mar guðmundsson : the work of the monetary policy committee opening remarks by mr mar guðmundsson, governor of the central bank of iceland, at an open meeting of the parliamentary economic affairs and trade committee on the work of the monetary policy committee, reykjavik, 17 november 2014. * * * the last meeting between representatives of the monetary policy committee ( mpc ) and the parliamentary economic affairs and trade committee took place on 5 march 2014. at that time, inflation had recently fallen below target, while short - and long - term inflation expectations were still above it. by now, inflation has been below target for nine months and is expected to be at target well into 2015, at least. the main difference in the situation now versus that in march is that inflation expectations have fallen back towards the target and, by some measures, are quite close to it, particularly short - term expectations. the big picture is that the economic recovery is now well enough advanced that spare capacity is disappearing. there still appears to be a sizeable current account surplus, although it has diminished since last year. the surplus covers net capital outflows and significantly more, as the central bank has bought foreign currency on the market for the equivalent of 95 b. kr., or 5 % of gdp. according to the bank ’ s forecast from early november, gdp growth is projected to measure just under 3 % this year and then rise to about 3½ % in 2015 before easing back to 3 % in 2016. this level of growth is expected to exceed the growth potential output, giving rise to a positive output gap, particularly in 2015. other things being equal, this will contribute to higher inflation. gdp growth in 2014 – 2016 will be driven by domestic demand, both private consumption and investment, and the contribution from net trade will be negative for the entire period. as a consequence, the sizeable current account surplus we have seen in 2013 and 2014 will shrink rapidly next year and give way to a small deficit by 2016. this is cause for concern in and of itself, and we hope that this forecast will not materialise, as iceland needs to maintain a current account surplus in the next several years as it focuses on putting its external debt onto a more solid footing and building up fx - reserves that are not financed with foreign loans. economic policy and economic incentives would then have to centre on improving the outlook for the current account balance. according to the forecast, which extends until end - 2017, inflation will be at

? let ’ s not forget that the risk of deflation was averted, and that risk was extremely dangerous. inflation has indeed been below the objective for some time, but behind this there are structural changes for which we don ’ t yet have a full explanation. is this damaging the institution ’ s credibility? no. we would have had a credibility problem if deflation had taken hold. the question is why wage increases are not passing through to price inflation. this is one of the legacies of the crisis a decade ago. what is christine lagarde ’ s biggest challenge? on the one hand, the severity of the economic slowdown. we expect growth to be slightly above 1 / 3 bis central bankers'speeches 1 %, but with downside risks. in the financial sector, the greatest challenges are banks ’ very low profitability, risks stemming from low rates and the assets managed by the funds industry, which have grown considerably. the ecb ’ s policies have had the undesired effect of redistributing income. they have had a certain negative effect on savers and have potentially pushed up asset prices, but they have also had a positive effect in the form of economic growth, job creation and wage increases. according to our calculations, the net effect has added 2 percentage points to growth. as a result of the ecb ’ s actions, the situation in europe is nothing like it was ten years ago. there has been criticism of the ecb becoming more political and less technical with christine lagarde and you at the helm – both of you are former ministers with no central banking experience. monetary policy must be just another element that has a place within economic policy. it ’ s good to have experience in other areas. central bankers have sometimes been working in an ivory tower. christine lagarde – not to mention myself – is well versed in the euro area ’ s mechanisms. the ecb ’ s decision - makers need to understand the context, make sound choices from among the alternatives and communicate appropriately. ms lagarde will do this extremely clearly. internal criticism, resignations, partisan leaks to the press … divisions within the ecb seem to have flared up in recent weeks. strangely, there ’ s sometimes more politics going on inside a central bank than in governments. seriously though, the 25 members of the governing council should try to build a consensus. and when a decision is made, it must be embraced. that isn ’ t happening right now