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New Frontiers in the Euro Debate in Iceland

Author(s): Thorsteinn Thorgeirsson

Date published: Mar 2019

SUERF Policy Note, Issue 59
by Thorsteinn Thorgeirsson, Central Bank of Iceland

JEL-codes: D33, E3, E44, E5, E65, F31, G01, J3, N1.
Keywords: Exchange rate policies, choice of currency, factor income distribution, monetary and financial stability.

The debate on currency arrangements and monetary policy frameworks in Iceland has been motivated by developments in Iceland and internationally in recent decades. Historically, Icelanders’ colonial experience and struggle to retain control of vital natural resources made them hesitant participants in the European integration process. While sidestepping direct participation in the process leading to EU and EMU membership, they joined EFTA, the EEA and Schengen. Economic growth and development have been rapid, but the modernisation and liberalisation of the economy have been attended by significant volatility in nominal and real variables. At the same time, the European integration process has continued with its own set of challenges. It is in this context that a vibrant debate has taken place on the choice of currency and associated policies. The main emphasis has been on whether to adopt the euro (through EU membership) or retain the Icelandic króna with the most efficacious monetary policy framework possible. This article offers a review of salient contributions to the debate and the main lessons drawn from it. The key themes of the debate involve the impact currency choice would have on economic growth and resilience to shocks. While the early debate was mostly concerned with trade-theoretic issues, institutional factors have become increasingly important. A new theory concerning a heretofore overlooked policy variable, the evolution of inequality as measured by the wage-productivity gap, is discussed. It is shown to be potentially important for economic and financial outcomes, with implications for the debate.

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SUERF Policy Note, Issue 59SUERF Policy Note, Issue 59

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