Too Little, Too Late? Testing The Optimality of Monetary Policy in Iceland

Birta B. Haraldsdottir and Bjarni G. Einarsson

Economics from Department of Economics, Central bank of Iceland

Abstract: We apply a sufficient statistics framework to detect nonoptimal monetary policy decisions in Iceland. The method relies on two sufficient statistics: (1) forecasts of policy objectives and (2) impulse responses of those objectives to monetary policy shocks. The weighted product of these two sufficient statistics forms the gradient of the policy maker’s loss function. The Optimal Policy Perturbation (OPP) statistic, derived from this gradient, provides the test for optimization failures. Our results suggest that the Central Bank of Iceland’s key interest rate has, on average, been set too low over the past two decades. There are two notable deviations from optimality: the periods leading up to the financial crisis and following the Covid-19 pandemic.

JEL-codes: E31 E32 E43 E52 E58 E61 E65 (search for similar items in EconPapers)
Date: 2026-08
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