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THE INDEX — December 2, 2009

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Heidar Gudjonsson: What is the way out for Iceland?

With its currency down over 70 percent in two years, with 90 percent of its financial sector collapsed, and with its stock index down 95 percent over the same period, what can Iceland do? The political discussion has been confusing at best, and the chaos in the economy is not helping.  Iceland was hit with a triple crisis: first a currency crisis that started in 2006, then a financial/economic crisis that started in October 2008, and finally a political crisis as of this year. The public is angry and confused, but there is a clear lack of leadership and constructive debate within the country. Some people argue that joining the European Union would be the only way out. After Iceland joins the EU, some of the government would be effectively outsourced and a new currency could be introduced by joining the European Monetary Union (EMU).  What this argument overlooks is the time factor. Negotiations with the EU would never take less than one year. Then all the existing 27 members of the Union would need to approve Iceland as a new member. There is currently a waiting list, and Iceland could not be fast-tracked to the front of that list. In fact, given the many problems that the EU is having as it is, the process may take three to four years, at best. To join the EMU, Iceland would need to fulfill the Maastricht criteria of low and stable inflation. But here the track record of Iceland is anything but impressive, having consistently volatile and high inflation of at least twice the criteria, over the internationally low inflation period of past two decades. Iceland would also need to have a very low budget deficit, something the current leftist government is hardly going to meet (the target is below 3 percent but the current deficit is 10 percent). The last big obstacle is government debt.  With the current IceSave agreement, which the government is pushing the parliament to approve, the Maastricht target would be impossible to reach for the next decade or so.

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