even tougher position with a lax monetary stance at present, which would leave us facing a much higher rate of inflation and a strong real exchange rate at the end of this expansionary episode. tightening the monetary stance under such conditions could also provoke problems and shocks for the financial system, with unforeseeable consequences. the real exchange rate is heading for a historical high this year which is unlikely to be sustainable for very long. it is important to engineer as soft a landing as possible. in this context i want to mention the study in the latest monetary bulletin which shows that the real exchange rate is no more volatile in iceland than in other countries, for example other inflation - targeting countries with which we often compare our performance. on the other hand, the importance of foreign trade varies from one economy to the next, so exchange fluctuations have a different impact on households and business in different countries. according to the central bank act, one of the bank ’ s roles is to promote an efficient and safe financial system, including payment systems domestically and with foreign countries. i shall not dwell on financial stability issues on this occasion. the reason is that the central bank will be publishing a separate financial stability report in april which will include its assessment of the position of the financial system. however, i would like to mention two points which are closely related to financial stability. one is the noteworthy overseas expansion by icelandic banks, which has major ramifications for the financial system. among the changes that this entails is that the banks are now less exposed to volatility in the icelandic economy, because of the large share of their activities that has been transferred abroad. at the same time, they are left more prone to shocks originating in foreign markets. this development calls for a review of the central bank ’ s working procedures. i shall not go into details here of possible changes, which were discussed in monetary bulletin last autumn. the other point is the growth in lending by the credit system, in particular by the banks. the surge in lending over the past two years is a cause of concern both for financial stability and the central bank ’ s inflation target. accounts of the credit system are published quarterly and the most recent statistics show that lending by the credit system as a whole increased by 16 % in real terms last year. the credit system embraces all undertakings involved in lending activities, including the hff and the pension funds. the latest figures for the largest credit institutions show that domestic lending by the deposit money banks (

mar guðmundsson : iceland ’ s economy and monetary regime – a series of crossroads speech by mr mar guðmundsson, governor of the central bank of iceland, at the 50th annual general meeting of the central bank of iceland, reykjavik, 7 april 2011. * * * honourable president ; prime minister ; other ministers ; speaker of parliament ; chairman of the board ; party chairmen, bank directors ; directors of public institutions ; ladies and gentlemen : this year ’ s annual general meeting of the central bank of iceland is held on the bank ’ s 50th anniversary. but it would hardly be accurate to say that the bank is facing halcyon days at this milestone. quite the contrary : times are turbulent. furthermore, iceland ’ s economy and monetary regime are standing at a complex series of crossroads, and the paths we choose could have a profound impact on future developments. this is reminiscent of the situation that reigned when the bank was founded, but i will come to that later. what exactly are these crossroads, then? the first fork in the road lies in the changing economic situation. instability and recession are giving way to better equilibrium and recovery. the current account deficit from iceland ’ s overheating period has been turned around to an underlying surplus that has supported the krona, which is now over 7½ % stronger than it was at the beginning of last year. at the same time, the central bank has bought foreign currency in the market for about 33 b. kr., as part of its plan to accumulate non - borrowed reserves. inflation reached the central bank ’ s inflation target towards the end of last year, due to a stronger currency, spare capacity in the economy, and inflation expectations approaching the target. this development is not independent of the monetary policy stance, however, as spare capacity can be associated with a vicious cycle of falling exchange rate and rising inflation expectations if confidence is lacking. indicators suggest that a weak economic recovery began in the third quarter of 2010, and forecasts assume that it will continue this year. the recovery is still weak, not least given the substantial slack in the economy. two points of concern in this connection are that business investment is very low in historical context and export growth is rather weak in view of the low real exchange rate and robust recovery of global trade. an important factor here is that iceland ’ s major export sectors face capacity constraints ; therefore, exports cannot be increased to any significant degree without further investment. growth is strong in export sectors without such