mar guðmundsson : monetary policy at a crossroads speech by mr mar guðmundsson, governor of the central bank of iceland, at the icelandic chamber of commerce monetary policy meeting, reykjavik, 5 november 2015. * * * honoured chairman, ladies and gentlemen : the iceland chamber of commerce has a decades - long tradition of holding a meeting like this one on economic developments and prospects and monetary policy. the meeting is held following the publication of the central bank ’ s autumn forecast and, in latter years, the monetary policy committee ’ s interest rate decision. the title of my talk today is monetary policy at a crossroads. these crossroads are, first, the disappearance of the slack in the economy and the development of a positive output gap, with the result that the task of monetary policy is no longer to stimulate gdp growth to the extent that the inflation target allows but to ensure that the tension in the economy does not cause overheating, which would jeopardise economic stability. the second crossroads is that, in recent months, the labour market situation has become much more serious than would have been anticipated given the state of the economy. the third lies in the unusual level of uncertainty about the inflation outlook, stemming from the interplay between domestic inflationary pressures and the global tendency towards deflation. and fourth is the recent rapid progress in solving the of the balance of payments problem iceland has faced since the financial crisis struck and the approaching liberalisation of capital controls. because of this, the monetary policy transmission mechanism has been somewhat disturbed, as iceland is more susceptible to contagion from low global interest rates at a time when financial conditions and the banks ’ liquidity are changing. some might say that these represent challenges rather than a crossroads. i prefer crossroads as a metaphor, however, because in all of these instances the economy is moving from one state to another. this certainly poses challenges for monetary policy and for all economic policy. but they are compounded by the fact that the economy is travelling through all of these crossroads at roughly the same time, and the challenges often interact in a manner that makes monetary policy formulation and conduct more problematic than usual. this will become clearer after i have described each of the crossroads more fully. the first one is growing demand pressures in the domestic economy. according to the bank ’ s forecast, published yesterday, gdp growth in 2015 and 2016, measuring 4. 6 % and 3. 2 %, respectively, will exceed growth in potential output. the sizeable slack that

and speedy provision of liquidity in reserve currencies more or less directly to internationally active banks. in the absence of almost total retrenchment in international banking – except in cases involving countries issuing reserve currencies and with strong fiscal capacity – the problem these swap lines were meant to address will not go away. the past few years have seen lively discussion of whether it is desirable and feasible to anchor the swaps more firmly in the international monetary system, through clearer and more transparent access criteria and a multilateral governance mechanism. clearly, there are arguments for such institutionalisation, but i sense that this might be premature and that we should allow the discussion to evolve further. those who oppose constraining central bank discretion in this area present important arguments. the most compelling are those based on the analogy with liquidity provision and lolr in a national setting, where flexibility, speed, and large scale can be essential. this argues in favour of giving central banks a major role in the arrangements. less compelling are arguments based on moral hazard, which would apply equally to domestic arrangements. what seems clear is that even greatly enhanced imf facilities are not close substitutes for swap lines among central banks. first, the swap lines are there to provide short - term collateralised fx liquidity to banks, whereas imf facilities are uncollateralised longer - term lending to sovereigns and are intended primarily to mitigate balance of payments problems. norway and the euro area were offered usd swaps without prior balance of payments disequilibrium and the euro area, at least, badly needed it. second, imf facilities generally cannot match the swap lines in terms of speed of delivery, as the decision processes at the imf are unavoidably more cumbersome. at present, the imf ’ s maximum lending capacity is just over a trillion us dollars. at their peak in early december 2008, the usd swaps amounted to over usd 580 billion, after having increased very rapidly to that level in a matter of a few weeks11. if needed, the total could have risen much higher because the swaps had been uncapped vis - a - vis key central banks, which also mattered greatly in terms of signalling. if the imf or any other international organisation is to be able to provide a credible alternative to the swaps, it must be able to expand its balance sheet speedily and on a large scale when the need arises. in short, it would have to function like