Iceland’s Post-Crisis Economy: A Myth or a Miracle?

Jon Danielsson, Director of the ESRC funded Systemic Risk Centre, London School of Economics.

When the Global Crisis struck in September 2008, all eyes were on the US (Eichengreen and Baldwin 2008). Iceland, however, was the first country to really suffer. Its three major banks collapsed in the same week in October 2008, and it became the first developed country to request assistance from the IMF in 30 years. GDP fell 65% in euro terms, many companies went bankrupt and others moved abroad. At the time, a third of the population considered emigration as a good option (Danielsson 2008).

Since then, Iceland’s economic recovery has been hailed as a miracle, especially by foreign commentators. It is therefore baffling to many that the Icelanders just voted out the government responsible for the post-Crisis recovery, returning the parties responsible for the pre-Crisis boom and bust to power. What’s going on?

The numbers look good

By first sight, the Icelandic economy looks to be doing surprisingly well. Inflation is 3%, unemployment is 5%, and the government budget is almost balanced. The currency stable and the economy grew 1.6% last year. The government is seen to have dealt firmly with foreign creditors and not bailed out its banks. Domestic creditors and the welfare system have supposedly been protected. Based on this record, the government could be expected to be the most popular in Europe. So why did it get voted out?

The positive economic statistics hide a multitude of sins, relating to government policies in the run-up to elections and bad economic management. OECD (2013) finds that Iceland suffered the worst percentage change in household market income between 2007 and 2010.

The rot underneath

The exchange rate of the Icelandic currency is firmly in the hand of the central bank since the country operates under strict capital controls (see Arnason and Danielsson 2011). Iceland is facing significant balance of payment problems. These will get worse over the coming years because large amounts of money owned by foreign entities are trapped in Iceland by the capital controls. When this money leaves the exchange rate is likely to fall. In spite of this, the exchange rate appreciated sharply in the run-up to the elections, reaching a peak right before the voting date. This temporarily stimulated the economy and held down inflation. Since the election, the currency has been falling.

There are other indications of future inflation, for example public sector wages have been rising in recent months. Based on past history, the most likely response of the Icelandic government will be to inflate away the impact of the salary increases.

Moreover, the national accounts that indicate a nearly balanced budget do not hold up to scrutiny. The recent slowdown in economic activity has reduced government revenue while actual and promised expenditures in the months before the election increased. Meanwhile, official statistics systematically exclude one-off items such as the continuous support for the government housing fund and unfunded pension liabilities. When those are included, the fiscal position of the government is precarious.

The main problem is lack of investment

The main long-run economic problem facing Iceland is its low and falling investment rate. Before the crisis, Iceland invested at the same rate as the rest of Europe, around 21% of GDP. Last year, the Icelandic investment rates fell to 14% of GDP, the fifth lowest in Europe. This is set to worsen. The Central Bank forecasts private-sector investment will fall 23% this year, whilst overall investment may fall by 9%.

Investment has been held back by three main factors:

  • Capital controls.
  • Political views on investment.
  • Tax policy.

Following its crisis in the fall of 2008, the government, the Central Bank and the IMF considered capital controls necessary because of the large amounts of money held by carry traders – this exceeded 40% of GDP. The authorities felt capital controls were necessary to prevent the money from leaving, causing the exchange rate to collapse.

The controls were meant to be temporary – a few weeks at most. Years later, they are still present today, and getting stronger. The controls led to a collapse in investment for the very simple reason that any potential investor is worried about being locked in an unstable currency controlled by a less than competent government. Those with the ability to invest have preferred to keep their options open by keeping their funds liquid.

Investment has also been held back by political interference in economic policy. The outgoing government was composed of two parties: left-of-centre Social Democrats and the left-wing Green Party (the latest incarnation of the Soviet-leaning Communist Party). The government has been overtly hostile to private-sector investment – especially foreign direct investment. They have frequently intervened in individual investment choices. 

Investment is also affected by the tax regime. Tax rates in Iceland, not surprisingly, have increased following the Crisis. Moreover, the tax regime has changed frequently, thus increasing the uncertainty for potential investors. This tax risk significantly contributes to low investment rates.

