Conclusiones del impacto de actividades de RSE en el desarrollo económico

In the fourteen years from 1994-2008 broad money increased by 900%. While the nominal GDP of Iceland roughly tripled in these fourteen years, broad money increased tenfold.

Money Categories Increase _‘94-‘08 % of M3 _{in ‘94} % of M3 _{in ‘08}

M3 M2

M1 Notes & Coin 6 x 2.1% 1.3%

Demand Deposits 19 x 17% 32%

Savings Accounts 6 x 55% 35%

Time Deposits 12 x 27% 31%

Table 4.1 Data: Central Bank of Iceland

Although all categories within broad money contributed to its tenfold increase, two categories stand out: Demand Deposits and Time Deposits, increasing nineteen- and twelvefold respectively.

In an attempt to understand the reason for the rapid multiplication of the money supply in Iceland, and its effects on the economy, the

following chapters look at developments in the financial markets in Iceland in the period of 2003-2008, a period of boom and bust of the Icelandic banking system.

4.3

2001 changes in monetary policy

Up until 2001 the CBI’s monetary policy was based on mainly fixed exchange rates. Since 1990 the exchange rate of the ISK had been allowed to fluctuate within a certain bands; first by 2.25%, then by 6% in 1995 by 9% in early 2000. In 2001 the exchange rate bands on the ISK were abolished.

In 2000, the CBI's legally mandated goals of maintaining "a suitable money supply" and the "full productivity of the economy" were abandoned for the single objective of promoting price stability. The basis for the current Central Bank Act in Iceland dates from 198625 _{when the role of the CBI was defined in the following way:}

[unofficial translation, our emphasis in bold] “3. Article. The Central Bank is responsible for:

Issuing bank notes, coins and bills, and making sure that the money supply and the supply of credit is suitable so that the price level can remain stable and the production possibility of the economy can be reached in an efficient manner

 Preserving and strengthening the foreign exchange reserves in order to ensure free trade with other economies and the financial security of the nation as it relates to other economies. The foreign exchange reserves should be preserved, as far as possible, in safe and liquid securities or deposits and foreign currency, which can be used for payment anywhere.

 Buying and selling foreign currency and supervising exchange rate matters and foreign exchange transactions  Advising the government on all matters pertaining to

foreign exchange and monetary issues

 Carrying out the banking transactions of the Treasury  Being the deposit institutions bank and fostering a stable

and healthy financial market.”

In spring 2001 Act number 36/1986 regarding the CBI was revised. The third article of the act, which defines the role of the CBI, now reads [unofficial translation]:

“The main objective of the Central Bank of Iceland is to promote price stability. With the consent of the Prime Minister, the Central Bank is authorized to declare a numerical target for the inflation rate.

The Central Bank shall help promote the government’s economic policy as long as such promotion is not inconsistent with its main objective stated in paragraph 1.”26

With the revised Central Bank Act, the CBI was longer required by law to focus on exchange rate stability or a suitable money supply as its main objectives. The CBI was however to watch the exchange rate developments closely and use open market operations - buying and selling foreign currency - if necessary, to promote price stability.27

In the CBI’s view, the monetary policy was thus only able to reach one macroeconomic goal, price stability, as inflation was in the long run “first and foremost a monetary phenomenon”.28

The changes in monetary policy made in 2001, put the main focus of monetary policy on controlling inflation by setting interest rates, but dismissed direct control of the money supply and exchange rate. This change may have been in line with what many central banks were doing at the time but with hindsight, it was not safe to abandon efforts to control the money supply.

4.3.1

Influencing demand and lending

After the policy change in 2001 the CBI has mainly used interest rates in the financial markets to hit its inflation target. To affect market rates, the CBI offers to both borrow and lend reserves to commercial banks on a short-term basis. Interest rates offered by the CBI have an effect on short-term interest rates in the financial markets. Through this, the CBI’s monetary policy affects the borrowing, spending and savings decisions of firms and households.

The CBI’s policy rate affects price levels via a complex interaction of:  Market interest rates

 Equity prices

26 _{Act on the Central Bank of Iceland no. 36/2001} 27 _{Petursson (2001)}

 Money supply and bank lending  Expectations and credibility

 Exchange rate of domestic currency

These factors affect domestic demand, imports and exports. Domestic demand, imports and exports in turn affect total demand and thus the production gap, which affects inflation. The exchange rate also affects domestic inflation, as roughly half of consumer goods in Iceland are imported.

An increase in the CBI's interest rate (the policy rate) is supposed to not only reduce borrowers' demand for loans but also the willingness of banks to lend money. The reason why higher interest reduces banks' willingness to lend is based on the premise that raising interest rates reduces the wealth of individuals in total as well as cash flow and market value of firms. Higher interest rates therefore increase risk of borrowers defaulting on loan repayments. A risk-averse bank is therefore expected to lend less when rates become higher.

In reality, the increased policy rates have not been proven as very effective at reducing bank lending in Iceland. In the years leading up to the crisis, both supply and demand for loans remained strong despite rising interest rates and the money supply continued to expand.