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英国论文网:British and Dutch GDP:The spread of the cri

The spread of the crisis to the rest of the world

12 November 2008
Iceland’s banking system is ruined. GDP is down 65% in euro terms. Many companiesface bankruptcy; others think of moving abroad. A third of the populationis considering emigration. The British and Dutch governments demand compensation,amounting to over 100% of Icelandic GDP, for their citizens who held
high-interest deposits in local branches of Icelandic banks. Europe’s leadersurgently need to take step to prevent similar things from happening to smallnations with big banking sectors.
Iceland experienced the deepest and most rapid financial crisis recorded in peacetime
英国论文网when its three major banks all collapsed in the same week in October 2008.
It is the first developed country to request assistance from the IMF in 30 years.
Following the use of anti-terror laws by the UK authorities against the Icelandicbank Landsbanki and the Icelandic authorities on 7 October, the Icelandic paymentsystem effectively came to a standstill, with extreme difficulties in transferringmoney between Iceland and abroad. For an economy as dependent on importsand exports as Iceland this has been catastrophic.While it is now possible to transfer money with some difficulty, the Icelandiccurrency market is now operating under capital controls while the governmentseeksfunding to re-float the Icelandic krona under the supervision of theIMF. There are stillmultiple simultaneous exchange rates for the krona.Negotiations with the IMF have finished, but at the time of writing the IMF hasdelayed a formal decision. Icelandic authorities claim this is due to pressurefromthe UK and Netherlands to compensate the citizens who deposited money inBritish and Dutch branches of the Icelandic bank Icesave. The net losses on thoseaccounts may exceed the Icelandic GDP, and the two governments are demandingthat the Icelandic government pay a substantial portion of that. The likely outcomewould be sovereign default.
How did we get here? Inflation targeting gone wrong
The original reasons for Iceland’s failure are series of policy mistakes dating backto the beginning of the decade.
The first casualty of the crisis:
Iceland
Jon Danielsson
London School of Economic
The first main cause of the crisis was the use of inflation targeting. Throughoutthe period of inflation targeting, inflation was generally above its target rate. In
response, the central bank kept rates high, exceeding 15% at times.In a small economy like Iceland, high interest rates encourage domestic firmsand households to borrow in foreign currency; it also attracts carry traders speculatingagainst ‘uncovered interest parity’. The result was a large foreign-currencyinflow. This lead to a sharp exchange rate appreciation that gave Icelanders anillusion of wealth and doubly rewarding the carry traders. The currency inflowsalso encouraged economic growth and inflation; outcomes that induced theCentral Bank to raise interest rates further.The end result was a bubble caused by the interaction of high domestic interestrates, currency appreciation, and capital inflows. While the stylized facts about



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