Welfare system and the protection of the poor

The outgoing government consistently maintained that it ringfenced the welfare system and protected the poorest in society. The Icelanders do not perceive it that way. After all, the OECD (2013) finds that market income inequality rose considerably in Iceland.

The welfare system has borne the brunt of the government’s economic policies. The pension system has been raided, especially affecting those with low pensions. Perhaps 1% of the population is dependent on charities for food. The health system has been scaled back, with co-payments increasing sharply. These policies have hit the poorest especially hard.

Loans available to Icelandic households have traditionally been inflation indexed or linked to foreign currencies. This meant that the post-Crisis debt burden increased sharply for many households. Iceland has seen significant debt relief, primarily because the courts have declared foreign-currency link loans to be illegal. This however has mostly benefitted the wealthiest parts of society.

Friendliness towards foreign creditors

The main reason why the Icelanders voted out their government was its deference towards foreign creditors. Iceland came under significant pressure from the IMF to accommodate foreign creditors, and the government gave in.

The most important dispute with foreign creditors is related to Icesave (see Danielsson 2010). Whilst an overwhelming majority of the population strongly opposed the Icesave settlement which cost Iceland 40% of its GDP, the government pressed ahead.

In addition, when resolving claims by foreign creditors to the remaining assets of the banking system, the government has handed the domestic banks to foreign vulture funds. Meanwhile, it has been accommodating to foreign creditors seeking to repatriate funds locked in Iceland because of the capital controls.

All of these policies were vocally opposed by voters. In the election campaign, foreign creditor friendliness was a major issue, and it is no wonder that the one party that most strongly opposed the Icesave deal – and the one that took the firmest position against foreign creditors – has emerged as the biggest victor in the election.


While it is surprising to many foreign observers that the Icelanders have chosen to return to the status quo ex ante, it is logical given how poorly governed Iceland has been since its crisis.

The voters opted for the same centre-right parties responsible for the pre-crisis boom. They want a government that:

  • Implements sensible pro-growth policies.
  • Firmly opposes EU membership.
  • Takes a firm line against foreign creditors.

All while working to lift capital controls and further integrating Iceland into the world economy. Icelander elected the new government because they have more trust in their ability to deliver on this list than did its left-of-centre predecessor.


Arnason, R and Jon Danielsson (2011) Iceland and the IMF: Why the capital controls are entirely wrong”,, 14 November.

Danielsson, Jon (2008), “The first casualty of the crisis: Iceland”,, 12 November.

Danielsson, Jon (2010), “The saga of Icesave: A new CEPR Policy Insight”,, 26 January.

OECD (2013) “Crisis squeezes income and puts pressure on inequality and poverty“,

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About Lambert Strether

Readers, I have had a correspondent characterize my views as realistic cynical. Let me briefly explain them. I believe in universal programs that provide concrete material benefits, especially to the working class. Medicare for All is the prime example, but tuition-free college and a Post Office Bank also fall under this heading. So do a Jobs Guarantee and a Debt Jubilee. Clearly, neither liberal Democrats nor conservative Republicans can deliver on such programs, because the two are different flavors of neoliberalism (“Because markets”). I don’t much care about the “ism” that delivers the benefits, although whichever one does have to put common humanity first, as opposed to markets. Could be a second FDR saving capitalism, democratic socialism leashing and collaring it, or communism razing it. I don’t much care, as long as the benefits are delivered. To me, the key issue — and this is why Medicare for All is always first with me — is the tens of thousands of excess “deaths from despair,” as described by the Case-Deaton study, and other recent studies. That enormous body count makes Medicare for All, at the very least, a moral and strategic imperative. And that level of suffering and organic damage makes the concerns of identity politics — even the worthy fight to help the refugees Bush, Obama, and Clinton’s wars created — bright shiny objects by comparison. Hence my frustration with the news flow — currently in my view the swirling intersection of two, separate Shock Doctrine campaigns, one by the Administration, and the other by out-of-power liberals and their allies in the State and in the press — a news flow that constantly forces me to focus on matters that I regard as of secondary importance to the excess deaths. What kind of political economy is it that halts or even reverses the increases in life expectancy that civilized societies have achieved? I am also very hopeful that the continuing destruction of both party establishments will open the space for voices supporting programs similar to those I have listed; let’s call such voices “the left.” Volatility creates opportunity, especially if the Democrat establishment, which puts markets first and opposes all such programs, isn’t allowed to get back into the saddle. Eyes on the prize! I love the tactical level, and secretly love even the horse race, since I’ve been blogging about it daily for fourteen years, but everything I write has this perspective at the back of it.


