a whole, in order to attempt to prevent serious shocks. persistent inflation is the result of lax monetary stance there are good reasons for assigning central banks a single main objective, namely to promote price stability. inflation is primarily a monetary phenomenon. short - lived inflation can have many causes, but persistent inflation is the consequence of a lax monetary stance. in the long run, monetary policy therefore primarily has an effect on prices. under normal conditions it only has a temporary impact on economic growth and employment. since central banks broadly speaking have only one instrument, i. e. interest rates, and can therefore only achieve a single long - term macroeconomic goal, it is natural to set price stability as the ultimate monetary goal. this is not to say that price stability is a more important goal than, say, full employment, but simply that monetary policy instruments are inherently better suited to impacting prices. it is pointless to set objectives for monetary policy which it cannot achieve. through price stability, a forward - orientated monetary policy can contribute towards creating a stable economic environment on which the long - term growth potential of the economy, namely growth and prosperity, is based. the reason that central banks can have a widespread effect on interest rate formation in the markets through their interest rate decisions is that they have the exclusive right to issue money in the economy, i. e. base money. by controlling the price of base money, i. e. the interest terms at which financial institutions can borrow short - term capital from them, central banks can influence the volume and price of liquidity in the financial system. central bank interest rate decisions have an impact on short - and long - term interest rates, financial system liquidity, money in circulation and bank lending, exchange rates of currencies, other asset prices and, last but not least, market participants ’ expectations about the future development of all these factors. all this, in turn, influences consumption and investment decisions of individuals and businesses, and thereby aggregate demand. the impact in individual areas can vary greatly from one time to the next. the new central bank act the previous central bank act dated from 1986 and was drafted over the period 1981 to 1984. it was a product of its time and did not reflect the perspectives that later established themselves. in the early 1990s the then minister of commerce appointed a committee to review the central bank act, chaired by professor agust einarsson, the current dean of the faculty of economics and business administration. following the committee ’ s

work the minister of commerce proposed a bill to parliament for a new central bank act which entailed sweeping changes from the 1986 act, including what are now considered to be many of the necessary elements of central bank legislation. however, the bill was not adopted by parliament. in may this year parliament passed a new central bank act with the approval of all 56 members who were present for voting on the bill. a detailed account of the main changes from earlier legislation has been given in the central bank ’ s publications. see i. a. the central bank of iceland ’ s monetary bulletin 2001 / 3 i shall only mention here that a single target was set for the central bank, i. e. to promote price stability. with the prime minister ’ s approval, the bank was also authorised to specify a numerical inflationary target. the bank was granted full independence to apply its instruments in order to achieve its main objective. its financial independence was increased by precluding in law treasury access to short - term funding with the central bank, which had previously been precluded with an agreement between the minister of finance and the bank. provisions on transparency and accountability towards the government and general public were made more focused. as i mentioned before, one of the central bank ’ s main objectives is to contribute towards an active and secure financial system, or financial stability as it is often known. in recent years central banks in many countries have been increasingly devoting themselves to monitoring financial stability. this development is partly the product of financial market liberalisation and the deregulation of capital movements, and partly a response to shocks which have struck many countries, both currency shocks and banking system setbacks. examples include the troubles encountered by banks in finland, norway and sweden a decade ago and the crises that hit asia and latin america in the latter part of the 1990s. the central bank of iceland has now built up a new organisational department, the financial stability department, which has the main role of monitoring factors affecting financial stability. twice a year the bank publishes articles on this topic in its quarterly monetary bulletin, an annual main study in may and a shorter account in november. in addition, the central bank and financial supervisory authority maintain close and productive cooperation, each seeking to ensure the security of the icelandic financial system in its respective way. inflation targeting to return to monetary policy itself, we should recall the joint declaration on the inflation target and changed monetary policy which was issued on march 27 by the government and the central bank of iceland.