seamlessly throughout, and there was continuous access to deposits and basic banking services in iceland. international payment flows were seriously affected, however, not least because of the freezing order imposed by the british authorities on icelandic banks, but also because of a general distrust among foreign counterparties. normal payment flows were restored through a concerted effort by the central bank in the ensuing months. see : “ financial globalisation and challenges for prudential policies and macroeconomic management “, 18 may 2007, http : / / www. bis. org / speeches / sp070525. htm bis central bankers ’ speeches i have painted the banking crisis and the immediate policy responses with a broad brush, but i expect that geir will give you a fuller story. it will also be interesting to hear from patrick what the essential features of the irish banking crisis unfolding around the same time are seen to be now, five years later. let me turn now to the macroeconomic part of the saga. i do not have time to discuss the macroeconomic build - up to the crisis, as the focus of this short meeting lies elsewhere. but to set the stage, let me say very briefly that all the usual suspects were present : very strong capital inflows fuelling a credit and asset price boom that subsequently turned into a bubble at the same time as the economy overheated and an unsustainable external position developed, as could be seen in a double - digit current account deficit. and macroeconomic and prudential policies were not up to the task. quite the contrary : there was a policy conflict between monetary policy and the demand levers pulled by the government, and the risks inherent in capital flows, fx balance sheets, and credit and asset price booms were left under - regulated and insufficiently supervised. but as so often before in this country, we dealt more effectively with the crisis than the buildup. there were two key elements to this. the first was crisis management vis - a - vis the failing banks, as embodied in the emergency act submitted by prime minister geir haarde to parliament shortly before the banks failed. the second was the economic programme developed by the icelandic authorities in co - operation with the imf. the programme had three key goals : stabilisation of the exchange rate, fiscal sustainability, and reconstruction of the financial sector. comprehensive capital controls were an important element in the programme, but their rationale was to help to stabilise the exchange rate in

a situation where the currency had fallen more than 50 % in 2008, where foreign krona positions that were a legacy of carry trade and capital inflows amounted to around 40 % of gdp, and where a large fiscal deficit that had to be financed in the domestic market had developed. the capital controls therefore gave monetary policy more scope to help stabilise and turn around the real economy once inflation came down. franek will discuss the imf programme in more detail, but i would like to make one more remark regarding fiscal consolidation, as it is such an important part of the story. the crisis hit government finances hard, as can be seen from this slide. bis central bankers ’ speeches it was therefore of vital importance that government debt was relatively low immediately before the crisis. however, fiscal consolidation was needed earlier than some considered optimal at the time from a demand management perspective, in order to regain internal and external confidence and open market access. the effort was huge, as can be seen from this slide, but back - loaded, as automatic stabilisers were mostly allowed to work in 2009. and it did not derail the recovery that began around the middle of 2010. the policy responses mitigated the recession but could not stop it from becoming the deepest in iceland ’ s post - war history and a severe one in international comparison, as can be seen from this slide. bis central bankers ’ speeches but iceland was not the hardest hit, as can also be seen from the slide, and this would be still clearer if we were to look at the labour market. iceland lost 12 % of gdp from peak to trough, slightly more than ireland. however, as was probably also the case in ireland, that peak was unsustainable and was associated with a significant positive output gap. iceland has regained 7½ % since, which is significantly more than ireland but less than latvia, which suffered a much deeper recession. finally, i would like to mention selected lessons that i think can be drawn from this experience. first, dealing with failing big banks in small countries : guaranteeing the entire banking system in iceland ’ s case would probably have resulted in sovereign default and the bankruptcy of the country. in general, taking such a step with big banks in small countries is risky, especially if a significant part of their balance sheets are in foreign currencies. the alternative is to save only key infrastructure elements, such as the domestic payment system. second, dealing with volatile capital flows : deal with the in