the policy rate is high for a sustained period of time. inflationary pressure has been greater than forecasts indicated – and more than was easily dealt with – and as a result, it has proven difficult to contain inflation. it took a while before the impact of the central bank ’ s restraining measures was sufficiently felt, but considerable changes took place over the past year, when policy rate decisions made themselves felt more strongly in all areas of the credit market. in the fall and in early winter, the market also felt the weight of rapidly deteriorating global lending terms, which will undeniably support the central bank ’ s tightening measures and will reduce domestic demand and inflationary pressure, as was mentioned in the board of governors ’ announcement of 14 february. it is possible that there will be a rapid drop in domestic demand as a result of high interest rates and a tightening credit supply. at this point, however, it is impossible to assert that this will be the case. exactly when it will be possible to lower the policy rate will be determined by economic developments and outlook. precipitate interest rate reductions would push inflation upward and standards of living downward. the suggestion that it is necessary to lower interest rates in order to control inflation is absurd. indeed, it is astounding how carelessly many people seem to view inflation. furthermore, it is appropriate to stress that the central bank believes it is impossible to choose between price stability and financial stability. if we were to relax our stance on price stability, it would surely undermine the credibility of monetary policy. inflation – and no less important – inflation expectations would increase drastically, which could lead, in short order, to an upward spiral of prices and wages and falling exchange rate. even though domestic financial institutions might seem to profit, for the short term, by a depreciation in the krona and a rise in inflation, a trend in this direction would quickly take its toll on indebted households and businesses and would eventually result in loan losses. from the standpoint of financial stability, it is critical that inflation be reined in. it is also appropriate to emphasise the obvious fact that icelandic banks ’ access to foreign credit will not change if the central bank lowers the policy rate. it has been maintained that, because central banks in other countries have lowered their interest rates, the wider interest rate differential with abroad that resulted should have given the central bank of iceland the margin to reduce its policy rate this february. this is not entirely correct. as is well

the marked to market ( mtm ) losses of corporates. the mtm is dynamic in nature and changes in line with market movements and represents the replacement cost of the derivative contracts. these accounting losses should therefore be looked at in totality along with the economic rationale of the hedges undertaken wherein the corporate had decided to lock in to a definite price and to forego the inherent forex risk. conclusion 24. let me now conclude. i have attempted to explain what is new normal in the currency market, how risk management needs to be reviewed and adjusted in the new scenario and responsibility of the boards in putting in place appropriate policies to manage risks. i have also flagged the rbi moves to bring orderliness in the market and shared with you the thinking process that went behind these measures. in concluding, i want to leave the thought that we expect greater responsibility on the part of corporates in managing their risks which calls for greater understanding of their actions from a macro perspective. in other words, in these extraordinary times it is essential for the central bank to think like the corporates and for the corporates to attempt to think like the central bank or at least understand their actions. 25. thank you for your attention. bis central bankers ’ speeches