than the euro would have serious drawbacks. 8 therefore, reforming the current regime appears preferable to a radical change should emu membership be unattainable, at least for the next decade. the fact that the vast majority of small countries either use another country ’ s currency or pursue some type of rigid fixed exchange rate policy could indicate, however, that a floating currency may face difficulties over the long haul ( chart 3 ). ladies and gentlemen : no monetary framework or choice of currency will solve iceland ’ s economic problems once and for all. the set of solutions labelled “ cure - for - all - ills ” is an empty set. protracted discussions of the contents of an empty set are not only empty in themselves ; they are absolutely pointless. irrespective of the framework, economic policy must be pursued with greater discipline than has been the case to date. however, imposing a framework that forces the authorities to adopt more long - term oriented policies could improve performance. one way to do this is to join a currency union. the experience of greece and other countries on the periphery of the emu shows, however, that if economic policies remain short - sighted and solving imminent fiscal problems is delayed for too long, the imposed discipline is anything but palatable. i think iceland ’ s experience of its collaboration with the imf indicates, however, that it would flourish under such discipline. but if emu membership is not an option, that discipline must come from within. the reforms proposed by the central bank in two recent reports are designed to foster such discipline. in many instances, the same measures could contribute to stability and sustainable output growth as a member of a currency union and, in some respects, could be easier to implement from within it. thank you. the most viable option would perhaps be the danish krone, provided that the authorities were willing to bet on its continued stability vis - a - vis the euro. bis central bankers ’ speeches below are the slides shown during the speech : chart 1 chart 2 bis central bankers ’ speeches chart 3 bis central bankers ’ speeches

is unique as regards both the size of its currency area and the volatility of private consumption, even when its small size is taken into account. it appears obvious that fluctuation in private consumption is driven primarily by exchange rate volatility, as chart 1 shows. it is difficult to reduce fluctuations in private consumption unless exchange rate volatility is reduced. although it can be argued from a theoretical standpoint that a floating currency should be a shock absorber, recent research suggests that fluctuations in the exchange rate may actually be a source of shock, at least in very small economies. not only is exchange rate volatility greater, but the adjustment of the exchange rate returns less than no benefit in the form of a more stable real economy. 4 all four of these explanations probably have some validity, but there is good reason to examine the fourth of these more closely. why is exchange rate adjustment not a shock absorber in small countries, as in the textbook example, but rather a source of shock? there could be a number of explanations for this. 1. the tendency of exchange rates to fluctuate in excess of what appears to be warranted by fundamentals could be a contributing factor. in a sense, the exchange rate of a currency is an asset price and, as such, is determined by expectations visa - vis an uncertain future. expectations can swing from euphoria concerning the expected future stream of foreign currency revenue from investment that will support a currency to despair and, in extreme cases, serious lack of confidence over a protracted period. exchange rate movements have a more profound effect on the economy than do other asset prices, however. in addition to storing value, a currency is a unit of account and a medium of exchange. fluctuations in currency exchange rates induces volatility of relative prices throughout the economy, particularly in small, dollarised economies, and elevate the risk of doing business. increased aluminium production has also reduced the impact of commodity market volatility on the domestic employment level. see francis breedon, thorarinn g. petursson, and andrew rose : exchange rate policy in small rich economies, central bank of iceland, working paper no. 53. bis central bankers ’ speeches 2. the tendency of currencies to fluctuate beyond what can be justified by fundamentals has much wider implications in small currency areas than in large ones, as small currency areas are more dependent on foreign markets. when the exchange rate falls, the price level