The Central Bank of Iceland has published a working paper assessing the optimality of monetary policy decisions from 2006 to 2025. The study finds that the key interest rate was, on average, set too low, with the largest deviations occurring around the financial crisis and the COVID-19 pandemic. Deviations were most pronounced at turning points in the business cycle, reflecting delays in both tightening and easing policy. The analysis indicates that policy was too loose before the financial crisis and too tight during the subsequent recovery. It also suggests that rates should have been lowered faster in late 2019 and early 2020, before becoming consistently too low as inflationary pressures intensified in 2022 and 2023. The paper applies an Optimal Policy Perturbation statistic based on contemporaneous forecasts for inflation and the output gap and their responses to policy shocks. Its wide confidence intervals reflect substantial forecast and model uncertainty, while the results indicate that the policy rate has more recently been broadly optimal.
Central Bank of Iceland2026-07-29
Central Bank of Iceland publishes study finding policy rate was generally too low over two decades
A Central Bank of Iceland working paper finds that the key interest rate was generally too low from 2006 to 2025. Policy was too loose before the financial crisis and during the post-pandemic inflation surge, but too tight after the financial crisis and insufficiently accommodative in late 2019 and early 2020. Recent policy was assessed as broadly optimal.