The following is the Executive summary of the OECD assessment and recommendations, taken from the Economic Survey of Iceland 2006 published on 9 August 2006.
Iceland’s economy and per capita income have grown at an impressive pace since the mid-1990s, making the country one of the most prosperous in the OECD. However, growth has been volatile and accompanied by recurrent large external and internal economic imbalances that reflect in part major investments in the energy and aluminium smelting sectors but also buoyant credit-funded household demand. In the recent period, concerns about these developments have led to a decline in investor confidence and sharp exchange rate correction, boosting inflation. While exchange rate depreciation was widely anticipated, the major challenge for macroeconomic policy is to swiftly restore economic balance and to strengthen the policy framework in a way that would avoid the recurrence of recent problems. Another challenge is to ensure that the financial sector continues to contribute to good economic performance both by minimising the risk to stability and by completing reforms. Finally, human capital development is the key to sustaining the rise in prosperity achieved over the last decade.
Promote economic stability by swiftly restoring balance and strengthening the policy framework
The implementation of monetary policy needs to be improved, so as to strengthen the credibility of the inflation target. In the near term, this implies that the monetary stance has to be tightened further until expected inflation is brought into line with the official target. Clearer communication could enhance the effectiveness of policy, likely leading to higher longer-term interest rates. The expansionary effect of tax cuts needs to be offset by additional expenditure restraint until domestic demand pressures abate. Budgetary control and enforcement mechanisms need to be strengthened to meet spending targets more effectively and the fiscal framework should become progressively more outcome-based. New major investment projects should not go ahead before economic imbalances have unwound and a comprehensive assessment has been made of their net benefits to the economy (taking account of resource use and environmental aspects). Greater transparency in the electricity sector would be helpful.
Continue financial sector liberalisation so as to foster growth and stability
Although the financial system is believed to be broadly sound, it is advisable to continue efforts aimed at assessing its robustness and to take supervisory steps, if needed, to address possible shortcomings. The successful liberalisation of the financial sector could be completed in various ways. First, distortions in the housing market need to be removed. One way is to charge the Housing Financing Fund a fee reflecting the cost of the government guarantee and the required return to capital. Home ownership should instead be promoted through a means-tested grant for first home owners, rather than cross-subsidisation of mortgage rates. Second, remaining restrictions on indexation in financial markets should be repealed. Finally, to improve the financing of innovative start-ups, consideration should be given to whether government-sponsored investment funds should be run along private-sector lines.
Adapt the education system to a rapidly changing economic environment
It is important that children from rural areas, who perform poorly in literacy tests, leave school with a set of basic competences. At the compulsory level, the focus should be on teacher quality and not quantity. Moreover, effective teaching time will need to be increased when some of the subject matter currently taught in upper-secondary schools is moved to the compulsory level in the context of a shortening of upper-secondary education. It needs to be ensured that this shortening does not undermine educational outcomes. Increased teaching time and a rapid and coherent adjustment of curricula can deliver this. Potential drop-outs should be encouraged to select vocational programmes. At the tertiary level, new legislation aimed at ensuring educational quality should be expedited, tuition fees should be introduced in public institutions, and instead of trying to offer a full range of programmes, studies abroad should be encouraged.
How to obtain this publication
The Policy Brief (pdf format) can be downloaded. It contains the OECD assesment and recommendations but not all of the charts included on the above pages.
The complete edition of the Economic Survey of Iceland 2006 is available from:
For further information please contact the Iceland Desk at the OECD Economics Department at firstname.lastname@example.org. The OECD Secretariat's report was prepared by Hannes Suppanz and Peter Tulip under the supervision of Patrick Lenain.