WHAT I WANT YOU TO
KNOW Iceland’s economic situation Or: Pray. is a direct outcome of its Compare: Ireland institutional history. experienced the same boom, the same bust History Matters. Contrast: But, we’re in the Remedies for Iceland’s EU. problem: Either join EU or kill its indigenous banking system.
Oct 2008, All 3 big
Icelandic banks fail & nationalisations abound. WHAT HAPPENED? Nov 2008, IMF called in UK ‘Attacks’ Icelandic economy Speculative Attacks continue
WHY? History Pre 1990‘s: Icelandic
economy previously highly regulated & politicized 1990‘s+: ﬁnancial liberalization with weak prudential regulation and supervision Privatised banks pursued highly leveraged positions Imprudent monetary policy-Inﬂation targeting Lack of Prudential regulation Speculative Finance: The Minsky Hypothesis
MINSKY MOMENTS 1.Idea: Credit markets
will breed their own reversal 2.How? 1.Cheap interest rates lead to increased lending. 2.This leads to increases in leverage (L/D ratio). 3.Perverse incentives breed dodgy lending via ﬁnancial innovations (Junk bonds/CDOS) ensues. 4.Something changes, dodgy loans default, banks fail, unless they get bailed out by Big Bank/Big Govt.
WHAT COULD HAVE BEEN DONE?
Dropped Inﬂation Targeting sooner (Danielsson) Introduce Prudential regulation sooner Listen to the experts (Buiter & Sibert)
PARALLELS WITH IRELAND Boom fueled
by cheap money, perverse incentives, and light regulation destabilised ﬁnancial system This lead to shocks in the real economy as bank lending dried up. UE increased, GDP collapsed.