  1. Duncan Hare

    The article misses the point.

    Compare Iceland with the PIIGS, not the state of affairs before the crash.

    1. winstongator

      Exactly. Why haven’t more commenters picked up on this? Why is there no mention of the Icelandic gov’t’s decision not to backstop bank debt – clear difference with Ireland?

    2. winstongator

      The author needs to make policy recommendations. To the degree that those recommendations parallel those attempted in other nations, we should then judge those recommendations’ outcomes in those other nations.

  2. Moneta

    Last week I was stuck in a meeting where quite a few participants were hailing Iceland.

    I believe they are running on borrowed time but kept my mouth shut and made a mental list of the naïve.

    It`s hard to fight these believers. They are part of the top 20% and are convinced that the bankers can just paper the whole thing over.

  3. Michael Hudson

    It’s a good article as far as it goes.
    The BIG problem for Iceland is the fact that the vulture banks (which may or may not be owned by the old crooks) have a HUGE accumulation of domestic debt service that they want to take abroad. This is IMPOSSIBLE given the effect it would have on crashng Iceland’s exchange rate. (There is nothing comparable among the PIIGS) So capital controls MUST continue.
    Debt service is STILL indexed to inflaton, making Icelanders pay the highest rates in the world. Most real estate is still in negative equity. the Social Democrtic government was basically anti-labor and anti-Icelandic in blindly supporting the most rapacious Europeans, headed by Gordon Brown and his demands that Icelandic citizens pay for the losses that his own Light Touch deregulation caused.
    Foreign investment in natural resources is “free” of a natural resource tax. Iceland got little.
    The new government still has not been appointed, but it does not seem about to deal with these serious problems.

    1. sd

      They agreed on ministers tonight. According to Bjarni, Independence Party got Education, Finance, Commerce and Health. No names yet.

  4. The Dork of Cork.

    Ireland has a lower rate of investment.

    Whatever…….Iceland should have given the keys & deeds of houses to people which hold those mortgages and thus try to enter a purer fiat world rather then treat legacy bank credit hyperinflation as somehow real.
    People would thus not be so adversely affected by inflation as debtors are now.
    The most dramatic physical legacy of the credit hyperinflation should also be dealt with.
    As in Ireland the amount of private cars per person is obscene.
    Either a much higher tax on new car purchase or a ban of credit provision for such vehicles should be brought in until the stock of vehicles goes down to a more reasonable level.

    The EU is a monster that should be avoided but if a French corporate can be brought in to help build a tram line in the capital it would be worth it as long as political interference is watched very closely.

    Deglobalization is a fact of life now as energy systems scale down.
    Capital controls within a sov currency of sorts is not so bad and is of course very much different from the capital controls brought into Cyprus (currency union)

  5. Yalt

    An odd article. It lists a number of, from the author’s perspective, failures of the outgoing government: capital controls, high taxes, hostility to foreigh direct investment, “interference in individual investment choices”…a familiar litany of neoliberal demands, plus one outlier, the government’s perceived deference to foreign creditors. Many claims are made that Icelanders agree that these were failures; in all cases but one this is either supposed to be demonstrated by the election results or there’s no evidence given whatsoever in support of the claim. In one case there’s even counterevidence–far from opposing capital controls, the article claims that Icelanders oppose the government’s willingness to cooperate with foreign investors trying to evade them.

    The only exception, the only instance in which any supporting evidence is presented regarding the opinions of Icelanders, is the one outlier.

    Isn’t the simple explanation here, the one actually supported by the facts presented, that there are a great many Icelanders pissed off at their government’s obeisance towards foreign creditors and, given a choice between that obeisance and a return to the status quo ex ante, they chose the latter regardless of what else it might entail?

