##son, mar ( 2007 ). “ financial globalisation and challenges for prudential policies and macroeconomic management. ” speech by deputy head of the monetary and economic department of the bis, at a meeting of the institut international d ’ etudes bancaires, reykjavik, iceland, 18 may 2007 ( http : / / www. bis. org / speeches / sp070525. htm ). a report written by william buiter and anne siebert in the spring of 2008 for one of the banks that failed later in the year gives sound analysis of the problems facing the icelandic banking system at the time. see buiter, william h., and anne sibert, ( 2008 ). “ the icelandic banking crisis and what to do about it : the lender of last resort theory of optimal currency areas ”, cepr policy insight, no. 26, october 2008. ( http : / / www. cepr. org / pubs / policyinsights / policyinsight26. pdf ). the build - up so how were these mammoths created? following a process of consolidation and privatisation, which was largely completed in 2003, the icelandic banks grew very rapidly. with headquarters in reykjavik, they expanded their activities abroad, for the most part by acquiring financial institutions in other countries, opening up bank branches, and stepping up their foreign operations. this phenomenal growth was made easier by iceland ’ s membership in the european economic area ( eea ). the eea agreement provided a legal and regulatory framework based on eu directives. this meant that the operating licences held by icelandic financial institutions were not limited to iceland but included all the countries in the eea. the european “ passport ” gave the banks the scope to operate throughout the eea, including permission to operate branches in other eea countries. statistics give a picture of rapid - fire growth over a very short period ( see graph ). from 2003 to 2007, the banks ’ total assets grew from less than two times iceland ’ s gdp to almost nine times. right before their collapse, total assets amounted to eleven times gdp. over 40 % of total assets were in foreign subsidiaries, 60 % of total lending was to non - residents, and 60 % of income was from foreign sources. over two - thirds of lending and over three - quarters of deposits were denominated in foreign currency, notably in pounds sterling. around 85 % of the banks ’ foreign lending was in europe, with

throughout the world responded to the twin threats of a failing banking system and falling confidence. at home, the monetary policy committee cut interest rates from 5 % to 0. 5 % in just six months. and with interest rates close to their lower bound, the committee in march of this year voted to start a programme of asset purchases financed by the issuance of central bank reserves, otherwise known as “ quantitative easing ”. these extraordinary actions were intended to reduce the risk of inflation falling below the 2 % inflation target that the bank of england is mandated to meet. they do so in a number of ways. the reduction in bank rate by lowering interest payments on loans has improved many companies ’ cash flows at a time when turnover is weak and working capital is scarce. a similar effect has operated for households : borrowers with floating rate mortgages in particular have seen their monthly repayments fall sharply. more generally, by reducing the returns on saving, the fall in interest rates has encouraged households and businesses to spend. the mpc ’ s programme of asset purchases has further stimulated demand by injecting additional money directly into the economy. the bank ’ s purchases of government bonds encourage investors to diversify into alternative assets, such as corporate bonds and equities. the bank is also operating directly in commercial paper and corporate bond markets to improve the functioning of those markets. both actions have helped to boost the prices of corporate assets, reducing yields and lowering the cost to companies of raising funds in capital markets. this in turn should help to stimulate increased spending. the dramatic easing in monetary policy occurred alongside a range of government policies. most importantly, the government ’ s actions to provide both capital and liquidity were see eichengreen and o ’ rourke ( 2009 ). romer ( 2009 ) makes a similar point. instrumental in stabilising the banking system. the temporary reduction in vat and the car scrappage scheme have boosted household spending and provided short - term support to retailers and the car industry. and the government ’ s business payment support service has reportedly enabled almost a quarter of a million small and medium - sized firms to delay tax payments. there are encouraging signs that these policy actions have been successful and the risk of a severe adverse feedback loop – as households, companies and banks simultaneously try to retrench – has been avoided. the banking system has stabilised. measures of business and household confidence have recovered significantly. and the most recent ons estimates for the third quarter suggest that the contraction in consumer