Impact of Exchange Rate Variability on Small Economies

This document is a presentation delivered by Þórarinn G. Pétursson, Deputy Governor of Monetary Policy, at the Reykjavik Economic Conference. It discusses the role of currency exchange rate variability in small open economies, particularly focusing on Iceland's experience over recent decades. The presentation outlines the trade-offs between exchange rate variability acting as a buffer or an amplifier of economic shocks. It details Iceland's transition from a fixed exchange rate to inflation targeting, the subsequent macroeconomic imbalances, and the financial crisis that ensued. Following the crisis, significant reforms were implemented, including the establishment of a Monetary Policy Committee and improvements in the Central Bank's toolkit. The presentation further explains how the behavior of the Icelandic krona changed post-crisis, becoming more stable and better able to absorb shocks. Empirical evidence is provided to illustrate the shift in the factors driving exchange rate fluctuations, highlighting the improved macroeconomic fundamentals in Iceland since the crisis.