. it has turned out that other countries have benefited from adopting such a framework. it was in light of this international experience that the central bank of iceland ’ s monetary policy framework was changed two years ago and formal inflation targeting was adopted. accordingly, the central bank is obliged to aim towards an annual rate of inflation which, measured in terms of the increase in the consumer price index over a twelve - month period, should generally be as close as possible to 2½ %. inflation targeting was introduced in a climate where the economy was severely overheating. for this reason an adjustment period was set for the central bank, whereby it should aim to attain the inflation target by no later than the end of 2003. we have reason to celebrate the fact that inflation had already reached the set target by november 2002. in 1996 a period of robust economic growth began in iceland which did not come to an end until 2002. gdp growth in 2001 is estimated at 2. 9 %, which is more than in most industrialised countries that year. this growth phase ended with severe overheating of the economy. among the forms this took was a current account deficit in excess of 10 % of gdp in 2000 and twelve - month inflation which peaked in the beginning of 2002 at 9. 4 %. in 2002, a sharp turnaround took place in the icelandic economy, under the strong influence of the central bank ’ s tight monetary stance. a small surplus was shown on the trade account and better external balance put the exchange rate of the krona on a surer footing. the krona appreciated substantially during the year after sharp depreciation in 2001, when it most likely dropped considerably below the equilibrium exchange rate. last year ’ s rapid disinflation was not least the result of the substantial appreciation of the krona, which in turn can be attributed to better external balance, lower inflation expectations as the year wore on, greater confidence in stability, and expectations that large - scale investment projects would go ahead. disinflation last year can also be attributed to a considerable weakness in domestic demand. national expenditure contracted by 2½ %. the decline in fixed capital formation was particularly pronounced, but private consumption also contracted. in spite of the contraction in national expenditure, however, gdp declined by only ½ %. this was due to favourable foreign trade developments, with a contraction in imports and expanding exports. the sudden turnaround in iceland ’ s current account from 2000 to 2002 is almost unparalleled among the developed countries

on the project will be 5 b. kr. higher in 2003 than previously estimated, and just over half a billion kr. greater in 2004. in all, this represents a total extra investment of 13 b. kr. during the current year and 19 b. kr. next year, over and above the amounts assumed when the central bank ’ s latest macro economic forecast was published last month. on the basis of these new assumptions, preliminary studies suggest that economic growth could easily end up in the range 2 - 2½ % this year and well over 3 % next year. the annual growth rate is as much as 1 % above what was previously forecast. the employment outlook has also improved considerably. given that the negative output gap was never very wide, and that seasonally adjusted unemployment measured 3. 2 % in february and has changed little since september, it is clear that inflationary pressures are likely to develop much sooner than was previously thought. inflation this year is likely to be close to the central bank ’ s 2½ % target, but other things being equal it could rise next year. while it is foreseeable that these major construction projects could coincide to some extent in 2004 and 2005, most of the weight will be felt in 2005 and 2006. thus economic policy implementation will face a greater challenge than was thought when only the reydarfjordur aluminium smelter and related hydropower development were foreseen. the new outlook calls for economic policy responses on both the monetary and fiscal side. while the scale of the response will be determined by exchange rate developments, it is clear that preventing overheating and inflation will be a major challenge in the period ahead. effective fiscal measures are necessary in order to prevent monetary policy from bearing the brunt of these pressures, since this would have an excessive impact on the traded goods sector. the firmer the fiscal stance is at the peak of construction activity, the smaller is the increase in the real exchange rate that will inevitably will accompany it, with a correspondingly beneficial effect on current export and most competing industries. ladies and gentlemen the global economy is shrouded in uncertainty. a low rate of growth has been attained in most industrialised countries since 2001 and the recovery is slower than had been hoped. the war in iraq heightens this uncertainty. favourable economic conditions among main trading partner countries is important for iceland ’ s terms of trade. a special cause for concern is therefore the deteriorating outlook in the euro region, which is important for