Iceland’s Currency Crisis

April 17, 2012 • Blogs, The Globalist Notebook • Views: 1555

By Neha Srivastava

Iceland is a strange and beautiful little country. Craggy rock, heated lagoons and volcanoes define the landscape. Just 319,000 people inhabit the place, less populous than Wichita, Kansas. It is known for a comprehensive and expansive welfare system along with a high Human Development Index. Yet, since the 2007-08 recession, Icelanders cannot be too happy, especially as their currency the krona has been devalued to uselessness.

Iceland, largely dependent on foreign imports, is caught in the midst of a sticky currency crisis. The days of the Icelandic Krona may be coming to a close. (Wikimedia Commons).

Along with Italy, Greece and other European countries, Iceland was devastated by the late-2000’s financial crisis. Its three largest banks went bankrupt, so the government accepted an IMF loan in 2008 on the condition that it sharply increase the national interest rate. This term change along with a mad dash by Icelanders to ditch the krona for other currencies resulted in the devaluation of the krona to 250 per Euro, a stark reduction from the 70:1 rate in 2007.

Now, it’s virtually impossible to buy anything with krona in Iceland. Imported goods are insanely expensive – which is equivalent to all Icelanders taking a huge pay-cut. The krona cannot function as a medium of exchange, and is hardly a unit of account or store of value anymore. Today, Iceland is on a path to economic recovery with a 2.5-3% growth rate, but it still needs to solve the currency problem.

Economists and the Icelandic government have proposed dollarization, abandoning the domestic currency for a more stable and solid foreign currency. This has advantages but also poses risks.  Foreign currency based stability would certainly control for inflation and unequal exchange rates, which could boost investor confidence and increase international trade. However, devaluation would no longer remain a monetary policy tool to address potential extreme circumstances in the future.

A recent Gallup poll indicated that 70% of Icelanders support switching to a foreign currency. Interestingly, the Canadian dollar, affectionately called the “looney”, has more support than the U.S. dollar, the Euro, and the Norwegian Crown. Canada has a strong and stable economy and monetary policy, and it’s similar to Iceland in economic structure and its large natural resource endowment.

Yet only a tiny fraction of Iceland’s trade is conducted with Canada. The majority of trade is with the European Union, so adopting the Euro seems most pragmatic. Generally, the more widespread the currency, the less vulnerable it is to economic shocks. However, Iceland is not yet a member of the European Union and most Icelanders oppose joining. Further, the uro and the Eurozone are not without their own problems.

The Krona reflects the unique country of Iceland, a small place of fisheries, aluminum, and geothermal power. Yet the country will need to adopt a new currency if it hopes to achieve economic stability, ecourage international investment, and facilitate growth.

Neha Srivastava ’14 is an Economics major in Ezra Stiles College. She is a Globalist Notebook beat blogger on global economic policy. Contact her at neha.srivastava@yale.edu.

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One Response to Iceland’s Currency Crisis

  1. Anthony Salcedo says:

    Interesting. Many of the same issues Ecuador faced during it’s financial crisis mirror Iceland’s, and it dollarized as a result. Ecuador also took out loans with the IMF, and has since claimed they are unjust and predatory. Excellent article.