  6. The Dork of Cork.

    Much like the Irish auto transport experience.

    Iceland private cars 1990 -95 : 119,000~ vehicles

    2008 : 209,740 (peak)

    2010 : 204,736 (trough)

    2011 : 206,112 (recovery ?)

    All of these economies suffer from a epic stock and flow crisis at these high $ oil prices.

    In 1950 there was just 6,038 vehicles on the island.
    I imagine must more cooperative car sharing was the order of the day back then.

    Inhabitants per passenger car
    Y1950 : 23.9
    Y1970 : 5
    Y1995 : 2.2

    Y2005 – 2011 : 1.5 to 1.6

    As in Ireland it needs to get back to 1990 -95 levels at the very least.

  7. The Dork of Cork.

    Icelandic new car reg Jan – April

    Y2006 : 6,609
    Y2007 : 4,210 (banks show weakness)
    Y2008 : 3,944
    Y2009 : 354 (implosion)
    Y2010 : 400
    Y2011 : 828
    Y2012 : 1,802 (recovery)
    Y2013 : 1,912
    Y2014 : ? (implosion ?)

    People will get this simple problem eventually.

    The banks destroy capital through consumer credit provision.

    It is impossible for Iceland to have a independent national economy when so much of internal activity requires gross external inputs.

    Diesel should be be burned in the trawlers and not playing at being happy American families.

    1. Moneta

      Most people are still deluded. Many think that printing will do the legwork when it will just lead us into maintaining our energy thirsty way of life or grow our economies into more energy dependency.

      We need to shrink our enery consumption per capita, yet rare are those who seem to see it.

      Each and every calamity will gradually force us into a more sustainable way of life.

      1. The Dork of Cork.


        It is a liquid fuel problem only in Iceland.
        Energy production need not decline.

        Unlike Ireland which is a classic extreme dash for gas country it does not have a domestic energy problem outside of transport.
        Iceland has a unique energy balance sheet.
        It imports almost no heating oil and no gas for either electricity production, heating or cooking.

        1. Moneta

          Nobody seems to account for the energy it takes to produce stuff and move it around.

          Its imports eat up a lot of resources and energy.

        2. Moneta

          By exporting low added value products only, it would have been difficult for Iceland to import high added value products. So to increase their lifestyles, Iceland threw itself into the high added value world of finance. But it collapsed.

          Right now banking globally is still being propped up and capital controls are backstopping the exit of money in this country but in time, the banking sector will be right-sized and so will Iceland’s consumerism.

          There is always a lag of a few years.

  8. Random Lurker

    There is something that doesn’t work in this article: it seems to me that the writer wants everithing and the opposite of everything.

    – Real wages fell, because the Krona fell. This is Bad
    – The government was forced to put up capital controls to slow the fall of the Krona, but also capital controls are Bad. We want capital controls to go away, because they scare investors.
    – However we don’t want to be soft to foreign creditors (who are the investors), we don’t want to pay back the debt. The government is too soft with them, this also is Bad (one wonders why those foreign investors are so scared).
    – When the courts actually say that we can avoid to pay back debt in foreign currency, this is also Bad because this helps mostly rich people (who are the ones who presumably have higer debts, for example business owners). Darn plutocratic former commies! They help the rich capitalists!
    – But then the plutocratic former commies hinder economic growth by taxing the business owners too much. Darn commies!
    – Those commies are so evil that they first rise wages for public workers, but then finance this by printing money, which causes inflation, which is Bad, because private debt is indexed to inflation, and this is certainly the fault of the government, that should instead spur real growth in wages SOMEHOW.
    – But we elected a new government, that we hope will spur growth by lowering taxes on businesses while not slashing welfare, remove the capital controls while stopping the slide of the Krona, will look reliable to international investors while not being soft on those same international investors by requiring their debtors to actually pay them back, and will spur growth without lowering real wages to increase exports, while increasing our distance from the EU that just looks like our biggest potential export market, because they’re evil and it’s all their fault.

    I understand that the politic and social landscape in Iceland has to be hard, but I just can’t understand what the author of this post wants.

