sifis. to the degree that systemically important institutions find the additional capital requirement makes some lending unprofitable, that lending could be assumed by smaller banks that do not pose similar systemic risk and thus have lower capital requirements. to be sure, there may not be perfect substitution, particularly not in the short term. in part for that reason, we contemplate a fairly generous transition period to the sifi capital regime. in addition, though, it is worth recalling that not every additional dollar of lending or capital market activity is necessarily socially optimal. just as monetary policy must at times induce higher credit costs in order to forestall the wider problems that high inflation would bring, so some checks on the scale of sifis are warranted to avoid a repeat of the financial crisis. a second objection lodged by opponents is that what they characterize as the “ punishment ” of size and interconnectedness is shortsighted, because sifis are needed in a global financial system. but as earlier noted, while there are good reasons for firms to be big, there bis central bankers ’ speeches is little if any research showing that firms need to have balance sheets with the size and composition some do in order to achieve genuine economies of scope and scale. moreover, a sifi capital requirement would not prohibit the size and interconnectedness of today ’ s firms. rather, it would incentivize firms to maintain those dimensions only if there are riskadjusted returns for activities that require this scale. if research does establish some true economies for the largest, most interconnected firms, those benefits would need to be balanced with the societal risks associated with their potential distress or failure. a third objection is that establishing sifi metrics and capital requirements will actually increase, rather than mitigate, moral hazard by identifying which firms are considered too - big - to - fail. for those of us in the united states, congress has already rejected this argument by its creation of the requirement for enhanced prudential standards. 7 more fundamentally, the likelihood of systemic impact does not change regardless of whether firms have to meet enhanced capital standards. and moral hazard is already undermining market discipline on firms that are perceived to be too - big - to - fail. higher capital standards will help offset the existing funding advantage for sifis. a fourth objection is that a sifi surcharge is unnecessary because basel iii and the dodd - frank act have already put in place an adequate set of safety and

birgir isleifur gunnarsson : interaction of monetary and financial stability in small open economies welcoming address by mr birgir isleifur gunnarsson, chairman of the board of governors of the central bank of iceland, at the suerf seminar, reykjavik, 3 june 2004. * * * ladies and gentleman on behalf of the central bank of iceland, i warmly welcome you to this seminar on the interaction of monetary and financial stability in small open economies. it is an honour for us to co - sponsor the seminar with suerf. we are grateful to david llewellyn, eduard hochreiter, beatrix krones and micheal bailey at suerf for the excellent cooperation which we have enjoyed with them in its preparation. the topic of the seminar is an appropriate one which is attracting increasing attention, both within and outside central banks. i trust that the presentations and discussions over the next two days will leave us with a better understanding of this interaction and of the issues on which we wish to focus our attention in the period ahead. we will be assisted by very impressive speakers and participants. i wish to extend my gratitude to those who have agreed to give lectures and present papers and i look forward to inspiring and stimulating contributions by them. in this address, i will briefly describe our own recent experience in the areas of monetary and financial stability. the current act on the central bank of iceland was adopted in 2001. it assigned to the central bank the main objective of pursuing price stability. the bank was granted instrument independence to pursue that main objective, its financial independence was enhanced and the act included clear provisions on transparency and accountability. the act also stated that the bank should promote an efficient and safe financial system, including payments systems domestically and with foreign countries. in addition to price stability, the bank was, in other words, given a clear mandate to concern itself with financial stability. an inflation targeting framework was adopted at practically the same time with a joint declaration of the government and the central bank which set a target for inflation of a 2½ % twelve - month rise in the cpi. the framework imposes strong demands on the professional capacity of the central bank. the bank regularly publishes a macroeconomic forecast and inflation forecast, with an associated inflation report. the inflation forecast provides the foundation for the inflation targeting policy. in its quarterly monetary bulletin, the bank publishes a detailed analysis of current economic and monetary developments and prospects. it also presents the rationale behind the decisions by the board of governors to