direction to 6 per cent in september 1995 in order to allow for the possibility of greater fluctuations in the exchange rate with more volatile capital movements. in february 2000 the target band was widened further to 9 per cent in either direction in order to create greater scope for monetary policy which was increasingly focusing on the maintenance of price stability. recent experience around the world has demonstrated that it is difficult to maintain soft exchange rate pegs with free capital movements, and the same has been the case in iceland. furthermore, developments in the domestic economy at the end of last decade were such that the stable exchange rate policy was gradually undermined. during the second half of the 1990´s, the icelandic economy entered a period of high economic growth. growth was initially well balanced and led by exports and increased investment in the private sector. but as it unfolded it became increasingly driven by consumption and investment in the non - traded goods sector, fuelled by a foreign financed credit expansion in the wake of intensified competition among lending institutions and a significant increase in credit availability. by 1998, signs of overheating were already increasingly visible in rising inflation and the ballooning current account deficit which climaxed in 2000 at 10 per cent of gdp. the central bank responded to the imbalances in the economy by tightening monetary policy. through the effects of the tighter monetary policy, the exchange rate of the krona gradually appreciated as can be seen from chart 1. in the spring of the year 2000 expectations in the market shifted for a variety of reasons ; but concerns about the current account deficit and lower expectations of future economic growth were the most important. subsequently the krona began to depreciate and continued to do so more or less uninterrupted, but on the whole in an orderly fashion, over a period of a year and a half until the end of november 2001. by that time, it had fallen from its peak by about a third against other currencies. as i mentioned before, experience has shown, that in the long run, it is very difficult to maintain soft exchange rate pegs with the free movement of capital across borders. iceland shares this experience with many other countries during the post - liberalisation face. the response to this has been the observed tendency to adopt hard pegs in the form of monetary unions or currency boards or to go in the direction of floating. as so many other countries, iceland adopted the second route. this was done in march 2001 by a joint declaration by the government and the central bank

border banks was dealt with and the lessons learned from it. it is now more widely known in our circles than it was to begin with and less controversial. for more, i can refer you to various publications and speeches of mine and others. but the main reason is that, as far as iceland is concerned, the problem is solved for the near future : we are simply not going to do it. we are not going to establish international banks headquartered in a very small country with its own currency without an access to a sufficient regional or international financial safety net. this does not preclude that we, as well as others, will with time forget the lessons of the crisis and find ways to create problems or even failures of our banks, but it should be a much more domestic and contained affair. so what did we do? deposits were given priority over unsecured bond holders prior to the failure of the banks. at the point of failure, smaller domestic banks were carved out of the failing private cross - border banks, which went into resolution governed by law. it was not a clean split, which later became a major impediment to lifting capital controls ; however, that impediment has now been removed. although they were not necessarily clearly articulated at the time, these measures were guided by the following goals : to preserve a functioning domestic payment system, ring - fence the state in the case of bank failures, limit the socialisation of private sector losses, and create the conditions for rebuilding a domestic banking system. 1 / 2 bis central bankers'speeches i have already alluded to some of the lessons learned, which relate to large, internationally active banks in small countries and the flaws in the framework for cross - border banking. this is by now well accepted and is partly what a banking union is all about. but it will not fix the problem for eea countries outside the eurozone, due to potential fx risks on banks ’ balance sheets. let me now turn back to the other story about macroeconomic management and financial stability in sofies. here the issue is that, with ongoing global financial integration, the interest rate channel of monetary transmission weakens in sofies, as longer domestic rates increasingly co - move with longer rates in the big countries. inflation targets could still be reached through the exchange rate channel, but exchange rates are not necessarily smooth reflections of underlying fundamentals. instead they tend to be excessively volatile and are sometimes misaligned for protracted periods. uip does