    1. Pat

      The contradictions you have identified are inherent in Icelandic society, not simply reasoning flaws by Jon Danielsson. Icelanders constantly engage in “magical thinking”. They want a welfare society but do not want to pay for it themselves, nor do they want to tax the rich kleptocrats who stole all the money during the big Icelandic bank scam.
      They want currency controls lifted, but they do not want to let foreign creditors cash out, to the amount of 5 billion (about 120% of their annual national budget). They complain about the lack of foreign investment, but conveniently forgot that foreign investors lost enormous amounts (some 100 billion euros) in the bank scam. Foreign investors get cheated whenever they set foot on Iceland, through new taxes and laws. They want debt relief for homeowners and want to get rid of inflation indexing, but do not want the government to run surpluses and print money. They claim they want political and economic change, but they vote back into power the very parties who destroyed the economy in the first place, the two utterly corrupt and incompetent right wing neo-liberal parties.

      In Iceland, everything is always somebody else’s fault. Mostly, they blame foreigners for all their problems. It is not enough that foreigners walk away from the roughly 90 out of 100 billion that they already lost in the crisis. Icelanders want them to walk away from the 5 billion of capital trapped in Iceland, plus the roughly 5-8 billion in equity in the two major banks the foreigners own. (Yes, I understand it was was smart for the country to default on all its bank debt, unlike Ireland. But you can’t have it both ways – default AND investment and a strong currency. Moreover, Icelanders show next to no inclination to recover the roughly 10-20 billion stolen by corrupt Icelandic kleptocrats and hidden in the Caymans and elsewhere, nor do they want to nationalize the fishing quotas that are currently owned by a handful of rich people.)

      Sure, the Icelandic economy has recovered somewhat, but this is not due to enlightened policies. It is because they defaulted on the massive bank debt, and because the export income from aluminum smelting and fishing is sufficient to support the population at about three-quarters of its pre-crash standard of living.
      The whole economy of Iceland is artificial. The government has almost no foreign reserves and cannot borrow any significant amounts through bonds, so the currency is either worth nothing, or has an indeterminate value. The currency currently trades at much lower levels abroad, meaning that whatever assets Icelanders own are actually worth much less than they think they are worth, by at least a half. So much for a recovery.

  9. ScottS

    Haha, took a while to get around to Icesave. Still mad, England? Tough. Iceland’s taxpayers don’t owe you deposit insurance. The deposit insurance should have been required and administered by British government.

  10. sd

    Recent Article and interview with Daniel Svavarsson, Director of Economics Landsbanki. In a nut shell, the party is back on in Iceland and it’s 2007 again.

    (link to google translate of the page)

    Undervalued or high expectations

    Head of Economics Landsbanki is concerned about a sharp rise in the share of newly registered companies, this indicates either that the companies have been valued too low to registration or investors have higher expectations for future profits of the respective companies.

    [..] There are signs that investors are beginning to take a much greater risk and sign up for a much higher amount than they can handle to pay to secure options and examples where banks borrow up to 75 percent in share prices collateral in shares themselves. Financial concerns of the growing demand for leveraged equity and warned recently of the notification.

  11. Jess

    Interesting read — those election results were a real head-scratcher. Thanks for the explainer Jon D!

    1. fajensen

      Not Really: The voters expects some degree of corruption and to be screwed over by the “conservative” political parties, not by the social democrats and socialists, and, yet this is exactly what happened everywhere in Europe. The Socialists ganged up with Kaptalists against the voters!

      If iceland had possesed a nut-job right wing nationalist party, they would have got the votes.

      PS: The real fun starts when the new government does a 180 reversal on the “No to the EU” election spin … of course it does, democracy is just a concept these days.

  12. Nathanael

    Krugman has commented before (rather quietly) that capital controls are the future. Every country is going to install capital controls and they’re going to stick around.

    So…. this entire analysis is off. The capital controls are going to be there forever. They will not be removed.

    1. Keith

      No one should ever be talking about Krugman as if he has any credibility. The name should be synonymous with the village idiot. “Who is that guy in the the town square acting like a dumbass?” “Oh that’s our village krugman”

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