OECD ECONOMIC SURVEYS: ICELAND - OECD Economic Surveys Iceland 2009. ORGANISATION FOR ECONOMIC CO-OPERATION

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  • OECD Economic Surveys

    Iceland

    2009

  • ORGANISATION FOR ECONOMIC CO-OPERATION AND DEVELOPMENT

    The OECD is a unique forum where the governments of 30 democracies work together to

    address the economic, social and environmental challenges of globalisation. The OECD is also at

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    domestic and international policies.

    The OECD member countries are: Australia, Austria, Belgium, Canada, the Czech Republic,

    Denmark, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Italy, Japan, Korea,

    Luxembourg, Mexico, the Netherlands, New Zealand, Norway, Poland, Portugal, the Slovak Republic,

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  • TABLE OF CONTENTS

    Table of ContentsTable of contents

    Executive summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

    Assessment and recommendations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

    Chapter 1. The financial and economic crisis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

    Iceland’s three main banks became vulnerable to a deterioration

    in global financial markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19

    Private sector balance sheets became vulnerable after rapid expansion . . . . . . . . . 25

    An unsustainable, domestic-demand led economic boom developed . . . . . . . . . . . 33

    The banks were unable to resist the deterioration in global financial markets. . . . 44

    Aftermath of the collapse of Iceland’s main banks . . . . . . . . . . . . . . . . . . . . . . . . . . . 47

    Prudential supervision and regulation need to be strengthened . . . . . . . . . . . . . . . . 52

    Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57

    Bibliography . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58

    Annex 1.A1. Progress in structural reform . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59

    Chapter 2. Challenging times for monetary and fiscal policies . . . . . . . . . . . . . . . . . . . . . 61

    The limits of monetary policy in a very small open economy . . . . . . . . . . . . . . . . . . 62

    The future of monetary policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68

    Substantial fiscal consolidation measures are urgently needed . . . . . . . . . . . . . . . . 83

    Measures to increase public revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 86

    Measures to contain public spending . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90

    Concluding remarks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101

    Bibliography . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 102

    Boxes

    1.1. Liberalisation of financial markets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19

    1.2. Macro- and micro-prudential supervision . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53

    1.3. Major recommendations of the Jännäri Report on prudential regulation

    and supervision . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54

    1.4. Recommendations to improve the financial system . . . . . . . . . . . . . . . . . . . . . . . 56

    2.1. The new Central Bank Act . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71

    2.2. How synchronised is Iceland with the euro area? . . . . . . . . . . . . . . . . . . . . . . . . . 75

    2.3. How loose is Employment Protection Legislation (EPL) in Iceland?. . . . . . . . . . . 78

    2.4. Measuring the efficiency of social spending . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94

    2.5. Policy recommendations for monetary and fiscal policies . . . . . . . . . . . . . . . . . . 101

    OECD ECONOMIC SURVEYS: ICELAND – ISBN 978-92-64-05451-6 – © OECD 2009 3

  • TABLE OF CONTENTS

    OECD ECONOMIC SURVEYS: ICELAND – ISBN 978-92-64-05451-6 – © OECD 20094

    Tables

    1.1. External equity assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22

    1.2. International investment positions in OECD countries, 2007. . . . . . . . . . . . . . . . 23

    1.3. Domestic Money Banks’ loan-to-deposit ratios . . . . . . . . . . . . . . . . . . . . . . . . . . . 23

    1.4. Domestic credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25

    1.5. Estimated debt and external assets of non-financial firms . . . . . . . . . . . . . . . . . 30

    1.6. Household net wealth composition and dynamics . . . . . . . . . . . . . . . . . . . . . . . . 31

    1.7. Decomposition of general government revenue and expenditure . . . . . . . . . . . 41

    1.8. Short-term economic developments and prospects . . . . . . . . . . . . . . . . . . . . . . . 51

    2.1. Correlation coefficients with euro area real GDP growth

    and inflation, 1997-2007 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75

    2.2. Correlation coefficients of underlying shocks between Iceland

    and selected countries, 1997-2007 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77

    2.3. General government finances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84

    2.4. Local government finances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99

    2.5. Agriculture: Producer support estimate. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100

    2.6. Estimated savings for selected fiscal consolidation measures. . . . . . . . . . . . . . . 101

    Figures

    1.1. Ratio of bank assets to GDP . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

    1.2. International investment position . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21

    1.3. Lending and deposits by customer residence. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24

    1.4. Stock-market developments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26

    1.5. Stock-market capitalisation relative to GDP . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27

    1.6. Cumulative growth in real house prices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28

    1.7. Cumulative growth in the ratio of house prices to disposable income. . . . . . . . 29

    1.8. Ratio of house prices to actual and imputed rentals . . . . . . . . . . . . . . . . . . . . . . . 29

    1.9. Household debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31

    1.10. Financial leverage of the household sector. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32

    1.11. Composition of household debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33

    1.12. Real GDP growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34

    1.13. Share of the construction and financial intermediation sectors