A Currency ‘Tragedy’ and the Geniuses Tasked With Repairing It

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  • Iceland has appointed a panel to design currency regime
  • A currency peg is one of many options being considered

Few currencies in western Europe have been put through the wringer like Iceland’s krona.

After the experiences of the past decade, during which an economic train wreck morphed into a textbook recovery, Iceland is now hammering out a new exchange-rate regime. The choices it makes will provide valuable insight into how small currencies can survive global shocks.

Finance Minister Benedikt Johannesson signaled he might prefer a currency peg, but walked back his comments after his boss, Prime Minister Bjarni Benediktsson, praised the virtues of a free-floating krona. Iceland’s currency lost as much as 1.5 percent against the euro on Monday, as the first-round result of France’s election triggered a rally in Europe’s single currency. Other Nordic currencies gained.

Read more on the government’s currency spat

To ensure the final decision isn’t political, Iceland has appointed a troika of experts. They declined to comment for this article. But their work and comments to date offer some clues on the kind of exchange-rate regime Iceland will choose.

The panel is starting its work just as Iceland ends more than eight years of capital controls. It’s expected to present its conclusions by the end of this year.

The Protagonists:

Asdis Kristjansdottir, a 38-year-old economist at the lobby group Business Iceland, has called the history of the krona a “tragedy” and blamed its continual crash every decade or so on fiscal and economic mismanagement. She was at Kaupthing Bank when the lender failed in 2008 and her father was a manager working for the committee that cleaned up Glitnir Bank, which also went bankrupt in 2008.

The government’s new five-year budget plans, which set tighter fiscal controls to limit future booms and busts, might assuage Kristjansdottir’s concerns on the krona.

Read more on changes to Iceland’s fiscal framework

Another member of the troika, 49-year-old Illugi Gunnarsson, has close ties to the Independence Party of the prime minister, having served as education minister, a lawmaker and as an adviser to a former premier, David Oddsson. Gunnarsson was also a board member of a fund operated by failed Glitnir. With degrees from the University of Iceland and the London Business School, Gunnarsson, along with the current premier, suggested in 2009 that Iceland adopt the euro with the support of the International Monetary Fund. The pair have since abandoned the idea, favoring the continued use of Iceland’s krona.

Asgeir Jonsson is the third member of the troika. He used to be the chief economist at Kaupthing until the lender collapsed in 2008. Jonsson received a PhD in economics from Indiana University, writing the thesis: "Short-term Stabilization in Small Open Economies."

According to Jonsson, krona weakness has over the past years helped disguise many of Iceland’s sins. At a meeting in 2015 with Business Iceland, he said that the "worst thing” about the krona is that “it allows us to get away with bad behavior. In a certain way that’s fun, but not good.” He’s voiced skepticism toward the notion of Iceland successfully enforcing a fixed-currency regime. “That peg would sooner or later be blown up by speculative buyers or in a market mob mentality,” he said this year, according to Morgunbladid.

One economist who has been following Iceland from afar and praised its handling of the crisis, Nobel laureate Paul Krugman, recently went back to his archives to dust off a paper he did on Iceland’s krona way back in 1991. It “still doesn’t read too badly a quarter-century and a financial crisis later,” he said on his blog. Its conclusion was that the advantages of an independent exchange rate “remain strong” but that it need not involve a free float and could “shadow” another currency regime through “target ranges.”

So it might be that the path forward lies in doing nothing and maintaining what the central bank has called an “inflation goal-plus” with frequent interventions in the currency markets.

Meanwhile, the man on the street may be hard to win over.

Simon Gisli Olafsson, a 51-years-old carpenter in Reykjavik, says he has “very limited” faith in the troika. "But we have to trust that these geniuses have learned some lessons from the past."

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