wage rises and tax cuts. these factors and others have fuelled domestic demand and thereby inflationary pressures. the central bank has pointed out how the small amount of outstanding treasury bonds in the market hinders policy rate changes from being transmitted with the necessary weight. price formation in the bond market is imperfect. the bank has aired the idea that the treasury should issue bonds with the explicit purpose of maintaining an active bond market. of course, such a suggestion must be qualified by the fact that the treasury is on the verge of eliminating its net debt and has no need to borrow. the central bank ’ s standpoint, however, is that given the significance of domestic capital markets, the importance of facilitating the impact of monetary policy measures and long - term strategies for treasury funding, it is in the treasury ’ s interest to maintain a smooth bond market, even though it has no direct funding requirement. one example of treasury issuance on such principles is norway, which has had even less need to borrow than the icelandic government. claims have been heard that the central bank ’ s monetary policy is either impotent or wrong, and that the icelandic krona is the root of macroeconomic instability. the central bank has pointed out that one consequence of globalisation and iceland ’ s integration with global capital markets, coupled with the exceptionally intense upswing experienced in recent years, has been that the transmission mechanism of monetary policy has altered. in this climate, the impact is transmitted with greater force to the exchange rate, and only later to domestic demand, as i mentioned earlier. this is reflected in a stronger krona than otherwise, which other things being equal delays the adjustment of the current account deficit. nonetheless, it is impossible to demonstrate that monetary policy is impotent. anecdotal evidence about households and businesses being squeezed by high interest rates confirms that the opposite is true. monetary policy does work, and will eventually impact demand and thereby the current account deficit. inflation soared in the recent term to peak at 8½ % just after mid - 2006, as i mentioned before. the central bank made a particularly sharp response to the deteriorating inflation outlook last year with a large hike in the policy rate on the back of sizeable earlier increases. there is no question that the tight monetary stance entailed by these measures reversed the development and drove inflation down, as subsequent data have shown. in its monetary bulletin published in july this year, the central bank forecast that inflation would be close to target in 2008 and it would be

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