When asked why the QE programme had been announced this spring, when the policy rate was considerably higher than it is now, the Governor answered that the objective of the announcement was to affect expectations. QE itself, however, must be applied in a conditions-based way; for example, the ISK depreciation in the autumn prompted the CBI to abandon plans submit bids in the bond market.
According to Ásgeir, the MPC thinks the bond purchase programme should shift into a higher gear in the near future. In this context, the CBI has bought Treasury bonds for at least ISK 1.5bn since 9 November, indicating that it has already begun the process. Furthermore, the MPC will respond if it notices imbalances in the bond market. The ISK is presumed to have bottomed out by now, giving greater scope for action.
Lowest or highest real rate?
The CBI’s Chief Economist, Þórarinn G. Pétursson, said when asked that Iceland’s real rate was around -3%, making it by far the lowest in the West. But it is worth noting that Þórarinn must have been referring to the CBI’s policy rate in terms of current inflation or the short-term inflation outlook. In terms of indexed Treasury bonds, Iceland’s long-term real rate is currently 0.4%, and in terms of the spread between nominal Treasury bonds and long-term inflation expectations it is in the same neighbourhood. It is hard to find rates this high elsewhere in the West. Iceland’s real rate therefore differs widely in international comparison, depending on whether it is examined in a short-term or a long-term context.
Þórarinn also noted that the equilibrium real rate would probably be lower in the near future than it has been hitherto. He mentioned that potential output would probably increase by about 1% in coming years, as opposed to an average of 2.7% in recent decades. We agree that the days of a high equilibrium real rate in Iceland are probably numbered, unless the saving rate falls markedly and/or potential output gets a massive jump-start.