Iceland’s response to their economic and banking crises

Abstract

In times before its economic crisis, Iceland developed to a country with one of the highest living standards in the world. This time was characterized by privatisation and liberalisation. Its rise, however, ended abruptly in 2008 with its economic and banking crisis. This crisis was enabled by an inefficient and deregulated banking sector combined with a weak and powerless supervision, which allowed banks to operate well beyond the capacity of the central bank. Total assets of the banking sector equated to 900 percent of the coutry’s GDP. With the beginning of the global financial crisis this model was no longer sustainable. Iceland responded with a mix of partly unorthodox measures:  Banking reforms were initiated and supervision was strengthened.  Commercials and Central Bank was recapitalized  Capital controls were introduced to stop the Icelandic Krona from depreciating  Monetary policy was tightened to reduce and stabilise inflation  Public expenditure was reduced and taxes raised to return to a budgetary surplus and a positive current account  Fiscal deficits were bypassed by credit lines from the IMF and many other countries Until now these measures had mixed results. It was possible to reduce inflation rate and stabilise the krona. Also did the fiscal balance return to positive, but is significantly lower than expected and planned. Similarly, the current account returned to appositive level, but nevertheless remained very volatile and small. Further did unemployment rate rise as a consequence of the restrictive policies, but has a trend to lower levels. The measures therefore were partly effective, but their long-term consequences have to be observed further on. Author keywords: Iceland, crisis, fiscal policy, monetary policy, IMF, inflation, unemplyment