as ¾ – of the stock of short - term treasury bonds is held by nonresidents. the yield on icelandic treasury debt is now a bit lower than in the euro area countries that are facing severe sovereign debt crises, and real yields are considerably lower. it is not a given that this would be so without the capital controls. if the controls were lifted today, interest rates would probably rise sharply, even though a large proportion of the investors that own these bonds are relatively at ease within the capital controls regime. without the controls, the authorities would have to take further action in order to achieve the objectives set for the coming year. it is therefore of pivotal importance to lengthen the maturity profile of treasury financing before the controls are lifted. marked progress has already been made in this area. the average duration of domestic treasury bonds has increased from 3 to 7 years. last spring, domestic pension funds and other investors purchased a sizeable supply of indexed longterm treasury bonds by participating in the first auctions under the liberalisation strategy, which were dedicated solely to investment in long treasury bonds. the aim was to lengthen the maturity profile of treasury financing and thereby reduce risk. although there has been a hiatus in the auctions and the pension funds lost interest in them after foreign stock markets fell this past summer, non - residents are growing interested in this investment option, which will continue to be available alongside the investment programme. the programme gives investors the option of buying icelandic kronur at the auction exchange rate ( near the offshore rate ) in order to invest in the domestic economy, provided they sell a corresponding amount of foreign currency in the domestic foreign exchange market. the investment programme, which was introduced in detail on 18 november,