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

of the central bank of iceland is 9 %. that can be compared with the repo rate of the european central bank of 2. 5 %. since september of last year, the central bank has raised its interest rates four times, by a total of 1. 8 percentage points. in early 1999 it also levied a liquidity requirement on icelandic credit institutions. the requirement is primarily prudential in nature. it was among other things aimed at reducing the reliance of domestic credit institutions on foreign short - term capital to finance their domestic lending activities which had risen sharply, but has subsequently diminished markedly. low inflation and macro - economic stability was only achieved in the early part of this decade. consequently, it is not at all surprising that we have to maintain interest rates that are significantly higher than among our main trading partners. the required difference is variable over time, depending among other things on the credibility of economic policy, relative cyclical positions and so on. the current differential is the widest since capital movements were liberalised and is of course explained to an important extent by the very different cyclical position of the icelandic economy from that of most of our trading partners, not the least in europe. it also entails the cost of maintaining an own currency, i. e. a premium for the availability of the exchange rate as an instrument. in this connection, i should also note that since the opening up of the capital account of the balance of payments, long - term interest rates, which used to be very high by any comparison, have been on a downward trend despite repeated increases in short term rates. this is not surprising and reflects a narrowing of long term interest rate differentials between iceland and other countries towards a much lower level than prevailed before capital movements were liberalised. two years ago the fiscal budget turned into surplus. that surplus has risen and in the budget proposal for the year 2000, which was submitted to parliament at the beginning of this month, the envisaged revenue surplus is equal to 2. 2 % of gdp. in the view of the central bank, it is essential that the targeted budget surplus be realised. it is important for the credibility of the overall policy of the government and because it will have dampening effects on domestic demand and thus reduce the current account deficit. the foundations of the icelandic economy have strengthened in recent years through effective natural resource management and increased diversification, including the expansion of services exports. iceland has made great strides in economic management as indicated by the stability and