Iceland: Fourth Post-Program Monitoring Discussions-Staff Report; Press Release; and Statement by the Executive Director for Iceland

KEY ISSUESContext: The recovery is continuing and the growth outlook is positive, but crisislegacies continue to weigh on the economy. The government is undertaking efforts to address them but this entails significant risks. Sound macroeconomic and financial sector policies are key to mitigating these risks and facilitating strong, durable growth.Capital account liberalization: The authorities are taking welcome initial steps to update the 2011 liberalization strategy. A comprehensive approach consistent with macroeconomic and financial stability and conditioned on balance of payments prospects and maintaining adequate reserve buffers will best support macroeconomic and financial stability.Monetary policy: The current stance is appropriate. The central bank should stand ready to respond to possible pressures stemming from factors such as 2015 wage formation, the fiscal stance, and a closing output gap. Maintaining a financially sound, independent, and accountable central bank is important for policy credibility and anchoring inflation expectations, which in turn supports stability and growth.Fiscal policy: The government's objectives of a balanced budget and lower debt are appropriate. Achieving them will require some 1 to 1½ percent of GDP in measures and a well-formulated medium-term fiscal plan. Their firm implementation will help ease budding wage and inflation pressures, lower borrowing costs, and rebuild fiscal buffers. The draft organic budget law now before Parliament will underpin these efforts.Financial sector policy: Prudent financial sector policies and practices—including maintaining capital and liquidity buffers and enhancing supervision—are needed to safeguard financial stability as capital controls are eased. The proposal to put theloss-making Housing Financing Fund in an orderly runoff mode is welcome.