was substantially below a level reconcilable with long - term equilibrium. this occurred at a time when the price of key exports was very high, making the years 2000 and 2001 especially favourable for the export sector and in fact also for import competing sectors. enterprises in these sectors now understandably feel the effects of the rise in the exchange rate. it is not to be expected, however, that the same conditions will again arise in these sectors as prevailed, for example, during 2001 and in the early part of 2002. in this connection it could be mentioned that, based on the predictions on performance made by financial enterprises, the contribution margin in fisheries companies will be fairly good this year, although not as good as in 2001 and 2002, which were quite exceptional. in the february issue of its monetary bulletin, the central bank published an analysis of the proposed major construction projects in east iceland and possible responses for economic management. the article concludes that unless economic counter - measures are taken, the projects will create overheating in the economy, inflation and instability. although their scope will be considerable, the projects are not so large that economic stability cannot be preserved and inflation contained by means of appropriate responses in economic management. mitigating measures would be most effective if they involved both monetary and fiscal restraint, as well as internal adjustment of the national economy, including a rise in the exchange rate. the more restraint shown on the fiscal side, the less need there will be to raise interest rates. a higher krona exchange rate also means less cause to raise interest rates. the exchange rate was fairly stable from the spring of 2002 until early this winter. it then began to rise and continued to do so steadily until early february of this year. the central bank has stated its view that the exchange rate rise in recent months has been primarily due to the effect of the proposed major construction projects in east iceland. the operations of the aluminium smelter will likely cause the equilibrium exchange rate for the krona to be higher than otherwise. furthermore, it appears evident that the influx of foreign currency in connection with these projects will be considerable, with higher domestic interest rates than otherwise. all of this affects market expectations and makes the krona exchange rate higher than it would be in the absence of plans for major development in east iceland. the economy could thus be said to have already begun adaptation to the coming projects, i. e. the exchange rate adjustment has begun and is even well on its way. in view of what has

the central bank expended substantial sums in intervening on the foreign exchange market, over isk 40 billion in total, without this sufficing to halt the slide of the krona. at best, it may have slowed the depreciation until the economy had cooled somewhat, and it also contributed to making the inflationary impact of the exchange rate drop less than it would otherwise have been. an article by gerður isberg and þorarinn g. petursson in this february ’ s issue of the central bank ’ s monetary bulletin describes the bank ’ s actions on the foreign exchange market during 2000 and 2001 and assesses their impact. the article concludes definitively that at best the intervention had only short - term effect in each case and the market soon returned to its previous situation. in other words, their conclusion is that intervention on the foreign exchange market against strong prevailing currents has precious little effect unless accompanied by corresponding changes in the domestic interest rates. this is in full accord with the experience in other countries. in recent public discussion the claim has often been made that the exchange rate of the krona is far too high and that the central bank needs to take steps to bring it down again. the fact of the matter is that the bank ’ s means of controlling the exchange rate are overestimated and the power of the market underestimated when the claim is made that the central bank can, through its actions, direct the krona to a specific level. the proposal has been made, for instance, that the central bank cut its interest rates substantially with the aim of lowering the exchange rate. in this context it should be pointed out that the bank has cut its policy rate substantially, from 10. 4 % only a year ago ( 11. 4 % two years ago ) to 5. 3 % at present. the bank ’ s nominal policy rate has not been lower since 1994 and the real policy rate is at its lowest since 1996. the domestic and foreign interest rate differential has narrowed significantly. in addition, the central bank ’ s interest rate is now below the estimated equilibrium interest rate and thus has a stimulating effect on the economy. the impact of interest rate changes generally is only visible after a certain time lag, prompting one to conclude that the effect of the major decrease in interest rates during the past year has yet to be fully felt. as is well known, the exchange rate for the krona plummeted in 2000 and 2001, and for quite some time