of interest rate changes on inflation emerges in 2 - 3 years, while the bulk of the effect emerges within about a year. the short - term impact on real variables tapers off within the same time frame. and it follows from this that in order to pursue forward - looking monetary policy with any degree of success, it is necessary to make forecasts. these call for economic analysis and modelling. in order to understand the problems associated with monetary policy implementation, one must bear in mind that statistics relating to the recent past often contain significant measurement errors, that we do not know what the “ right ” economic model is, and that the future is always in some sense unknowable. in other words, monetary policy is always implemented under conditions of uncertainty – to varying degrees, of course. this is why we consider a large number of economic indicators and use several models. furthermore, we do not put a single economist in front of a computer and assign that person the task of determining the monetary stance ; instead, we have a committee that exchanges opinions and assesses the current situation and outlook at the time in question. the observations i have just made are general in nature and apply to large and small countries alike. but we know that monetary policy in small, open economies is accompanied by particular challenges – challenges that we must take into consideration when developing a monetary policy framework for iceland. in this context, it should be noted, first of all, that smaller economies generally have a tendency to be more volatile than larger ones, owing both to less economic diversity and the greater relative weight of individual shocks. second, the relative weight of the tradable sector is often greater than in larger economies. because of this, economic developments are more dependent on the exchange rate, and pass - through from the exchange rate to inflation is generally stronger. third, financial markets are shallower than in larger economies, other things being equal, and this contributes to greater volatility of financial prices. fourth, in an environment of unrestricted capital flows and increasing international financial integration, the possibility for small economies to affect their own financial conditions through monetary policy diminishes. the question then arises : should there be an exchange rate target or an inflation target? the answer is not always straightforward. other things being equal, an inflation target is more appropriate because it stands closer to the factors important to economic well - being, and it is easier to decide what an inflation target should be than to estimate the “ right ” exchange rate target

and has worked well. under normal conditions, interest rates on central bank transactions with financial institutions would continue to be the bank ’ s main monetary policy instrument. foreign exchange market intervention is also a monetary policy instrument, as i have mentioned, and other instruments can also be used, such as reserve requirements and direct intervention in the bond market. their efficacy is generally less certain than with interest rates, however, and as a result they are used less often. the mpc would be entrusted with a capital flow management tool or tools to affect carry trade, of the type i mentioned a moment ago. these tools would not be used against the regular flows that are a normal part of monetary policy transmission ; instead, they would primarily be used when flows became too strong and there is the risk that monetary policy transmission along the interest rate channel would be weakened excessively in implementing monetary policy, the mpc takes into account the impact of monetary policy and its interactions with other aspects of economic and prudential policies, insofar as this is consistent with medium - term price stability. there will be reliable processes for exchange of information, discussion, and analysis of the interactions among these various factors. this will take place through consultations between the ministry of finance and the central bank ; through the proposed macroeconomic council, where the interactions between economic policy and labour market decisions would be discussed ; or in the systemic risk committee and financial stability council and joint meetings of the monetary policy committee and the systemic risk committee. the central bank plans to strengthen these processes still further by launching a new publication next year. the report, which will be issued at least once a year, will focus on the external position of the economy and its sustainability, the outlook for the balance of payments, and the exchange rate and signs of major deviations from the equilibrium exchange rate. honoured guests : the revised monetary policy framework will be finalised in the next few months, before capital controls on residents are lifted. its final form will be a joint declaration by the government and the central bank, like that dating from 2001. the discourse will therefore continue. in this context, i would like to thank the confederation of icelandic employers for having this topic on its agenda today and for giving me the opportunity to express my views on the subject. but we must keep one thing in mind. the new framework will be better than the one we had before the crisis, but it will not be a panacea. monetary policy is limited in terms of what it can deliver