Since Iceland, comes from a small domestic market, the banks in Iceland have financed their expansion from getting loans on the inter-bank lending market and, more recently, by getting deposits from outside Iceland (which are also a form of external debt). Large amount of debt was also taken by the households, which was equivalent to 213% of the disposable income, causing inflation in the country. Due to the practice of the Central Bank of Iceland issuing loans (liquidity)to the different banks on the basis of uncovered bonds which are newly issued and printing money on demand, this lead to inflation being exacerbated.
Due to the financial crisis, the country of Iceland suffered inflation. On 25th of March 2008, popular website, Bloomberg.com that Iceland had raised its rates to 15% by raising its repo rate by a huge 1.25% in one day. The website also reported that the country was facing an inflation rate of about 7%. However, the Central Bank of Iceland had a goal of maintaining the inflation rate of about 2.5%. Also the Icelandic currency, krona has declined against the euro, from about 100 ISK per euro at the beginning of the year (2008), to its nadir of 125 on March 19 2008. Due to the interest rate hike it had the effect of moving it to about 116 from about 122. In August 2006, the country of Iceland made news when it had increased its interest rate to 13.5%. At that time, the krona was very strong against the euro. Iceland made news previously in August, 2006 when it increased its interest rate to 13.5%. The krona was then trading at a stronger at 90 to one euro.
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Since the financial crisis brought a huge change in the development of the economies in the world, as well as making many banks go bankrupt, the Icelandic debt is now over 320 billion krona, which is roughly about $4 billion US dollars. This figure is huge; as one can say considering that it's about a quarter of their GDP.
Iceland Inflation Rate
The above graph shows Icelandic inflation rate over the past 2 years. In the graph, one can make out how the inflation rate climbed up consistently in the year 2008, whereas in the year 2009, the inflation rates kept on falling except in the month of June where it increased, but since then it had kept on decreasing.
MONETARY POLICY AND FISCAL POLICY
Definition of Monetary Policy:
In response to the rise in prices — 14% in the twelve months to September 2008, compared with a target of 2.5% — the Central Bank of Iceland has held interest rates high (15.5%). Such high interest rates, compared with 5.5% in the United Kingdom or 4% in the eurozone for example, have encouraged overseas investors to hold deposits in Icelandic krónur, leading to monetary inflation: the Icelandic money supply (M3) grew 56.5% in the twelve months to September 2008, compared with 5.0% GDP growth. The situation was effectively an economic bubble, with investors overestimating the true value of the króna.
Definition of Fiscal Policy:
* Structural Unemployment.
* Frictional Unemployment.
* Cyclical Unemployment.
Since the financial crisis, lead to large percentage of unemployment all over the world, Iceland was also one of them which quite high rate of unemployment. Unemployment in Iceland increased tree times more by the end of November 2008. There were more than 7000 registered jobseekers (about 4% of the workforce) in November compared to just 2136 at the end of August 2008. The debt repayment had become more costly as household debt (80%) and 13% denominated in foreign currencies had become indexed. The impact of the crisis was such that since October 2008, 14% of the total workforce had experienced reductions in pay, whereas around 7% of the workforce had their working hours reduced. According to IFL (Icelandic Federation of Labour) president Gylfi Arnbjörnsson, the above figures were lower than expected More than 85% of the workforce who were currently registered as unemployed in the country, stated that they had become unemployed or lost their jobs in October after that, due to the economic collapse.
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In December 2008, the unemployed figures which were registered in Iceland was 4.8 per cent, or around 7,902 people - an increase of some 45 percent in November, according to the figures from the Directorate of Labour. These unemployment figures were the highest, Iceland had recorded since January 1997.
In the same month i.e. December in the year 2007, unemployment rate partly was 0.8 percent, or 1.357 people. The Directorate of Labour had estimated that the figure will rise to 6.4-6.9 percent by the end of January 2009.
Among those unemployed, the unemployment rate among young people had increased the fastest, with the number of registered 16-24 year olds jumping from 1,408 to 2,069 in the month to the end of December 2008. This age group accounts for 23 percent of the entire jobless total.
The Iceland currency which is known as króna had been declined more than 35% against the euro from January to September 2008.Inflation of consumer prices was running at 14% and Iceland's interest rates had been raised to 15.5% to deal with the high inflation.
In the month of October 2008, the effects of financial crisis brought about a collapse in the Icelandic banking sector. The Central Bank of Iceland abandoned its attempt to peg the Icelandic króna at 131 krónur to the euro after it had tried to set this peg in the month. During the month, the Icelandic króna was trading at 340 to the euro when trading in the currency had collapsed because the last major Icelandic bank had been takeover by the FME and thus the loss of all króna trade clearing houses. Then, the central bank introduced restrictions on the purchase of foreign currency within Iceland. From October to November, the European Central Bank quoted a reference rate of 305 krónur to the euro.
The Central Bank of Iceland had then set up a temporary system of daily currency auctions in the month of October to facilitate international trade. The value of the króna was determined by supply and demand which took place in these auctions. The first auction sold €25 million at a rate of 150 krónur to the euro. Commercial króna trading outside Iceland had again been started in the end of October, at an exchange rate of 240 krónur to the euro, after which Icelandic interest rates had been raised to 18%. The foreign exchange reserves of the Central Bank of Iceland had felled by US$289 million during the month of October 2008.
During November 2008, the real exchange rate (discounting inflation) of the Icelandic króna, which was quoted by the Central Bank of Iceland, was approximately one-third lesser than the average rate from the period 1980-2008, and also 20% lower than the historical lows during the same period. The external rate which was quoted by the European Central Bank was still lower. On the last trading day of the month November, the Central Bank of Iceland had quoted 182.5 krónur to the euro, while the European Central Bank had quoted 280 krónur to the euro.