Country Report Iceland July 1998 Main report

Economic policy: Central Bank sees a need for fiscal tightening

Although there are still few signs of inflation, the Central Bank of Iceland has warned the government that it might have to tighten fiscal policy in order prevent the economy from overheating. According to the Central Bank, the rapidly deteriorating trade balance and low savings levels require a tighter policy stance to dampen domestic demand by either raising taxes or cutting government expenditure. Although this year's budget projects a surplus of Ikr3bn ($42m), the Central Bank has suggested that the fiscal position is not as prudent as it might be, as almost Ikr2.7bn of the surplus can be accounted for by the projected profits from the government's privatisation programme and as tax receipts are rising rapidly on the back of rapid growth. Adjusting for the unusually high income receipts the Central Bank estimates that government will have to increase the fiscal surplus by up to Ikr5bn in order to ensure economic stability. Even though the Central Bank does not rule out the possibility of putting up interest rates, it has pointed out that the interest-rate differential between Iceland and other countries is already quite high, at more than 250 basis points, making fiscal tightening the preferred option over tighter monetary policy.

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