Financial stability should be prioritised over price stability

Primary recommendations:

• Financial stability shall take priority over price stability if conditions develop such that the former is jeopardised.
• The Central Bank’s sphere of responsibility shall be expanded. The Bank shall be solely responsibile for macroprudential and microprudential policies instead of the current division of responsibilities between the Bank and the Financial Supervisory Authority.
• The Central Bank’s inflation target shall exclude house prices.
• There shall be two Deputy Governors, one to focus on financial stability and the other to focus on conventional monetary policy.

The task force on the monetary policy framework has formulated 11 proposals concerning the framework for prudential tools, a revised and improved inflation target, more targeted application of the Central Bank’s policy instruments, and procedures for monetary policy decision making. In its findings, the task force emphasises that each monetary policy framework has its advantages and disadvantages. Iceland has been subject to persistent monetary instability because the ground rules have not been followed. The most important thing is to follow the ground rules required by each framework at any given time, irrespective of which policy framework is chosen.

In the task force’s opinion, there is nothing to indicate that inflation targeting could not be as successful here as it has been in the Nordic countries. The foundations for monetary policy should be strengthened with more targeted use of macroprudential policy, so that the Central Bank of Iceland will be solely responsible for financial stability in the same way as it is now solely responsible for price stability. The task force is of the opinion, however, that a currency board would entail an unacceptable level of risk to financial stability, and it therefore does not recommend that option.

The task force for monetary policy review was appointed in March 2017. Its members are three economists: Dr. Ásgeir Jónsson (Chair), Ásdís Kristjánsdóttir, and Illugi Gunnarsson. The task force engaged the following economists to advise the authorities on Iceland’s future monetary and exchange rate policy options:

• Patrick Honohan, former Governor of the Central Bank of Ireland, and Athanasios Orphanides, professor at Massachusetts Institute of Technology (MIT) and former Governor of the Central Bank of Cyprus, to assess Iceland’s experience of inflation targeting and propose possible reforms.
• Sebastian Edwards, professor at the University of California at Los Angeles (UCLA), to evaluate monetary policy options for Iceland other than the current inflation target.
• Kristin Forbes, professor at MIT, to examine the application of financial stability instruments.
• Lars Jonung, professor at the University of Lund, and Fredrik N. G. Andersson, Associate Professor at the same university, to explore Icelandic monetary policy in a Nordic context.

The reports of the task force and the foreign economists can be found below.

Findings of the task force on the review of monetary policy (The Future of Icelandic Monetary Policy)

• 11 Proposals from the task force on monetary policy – summary
• 10 lessons from Icelandic monetary history – summary

Appendix:

• Analytica: CPI Formulation and Owner-Occupied Housing User Cost
• Marías Halldór Gestsson: An analysis of CBs inflation forecast errors
• Marías Halldór Gestsson: Efficient monetary policy frontier for Iceland
• Marías Halldór Gestsson: The effects of CBs policy rate on interest rates in Iceland

Reports of foreign experts:

• Patrick Honohan and Athanasios Orphanides: Reassessing Iceland´s Monetary Regime
• Sebastian Edwards: Monetary Policy in Iceland: An Evaluation
• Kristin Forbes: Macroprudential Policy after the Crisis: Forging a Thor´s Hammer for Financial Stability in Iceland
• Fredrik NG Andersson and Lars Jonung: Lessons for Iceland from the monetary policy of Sweden

Presentations from the monetary policy conference held June 6th 2018

• Macroprudential policy after the crisis 
  Kristin J. Forbes, professor at MIT
• Iceland's monetary policy regime 
  Patrick Honohan, former Governor of the Central Bank of Ireland
• Monetary policy in Iceland: An evaluation  
  Sebastian Edwards, professor at the University of California at Los Angeles (UCLA)
• Lessons for Iceland from the monetary policy of Sweden 
  Fredrik N. G. Andersson and Lars Jonung, professorsat the University of Lund