Disgruntled Icelanders recently forced their prime minister to quit, and are threatening to hand power to self-styled pirates at an early election.
But whereas other European voters are culling traditional parties out of weakness, Reykjavik’s are rebelling out of strength.
In contrast to eurozone countries (core as well as periphery) that remain deeply constrained by excessive external debt, Iceland has just paid down its foreign obligations by a cool US$61 billion, returning them to the safe 2006 level.
The country that suffered proportionally the world’s biggest financial collapse in 2008 is now set to boom again as it diversifies from fish, tourism and aluminium into renewable energy and information technology.
Its GDP, already among the highest in the world per capita, is back above the pre-crisis level and set to rise (on central bank forecasts) by 4% in 2016 and 2017 – twice the eurozone and UK rates.
Although its overgrown banks were one of the causes of the global financial crisis, Iceland responded to their meltdown in the opposite way from the rest of Europe – and against the received wisdom of most economists.
It allowed its currency to fall in value – an option unavailable to eurozone members, which had to ratchet down wages and prices through “internal devaluation”. It nationalised the big banks that had run up unsustainable debt, rescuing only the fraction that served the domestic economy.
It imposed capital controls so that the banks’ creditors and other foreign investors couldn’t withdraw their money. Locals, including pension funds, couldn’t invest abroad.
Let’s get fiscal
The central bank also tightened monetary policy. Its policy rate peaked at 18% in 2009, and was still at 5.75% this month. In the UK, eurozone and the US, central banks pushed their rates to near-zero and applied quantitative easing. Defying the austerity that prevailed across Europe, Iceland then allowed fiscal policy to take the economic and social strain. In particular, public money was used to relieve households of the debt that would otherwise stop any spending recovery.
Economist Paul Krugman, perhaps shielded from the orthodoxy by a Nobel prize, has repeatedly drawn attention to the way these policies allowed rule-breaking Iceland to recover far earlier than less afflicted eurozone peers – even Ireland, the poster child for conventional “adjustment policies”.
Until now, critics had one powerful riposte to this improbable ray of Nordic sunshine. They said it was a false dawn. They argued that the whole recovery was only achieved on the back of draconian capital controls, in place since November 2008. Removing them would be painful, but failing to lift them promptly would have equally dire consequences.
Foreign investors would despair of getting their trapped cash back – making it impossible for Icelanders to borrow again even for worthwhile investment far away from banking. The critics said that domestic investors’ savings would, with nowhere else to go, turn the already strong tourism and stock market investment booms into overheated bubbles whose bursting unleashes more trouble.