unemployment generally begins to decline somewhat after output growth has begun to recover. unemployment is forecast to taper off steadily throughout the forecast horizon, falling to 3 % by 2013. as i mentioned earlier, underlying inflation is already very close to target. according to the bank ’ s new baseline forecast, inflation will reach the target by the end of 2010. due to the spare capacity in the economy and the expectation of further ( albeit modest ) appreciation of the krona, inflation will continue to subside, falling below 2 % around mid - 2011. it will then rise slowly and return to target towards the end of the current forecast horizon, which extends until q4 / 2013 ( see chart 3 ). but these are “ only forecasts ”, as it were, and uncertainties are more numerous and more prominent than in the average year. external factors could change the scenario, but the authorities could also have either a positive or a negative effect on matters. the new monetary bulletin lists a variety of uncertainties. for example, output growth could be hindered by a number of factors : a setback in global recovery, further delays in the energyintensive industrial projects that have been on the drawing board, or cutbacks in household consumption resulting from consumers ’ deciding to save more and improve their net asset position more quickly than in the baseline scenario. the negative effects of the last of these will subside over time, however, and in a small, open economy like iceland ’ s, the longterm effect should be positive. on the other hand, output could grow more than in the baseline forecast, particularly if risk premia on icelandic financial assets decline significantly in the near future, foreign credit markets open up to iceland again, foreign direct investment increases, and overall business investment becomes stronger. but these are big “ ifs. ” the roughly 3 % output growth currently forecast for 2012 and 2013 is quite acceptable in the average economic climate. but projected growth for 2011 and 2012 is weak in view of the sizeable slack in the icelandic economy. furthermore, the foundations are not strong enough, as the contribution of external trade to output growth is negative and investment will be far below the historical average, even if it increases significantly from current levels. according to the forecast, exports of goods and services will increase by a scant 1 % in 2011, followed by 2 % annual growth in 2012 and 2013, even though the real exchange rate will be notably below its historical average throughout the period. total investment will

there is no simple economic formula stating how these pros and cons should be weighted together so as to yield a clear answer. in addition, it is quite uncertain how these factors will develop in the future. but it should also be noted that this report contains numerous findings indicating that the selection of a currency and exchange rate policy may be less important for economic welfare and stability than might be expected in view of the public discussion on the issue. an example of this is how different countries have fared during the financial crisis ( see chapters 16 and 17 ) and how likely asset price bubbles are to develop inside and outside a currency union ( see chapter 11 ). based on the limited experience to date, it appears that fiscal policy, financial system structure and regulatory framework, and the incentives and opportunities of private agents to borrow are much more important. one of the reasons it is difficult at this point to draw a clear conclusion about which path iceland should take is the uncertainty about near - term developments in the two most likely scenarios : an improved framework for the krona and removal of the capital controls, or eu membership and eventual adoption of the euro. it therefore appears sensible to continue to analyse and develop these two options for a while yet, both by preparing a stronger framework for the krona and by pursuing iceland ’ s application for eu membership. if the euro area crisis is resolved in the near future and the currency union framework is strengthened, and if iceland decides to join the eu and the euro area, reforms to the current monetary framework will also prove helpful during the run - up to adoption of the euro. in a best - case scenario, euro area membership will take several years at the very least. iceland must make a decisive effort to lift the capital controls. it is therefore critical to develop the monetary and exchange rate policies that would be used afterwards. these policies must be adequate until iceland adopts the euro if it so chooses, although some changes could take place along the way, such as with participation in erm - ii. but the monetary framework must also be suitable for the long term. to the extent possible, it must be a viable alternative to euro area membership so that icelanders can assess the pros and cons of the options available to them. the central bank of iceland has recently invested considerable work in these projects, including preparing the publications mentioned in this chapter, and further bis central bankers ’ speeches work is planned. the bank has also invested a great deal of work in projects related to