Abstract
Fredrik Andersson and Lars Jonung describe Iceland’s economy and list the possible currency regimes. They ask which is the best monetary policy regime for Iceland and conclude that a flexible exchange rate with an inflation target can be ruled out because such a system has served as a shock amplifier. They find that Iceland can only maintain a domestic inflation target over the long run through capital controls. But the authors consider such controls to be very costly and likely to increase corruption. Instead of a floating regime, they find that a fixed exchange rate regime is the preferred choice. But as a microstate, Iceland is not able to create sufficient credibility for such a regime, which leaves a monetary union as a solution. But since full euroization is not an option for Iceland because it is not a full member of the European Union, nor will be a member in the foreseeable future, the preferred monetary union alternative is, in their view, a currency board, accompanied by a wide-ranging reform package to foster fiscal stability, wage and price flexibility, and financial stability.
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- 1.
See, for example, the inclusion of Iceland among microstates in https://en.wikipedia.org/wiki/Microstate.
- 2.
For the concept of the microstate and the implications of a microstate for the choice of exchange rate arrangement, see Imam (2010). In a similar vein, Breedon et al. (2012) examine the exchange rate policy of 37 small rich economies using Iceland as a benchmark. Here, the sample includes countries with a population between 30,000 and 3,000,000, thus some are larger than microstates.
- 3.
See Gylfason (2009).
- 4.
- 5.
The trilemma can be traced back to the Mundell-Fleming approach developed in the 1960s. It received considerable attention in the debate concerning optimal currency unions and the common European currency. Work in the 1990s gave empirical support to the trilemma. See Obstfeld and Taylor (2017) for a current review.
- 6.
See for example Rey (2013).
- 7.
See e.g. Obstfeld and Taylor (2017).
- 8.
This is well demonstrated by the case of Sweden under inflation targeting. See Andersson and Jonung (2018).
- 9.
- 10.
For data on credit, see https://www.sedlabanki.is/hagtolur/hagtolur.
- 11.
- 12.
- 13.
Capital controls have been lifted over time and were largely abandoned by early 2017, although some restrictions remain. See Central Bank of Iceland (2017) for an assessment of the inflation targeting framework of Iceland before and after the crisis of 2008.
- 14.
Iceland was once a part of the Scandinavian Currency Union (SCU) because of being under Danish rule. The SCU functioned as a successful monetary union from the early 1870s until the outbreak of World War I (Jonung 2007), providing Iceland with the benefits of being a member of a monetary union.
- 15.
See ECB (2017).
- 16.
Imam (2010).
- 17.
Sometimes the experience of the convertibility plan of Argentina 1991–2002 is viewed as a case of a failed currency board. However, the convertibility plan did not strictly follow the rules of a currency board. See e.g. Hanke (2008).
- 18.
A radical solution to minimize political influence on the currency board would be to place its main office outside Iceland, for example in Frankfurt, Germany, close to the ECB.
- 19.
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Andersson, F.N.G., Jonung, L. (2019). Iceland Should Replace Its Central Bank with a Currency Board. In: Aliber, R., Zoega, G. (eds) The 2008 Global Financial Crisis in Retrospect. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-030-12395-6_18
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