technology and financial innovation, and strong arguments were being made to the effect that open capital accounts would bring significant benefits. after all, ongoing real economic integration at a global level demanded at least some degree of global financial integration. in turn, freer capital movements, the ongoing cross - border financial integration, and the growth of private capital flows that followed undermined pegged exchange rates and thus contributed to the spread of flexible exchange rate regimes and inflation targeting in many parts of the world, but in the european union this development provided part of the rationale for a monetary union. the current international monetary system and the official part of the global financial safety net largely reflect the contours of the global economy as they were before global financial integration and private capital flows reached the level we have seen in this century. back then, the global macroeconomic problem was related to global current account imbalances and asymmetric adjustment. keeping your own house in order was in most cases both necessary and sufficient for maintaining economic stability in individual countries. imf facilities to lend to sovereigns of debtor countries facing balance of payments difficulties were the most important part of the global financial safety net ( gfsn ). the world we currently live in is different. financial imbalances in both net and gross balance sheets can be more important than current account imbalances and certainly were so in the build - up to the great financial crisis ( gfc ). this is a world of cross - border spillovers and spillbacks. it is a world where, for small and open economies ( soes ), keeping your own house in order is certainly necessary but no longer sufficient, at least not if we restrict ourselves to traditional demand management and prudential instruments. financially integrated small and open economies can still be overwhelmed by large and volatile capital flows driven by push factors. it is a world that needs additions to the gfsn, some of which we partly have – such as fx liquidity provisions to internationally active banks through central bank - swaps – but some of which we do not have. the international community is certainly aware of these issues. the imf has done good analytical work in this area and proposed reforms. work has been done under the auspices of the g20 looking at potential reforms to the international monetary sytem ( ims ), and currently the eminent persons group is working on a report to the g20 to be delivered at this year ’ s autumn meetings of the imf. but progress in

##uation band, a currency board, or adoption of another currency. some of these options have been the focus of recent public discussion as alternatives to euro area membership through eu accession or the current flexible exchange rate regime. consequently, these options should be analysed just as other possible solutions are. the possibility of retaining a flexible exchange rate regime while making relevant changes to the economic policy and financial regulatory framework based on recent experience was discussed in the central bank ’ s 2010 report entitled monetary policy in iceland after capital controls. the present report therefore does not discuss those options in as much detail. in chapter 3, however, is an in - depth discussion of icelanders ’ experience with independent monetary policy and a floating exchange rate. the strategy formulated in coming months must take into account this material if all options are to be considered. it is also necessary to examine which prudential rules would be applied in order to reduce the risks related to domestic financial institutions ’ foreign assets and liabilities and the risks related to unrestricted capital flows. these rules are discussed in a newly published central bank report entitled prudential rules following capital controls. that report discusses the limitations on liquidity and foreign exchange risk and the restrictions on domestic financial firms ’ international operations that must be in place if movement of capital bis central bankers ’ speeches is unrestricted in other respects, particularly if iceland retains its own currency. the discussion below also takes account of these two publications. 1 1. 2 iceland ’ s experience with its own currency iceland has had its own currency since 1885, maintaining parity with the danish krone until june 1922, when it was devalued by 23 %, followed by a temporary float ( see chapter 12 ). it can be said that the krona came into existence as an independent currency at that time. the experience with it has been mixed, and efforts to preserve the value of the currency have been largely unsuccessful. the krona is now worth only 0. 05 % of its value prior to the 1922 devaluation ; in other words, it has depreciated by 99. 95 %. in terms of consumer prices, the krona has eroded in value even more, or about 99. 99 %. in other words, its purchasing power in terms of goods and services is currently only 0. 013 % of what it was in june 1944, when the republic of iceland was founded. nevertheless, over this period, iceland developed from being one of the poorest countries in europe to one