preferably affect no one. in the search for such approaches, it is sometimes claimed to be preferable to target liquidity through minimum reserve requirements, rather than interest rates, or to change the composition of the cpi, for example by excluding housing costs, which in fact would leave the rate of inflation within the target at the moment. the central bank has explained its position towards both these ideas. regarding minimum reserve requirements, the bank has pointed out that strong domestic financial institutions have various possibilities for sidestepping the effects of tighter liquidity. individual credit institutions would therefore be affected very unequally. such a measure would doubtless hit the savings banks very hard, since they do not have the same scope as the commercial banks for sidestepping the effects. international experience also shows that the impact of changes in minimum reserve requirements is extremely difficult to predict. for individual institutions, the consequences could be very significant. this is the main reason that none of the world ’ s main central banks use changes in minimum reserve requirements as a policy instrument any longer. however, even if liquidity worked, their impact on interest rates and the exchange rate would be broadly the same as raising the policy rate, although the transmission mechanism might be different, and they would affect individual segments of the credit system unevenly. in addition, changing the minimum reserve requirement is not a transparent measure and its impact on expectations is unpredictable. the central bank firmly advocates that housing costs should remain part of the reference index for the inflation target, and believes that by and large the best available methodology is being used by statistics iceland to evaluate them. this is because housing costs are a major item in household consumption in iceland, where the level of owneroccupancy is 80 %. excluding changes in housing prices would ignore a large proportion of household expenditures. experience also shows that housing inflation has the advantage, from the perspective of central banks on an inflation target, of being a leading indicator of general inflation later on. presumably this is because the housing market is independent from foreign markets. increased housing demand cannot be channelled out of the economy, unlike various other goods and services, nor is foreign competition present to any significant extent. when demand surges, housing prices often rise sooner and by more than prices of goods and services in general. it may be added that if housing prices had not been included in the cpi, the rate of inflation would have exceeded 10 % in the recessionary year of 2001, which would have demanded even tougher measures on the

in which it discusses economic and monetary developments and prospects and has published its new macroeconomic forecast. without going into detail here, the broad finding is that robust private consumption will continue and investment will increase, especially business investment, for reasons including that aluminium - related projects have been stepped up for this year, as i mentioned earlier. public consumption growth is expected to be modest, however. gdp growth will be 6. 4 % this year. it will be marginally less next year, when growth of private consumption and investment will also slow down. the positive output gap will widen considerably this year and in 2006. this year the current account deficit will peak at 12 % of gdp, then shrink next year, contrary to previous forecasts. from all this it is clear that the economy will be characterised by vigorous expansion this year and into 2006. according to the inflation forecast also published in monetary bulletin, the outlook for inflation has improved since the previous forecast in december but will remain above target two years ahead. the higher policy rate and a substantial appreciation of the krona will subdue domestic demand and dampen rises in import prices, especially in the short term. inflation will therefore be somewhat lower over the forecast horizon than was forecast in december. the central bank forecasts an inflation rate around the 2½ % target one year ahead, which is lower than forecast in december. two years ahead, inflation is forecast at just over 3 %, which is also somewhat lower than the rate forecast in december, although still above target. it is important to remember that an unchanged monetary policy stance and unchanged strong exchange rate are assumed over the forecast horizon. the forecast describes the way that the bank considers developments are most likely to unfold if it takes no further measures than it had already taken. obviously, uncertainty increases over the horizon of the forecast. a particular uncertainty is the exchange rate, which is at a historical high at present as i have discussed, posing a higher probability that it will give way over this period and inflation will increase. in light of this forecast, at the same time as monetary bulletin was published the central bank decided to raise its policy interest rate by 0. 25 percentage points, which is a somewhat lower hike than market agents had predicted and also less than the bank ’ s other recent policy rate rises. the policy rate is therefore currently 9 %. among other things, the decision to take a relatively modest step now is based on the fact that the tightening implied by the recent policy rate hikes and the significant