Excerpts from the Ministry's Weekly Web Release January 24, 2002.

The interrelationship of prices, wages and the exchange rate
During the last two years, prices have risen considerably more in Iceland than in the neighbouring countries, thereby rekindling fears of the inflation that was so memorably overpowered a decade ago. Inflation has been on the rise in Iceland instead of abating as forecasts anticipated. This has led to a serious discussion of specific measures to keep prices in check, especially following a rise in the CPI in January. Great interests are at stake and it is important to ensure that the inflation goals of the government, the Confederation of Employers and the Federation of Labour
are achieved, and that the revision clause in the current wage agreements is not invoked.

It should be emphasised in this respect that one economic factor cannot be taken out of context of the overall development of the economy. It is a known fact that changes in the production and distribution costs of goods and services show up as price changes after productivity changes in the relevant sectors have been taken into account. Of course other factors matter as well, but at the end of the day there are no magic solutions. In order to keep inflation in check, domestic cost increases have to be in keeping with those of Iceland's competing countries.

Extensive pay rises recently have unavoidably contributed to higher prices, firstly due to increased production costs and secondly due to increased purchasing power causing demand pressure on the market. The strong correlation between the price of competitive services and wage development is especially prominent. Looking at the whole picture, the price level of imported goods has complied with the traditional pattern and changed in concert with the exchange rate and increases in the trading countries. However, the price of imported foods and beverages has increased considerably more than suggested by changes in the exchange rate. The price of other imported goods has increased much less and some hardly at all despite considerable changes in the exchange rate. This difference undeniably leads to the question of whether different market conditions affect price formation and, if so, in what way. It is not clear whether extensive concentration on the food market is part of the explanation, although that explanation must appear convenient. In order to get to the bottom of the matter, a thorough investigation into the context of price formation and concentration in the relevant line of commerce would be needed. However, it may be reasoned that a stronger krona exchange rate should soon lower the price levels of imported goods, especially foods.

When considering the development of the exchange rate during the last few months is seems that the exchange rate index is adjusting to a certain equilibrium at around 140 points, which is in keeping with the exchange rate assumption used in the 2002 fiscal budget. Compared to the status in October and November, this is a significant appreciation which is bound to have a positive effect on price developments in the coming months and so contribute to the achievement of the above-mentioned inflation goals.

Double taxation treaties
In 2001, the Icelandic delegation on double taxation treaties concluded treaties with Italy and Malta, thereby making Iceland a party to 23 double taxation treaties with 27 foreign countries. A joint treaty is in force between the Nordic countries. Although great progress has been made in only a few years (13 treaties during the last five years), Iceland still has far to go compared to the other Nordic countries. Denmark has concluded 74 treaties, Finland 64, Norway 77 and Sweden 78.

On basis of the current policy, the delegation's long-term goal is to conclude treaties with all OECD member countries in the next few years. Treaties with 20 out of 30 OECD member countries have already been completed and the drawing-up of a treaty with Ireland is in the final stages. Plans are for discussions to commence with Greece in April and South Korea in May. Discussions with Hungary are expected to commence this year. This leaves Austria, Australia, Japan, Mexico, New Zealand and Turkey. Discussions have been requested formally with all these countries, apart from Turkey, but dates are still uncertain.

Furthermore, the delegation is planning to conclude treaties with all the new EU countries, but treaties with Slovenia and Cyprus are yet to be concluded. It is also on the delegation's agenda to seek discussions with Chile, Brazil, South Africa and Namibia. Finally, the delegation's second meeting with Greenland will take place in early February and a meeting with the United States will take place around mid-March.


For comments and/or suggestions, send e-mail to:
"bolli.thor.bollason@fjr.stjr.is"
or contact the Ministry of Finance,
Weekly Web Release, Arnarhvoll, 150 Reykjavik, Iceland