than the already sizeable ones provided for in the bank ’ s forecast. the inflation outlook would then deteriorate, which would call for interest rate hikes. gdp growth would weaken as a result, perhaps even ending in a contraction. but there is always some uncertainty in both directions, and naturally, we could end up on the receiving end of positive shocks that improve the situation. but under these conditions, it is likely that the risk to gdp growth is tilted to the downside. in this connection, it is important to remember that we have seldom, if ever, been as well prepared for adverse shocks as we are now. our external assets exceed our external liabilities. our international reserves are close to an all - time high and are almost entirely financed domestically. public and private sector debt has fallen steeply relative to income in the past few years. our banks are robust, with high capital ratios and abundant liquidity, and the central bank ’ s newly published stress test indicates that they can withstand much more severe shocks than we currently consider likely. unlike many other advanced countries, we have considerable scope for economic policy to respond to shocks, as central bank interest rates are well above zero and the government is operating at a surplus and is relatively well positioned with regard to debt. the exchange rate of the krona is still strong, although it has fallen in the recent term, and the real exchange rate is estimated to be broadly as it was in late summer 2016. all in all, it can be said that our position is still relatively good, and nothing has yet happened to give cause for deep - seated pessimism. yesterday the bank announced a 0. 25 % increase in its key interest rate, to 4. 5 %. this rate hike was decided in view of economic developments and prospects, including those described in the bank ’ s new forecast, and in view of the considerable decline in the bank ’ s real rate in recent months, which stems from rising inflation and inflation expectations. one of the factors the monetary policy committee considers when it assesses the monetary stance is the central bank ’ s real rate in terms of various measures of inflation and inflation expectations. this is illustrated in chart 1, which shows that the real rate was 0. 8 % just before the last interest rate decision. this is lower than in 2013, when there was still a considerable slack in the economy. of course, the progress made in anchoring long - term inflation expectations at the target — another term for enhancing

a situation where the currency had fallen more than 50 % in 2008, where foreign krona positions that were a legacy of carry trade and capital inflows amounted to around 40 % of gdp, and where a large fiscal deficit that had to be financed in the domestic market had developed. the capital controls therefore gave monetary policy more scope to help stabilise and turn around the real economy once inflation came down. franek will discuss the imf programme in more detail, but i would like to make one more remark regarding fiscal consolidation, as it is such an important part of the story. the crisis hit government finances hard, as can be seen from this slide. bis central bankers ’ speeches it was therefore of vital importance that government debt was relatively low immediately before the crisis. however, fiscal consolidation was needed earlier than some considered optimal at the time from a demand management perspective, in order to regain internal and external confidence and open market access. the effort was huge, as can be seen from this slide, but back - loaded, as automatic stabilisers were mostly allowed to work in 2009. and it did not derail the recovery that began around the middle of 2010. the policy responses mitigated the recession but could not stop it from becoming the deepest in iceland ’ s post - war history and a severe one in international comparison, as can be seen from this slide. bis central bankers ’ speeches but iceland was not the hardest hit, as can also be seen from the slide, and this would be still clearer if we were to look at the labour market. iceland lost 12 % of gdp from peak to trough, slightly more than ireland. however, as was probably also the case in ireland, that peak was unsustainable and was associated with a significant positive output gap. iceland has regained 7½ % since, which is significantly more than ireland but less than latvia, which suffered a much deeper recession. finally, i would like to mention selected lessons that i think can be drawn from this experience. first, dealing with failing big banks in small countries : guaranteeing the entire banking system in iceland ’ s case would probably have resulted in sovereign default and the bankruptcy of the country. in general, taking such a step with big banks in small countries is risky, especially if a significant part of their balance sheets are in foreign currencies. the alternative is to save only key infrastructure elements, such as the domestic payment system. second, dealing with volatile capital flows : deal with the in