Economics Department

Economic Survey of Iceland 2011

 

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Overview of the Economic Survey of Iceland 2011

Iceland is resolving the economic problems left by the financial crisis. It is well advanced in implementing the comprehensive programme agreed with the IMF to overcome these problems. Iceland is slowly emerging from a deep recession following the collapse of its main banks. The economy stopped contracting by late 2010 and a consumption and business investment-led recovery is projected to gather momentum, lifting economic growth to 3 per cent by 2012. Inflation is projected to remain low and the underlying current account surplus to be sustained.

Much has been done to restore the financial sector to health. The banking system was recapitalised by the end of 2009 and steps have recently been taken to accelerate private-sector debt restructuring. Reforms have been made to regulation and supervision to address shortcomings exposed by the financial crisis. The Central Bank of Iceland (CBI) and the Financial Supervisory Authority (FME) have signed a co operation agreement to strengthen macro-prudential supervision, although policy implementation could be more effective if the FME were merged into the CBI, thereby expanding the CBI’s responsibilities to include prudential regulation and supervision. A strategy to relax capital controls was recently adopted, with a period of liberalization likely to span several years.

The monetary policy framework needs to be strengthened. Monetary policy alone has not been very effective either in countering the credit cycle or in delivering price stability. To improve performance, the CBI should adopt an inflation targeting regime that places greater weight on smoothing fluctuations in the exchange rate and is supported by fiscal policy and macro-prudential regulation. In the event that Iceland joins the EU, it should seek to adopt the euro as quickly as possible.

The government has begun to put the public finances on a sustainable path. The financial crisis wreaked havoc with Iceland’s public finances. The general government budget balance (excluding debt write-offs) plunged from near balance in 2008 to a deficit of 10% of GDP in 2009 and net general government debt increased from approximately nothing in 2007 to 40% of GDP in 2009. Total direct fiscal costs of the recent financial crisis amount to about 20% of GDP, which is higher than in any other country except Ireland (Figure). To restore Iceland’s public finances to a sustainable path, the government is implementing a fiscal consolidation programme agreed with the IMF. The budget deficit is set to fall below 3% of GDP in 2011, and a small surplus is projected by 2013. The fiscal framework has been strengthened but the government should go further by adopting a medium-term budget balance fiscal rule consistent with a debt target.

 

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Steps are being taken to promote the return to work of workers who lost their jobs. The government has substantially boosted expenditure on public employment services to offer appropriate job matching and training services. Additional funds will be made available to give access to the education system to all persons seeking to complete their secondary education. Vocational programmes are to be developed, training classes made more relevant and the highly successful long-term internship programme will be expanded. As unemployment declines, the temporary extension of unemployment benefit duration should be allowed to end, so as not to weaken incentives for the unemployed to move into employment.

Challenges to the fisheries management system need to be addressed in a way that preserves a sustainable and efficient fishery. Iceland has been successful in managing its large fishing industry thanks to its systems of Total Allowable Catches (TACs) based on scientific recommendations and the Individual Quota System (IQS), which gives quota holders a strong incentive to ensure that the resource is managed well. This system could be threatened by potential policy responses to the perceived unfairness of quotas initially having been given away and Iceland’s possible accession to the EU. It should be kept in mind that when the quotas were initially allocated the right to fish was limited, as this was a move from an open access system. However, there is nothing the government can do now to undo the perceived unfairness of the initial allocation as most current quota holders purchased their quotas. Nevertheless, to strengthen political consensus on the quota system, the government should increase the special resource tax on fishing to a level that neither causes financial difficulties in the industry nor destroys the quota system. The government should also progressively reduce TACs from the level compatible with biological sustainability to the level that maximises resource rents where needed and tax away all of this increase in rent. To maintain the value of the fisheries resource within the EU, the Iceland authorities plan to negotiate to maintain the power to set TACs on a scientific basis and to preserve the ITQ system.

How to obtain this publication

 

The complete edition of the Economic Survey of Iceland is available from:

 

Additional information

For further information please contact the Iceland Desk at the OECD Economics Department at eco.survey@oecd.org.

The OECD Secretariat's report was prepared by David Carey, Alan Detmeister, Gunnar Haraldsson and Sebastian Schich under the supervision of Patrick Lenain. Research assistance was provided by Roselyne Jamin.

www.oecd.org/eco/surveys/iceland

 

 

 

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