Hagkerfi bíður skipbrot: Reynsla Íslendinga af sjálfstæðri peningamálastefnu Alþjóðamálastofnun 26. febrúar Gylfi Zoega

Crises Currency crisis Financial crisis –Banking crisis –30-60% of non-financial firms technically bankrupt Inflation and rising unemployment Political crisis –Government lacked trust domestically –Unresolved disputes with European countries A deep recession (10% fall in GDP) and lower living standards Uncertainty about future directions

Savings and investment

Debt

Credit expansion

The mother of all bubbles

Monetary policy

Labour market

No more floating! Problem with a system of floating exchange rates with capital mobility –Transmission channel through exchange rates, affects mainly import prices –A system of CPI indexed loans with fixed exchange rates prevents the interest rate from affecting housing investment –Central Bank of Iceland lacks credibility! –Businesses borrow in foreign currencies, so central bank interest rates have limited effects on their investment activities. –Carry trade

No more floating! –Vicious circle: High domestic interest rates induce firms to borrow in foreign currencies Business debt in foreign currencies makes the central bank reluctant to lower interest rates, firms can expect high interest rates and high exchange rates. Businesses borrow even more in foreign currencies. Monetary policy becomes primarily focused on firms’ balance sheets, any exchange rate depreciation will make firms and industries bankrupt. Active monetary policy has increased the chances of a financial crises.

Lessons and responses EEA treaty imperfect –Big firms and banks and weak local institutions (CB, FSA, Treasury, politics, media, ….) –Independent currency in a small state incompatible with free capital mobility in the long run, “fair weather phenomenon” –Responses: Floating rates with capital controls Currency board outside EU Apply to the European Union and aim at satisfying Maastricht criteria

Options Floating rates with capital controls –Relive the past; problems include rationing of capital, corruption, inefficient allocation of capital between industries and firms Currency board outside EU –Possible on the road to Maastricht, but currently domestic institutions lack credibility and the country also lacks foreign currency reserves. Possible long-term solution outside the EU. Apply to the European Union and aim at satisfying Maastricht criteria –Apply this spring or summer, affect expectations, make the current float easier, and aim at having fixed exchange rates in the future.