The Icelandic krona is the smallest currency in the world. The central bank failed to build foreign currency reserves as the Icelandic banks expanded internationally. The central bank pursued a policy of high interest rates to fight overheating of the economy. This was a fatally flawed policy that many, including yours truly, warned against. Predictably the high interest rates attracted investors who borrowed in low yield currencies and took advantage of carry trade. This in turn drove up the krona and fueled economic expansion. Icelanders, individuals and companies, borrowed in low yield currencies and the prices of imported goods came down in krona. This was all fine until international credit tightened and later crumbled. The Icelandic house of cards came crashing down. The central bank tried to fight the international credit crisis by repeatedly raising interest rates but to no avail. In a nervous financial world the krona was toxic and no one would touch it.In hindsight Iceland may have been better off joining a larger currency area like the EU.
Tuesday, December 2, 2008
Be glad you are not in Iceland
Current residents are facing a falling currency and much higher prices for imports, which is most of what they consume. From a former student living in Reykjavik: