bonds 1985 - 2016 % — international interest — iceland rates on indexed long - term treasury bonds ( 5 - 10 years ). international interest rates are the simple average of rates for the us ( from 1999 ), the uk, and germany. the icelandic data are compiled from data on initial offerings of treasury savings bonds and yields on housing financing fund bonds and indexed treasury bonds. the figure from 2016 is the average through mid - november. sources : bank of england, us federal reserve bank, central bank of iceland. this development began long before the financial crisis. the crisis, the ensuing economic contraction, and the monetary easing in response to the crisis amplified this tendency still further, and long - term real rates are now at an absolute historical low. in part, this is related to the business cycle position in larger advanced countries and could turn around in coming years. however, it is unlikely that the decline in real rates over the past few decades will reverse to any large degree in the near future. one of the main theories in conventional economics is that monetary policy cannot affect real variables – including long - term real interest rates – except temporarily. although this is something of a simplification, and it is possible that monetary policy that is either far too tight or far too loose over a long period could have more of an impact than this, particularly in an economy with major imbalances, the theory is nevertheless a close enough approximation under normal circumstances to take account of it here. the period under scrutiny is too long for monetary policy to have had a substantial impact on developments. furthermore, it is clear that the tendency to cut interest rates is not limited to individual countries ; it is an international pattern, although it surfaces to varying degrees in different countries. therefore, the explanations will most likely be found in factors affecting the propensity to save, the willingness to invest, and weaker growth in potential output globally. all three of these have contributed to lower real rates over this period, although reduced growth in potential output might be more recent. the aging of the population, increased public saving in emerging countries ( including the accumulation of foreign exchange reserves ), and increased income inequality within countries are among the factors that have contributed to the increase in the propensity to save. declining relative prices of investment products and increased uncertainty and risk aversion, particularly during the aftermath of the crisis, have negatively affected the willingness to invest. but how does iceland fit into this picture? as chart 1 indicates, developments here have been

has pulled in this direction as well, as i mentioned, and in a historically important development, inflation expectations are close to target by most if not all measures. if this continues, monetary policy will have greater scope to mitigate the impact if positive developments give way to negative shocks. and according to the bank ’ s baseline forecast, the outlook is good : continued strong gdp growth and full employment ; a current account surplus throughout the forecast horizon ; the prospect that icelanders will soon own more assets abroad than foreign nationals own in iceland ; and inflation at target for the entire period. one can ask, in view of this, why some observers are so dissatisfied with monetary policy. i will discuss this in more detail later on. but there are significant risks, and we must be on the watch for them. there is an obvious risk of economic overheating. the labour market could spiral out of control. economic policy mistakes could take place – for instance, if fiscal policy begins to pull too strongly in a different direction from monetary policy. we have seen the repercussions of this before. i will now turn to the main topics of my speech today : the level of interest rates in their long - term context, the foreign exchange market, and possible changes to the monetary policy framework. level of interest rates during the run - up to the recent parliamentary elections, there was considerable discussion of the level of interest rates in iceland. if we are to come to a sensible conclusion on whether the nominal interest rate set by monetary policy is appropriate or not in terms of inflation, inflation expectations, the business cycle, a plausible estimate of the equilibrium real rate, and foreign interest rates, it is important that the discussion be based on facts. when we consider the interest rates that are most important for households and businesses – i. e., longer - term real interest rates rather than the rates decided directly by the bank – it is also important to realise to what extent monetary policy can affect those rates. the answer to this is that monetary policy only has a short - term impact on long - run real rates that are ultimately determined by underlying economic fundamentals, not least the interactions between the propensity to save and the impetus to invest. let us now examine a few facts of importance in this context. first, it should be noted that international long - term real rates have been falling over the past three decades, as can be seen in chart 1. chart 1 : real long - term treasury rates on price indexed