PRESS RELEASE FROM THE CENTRAL BANK OF ICELAND:
The Central Bank of Iceland today announced a decision to reduce the policy rate by 3.5%.
The Icelandic economy has been subjected to unprecedented turbulence in the past few weeks. The Icelandic banking system has not been able to withstand the trials it has faced as a result of difficult market conditions, global deterioration of confidence in economic affairs, and domestic risk appetite.
A variety of jobs have disappeared virtually in the blink of an eye, demand has declined precipitously, and by all measures, expectations are at a low ebb. The impact of the collapse of the banking system will be extremely burdensome and the accompanying economic contraction very sharp.
Preliminary forecasts are coloured by these factors.
The Board of Governors has engaged in informal discussions with representatives of the private sector, as well as with a number of other parties, and has reviewed this grave situation.
As a result, the Board of Governors has decided to lower the policy interest rate by 3.5% effective immediately. The policy rate will be 12%. The next policy interest rate decision date is November 6, 2008.
“12% is probably still too high as the inflationary risk probably comes via the implosion of the krona.”
Encouraging people to lend more from the banks at this time is essentially the same as printing new banknote with more zeros added to them. It won’t increase the amount of goods on the Icelandic market in any way, it will only result in boosting the money supply. That means inflation.
To fight inflation, you would have either to decrease the amount of money floating around, or to increase the supply of goods. Many goods came from abroad, and the sellers there don’t accept ISKs right now, so this is not a solution. And the central bank is doing the total opposite of reducing the money supply. Strange.
Really, it’s surreal if you think about it: The recipe for curing the crisis that was created by easy money is even more easy money??? Does that make sense to anyone here?
Icelandic monetary policy changes of direction.
Monetary policy of the Central bank of Iceland was the suitable one, whenever the krona remained calm. With collapse of the krona in last weeks, and the VERY serious banking subject, course of economic policy that was valid until now, no longer is: it is necessary to change it; growth sinks. Now primary target is not the inflation but stabilize the krona, and thus maintain and, later, reduce frightful inflation. Since September inflation calculated when Euro worth = Ikr 130 and dollar = Ikr 90, approximately, and now Euro = 150 and dollar = 110, this will very hard suppose an increase of prices in October and successive months, unless desire to buy has collapsed absolutely.
Monetary policies of the Central bank have been good; before and now. Although Central bank should have stabilized the krona, and make a harder rates policy for years. Present situation will come with harder inflation next months: Moody’s says up to 27% in 2008, and 9% next year: TERRIBLE !
Obviously, the central bank tries to counter the loss of jobs in the financial industry by boosting the domestic economy in other businesses. But woldn’t it be much better now to reduce the amount of money on the markets instead, in order to get the ISK back to a stable exchange rate? Icelanders can live with less income for some time, but they can’t live without imports when the ISK is toxic.
Is “cheaper” credit the right signal to send, at a time where the nation has only 400 millions in credit swaps to spend for imports? That’s only a bit more than 1000 Euro for every Icelander. How long will this last? And won’t more credits only result in even more inflation?
I have only basic knowledge of economy, but I would really like to see what renowned economists think about this move. Was this encouraged by the IMF? I doubt it.
12% is probably still too high as the inflationary risk probably comes via the implosion of the krona. 5% IR and halt on indexation might be a good move.