A Lesson From Iceland: It Pays to Have Your Own Currency

One of the major lessons of the euro crisis was this: When big adjustments in a country’s wages and prices relative to those of trading partners are necessary, it’s far easier to achieve those adjustments via currency depreciation than via relative deflation – which is one main reason that there have been such huge costs for the euro.

But many economists remain deeply unwilling to accept this point. And so in Thorvaldur Gylfason’s otherwise useful survey of Iceland since the financial crisis, we get this: “In Ireland, the 2007 level of the purchasing power of per capita [gross national income] was restored a year later than in Iceland, in 2014,” Mr. Gylfason wrote recently at VoxEU.org.

It is, therefore, not true that having its own currency (which lost a third of its value in real terms during the crash) saved Iceland from the sorry fate that Ireland would have to suffer because Ireland is anchored to the euro. Ireland adjusted by other means. Iceland, had it used the euro, could have done the same. The Icelandic króna has lost 99.95 percent of its value vis-à-vis the Danish krone since 1939 when the two currencies were equivalent, convincing many local observers that Iceland is ripe for the adoption of the euro.

First off, that comment about depreciation since 1939 – 1939! – is a cheap shot. But what about the comparison with Ireland? It’s true that gross domestic product per capita in Ireland (in this case, using gross national income doesn’t make much difference) recovered to its pre-crisis level only a bit later than Iceland’s did. But G.D.P. isn’t the only indicator, and it’s one that is arguably distorted by the nature of the Irish export sector, which held up fairly well and is highly capital-intensive (think pharmaceuticals) – that is, it contributes a lot to G.D.P. but employs very few people.

If you look instead at employment (see the chart), Iceland did far better than Ireland. Unemployment data in Iceland also shows a much more favorable picture. Less formally, everyone I know who tracked both countries has the sense that the human toll in Iceland was much less severe than it was in Ireland.

And if you remember, everyone expected the Icelandic crisis to be a lot worse, given the incredible scale of the banking overreach – early on, comparisons between the two countries in Ireland were regarded as black humor, not something expected to be taken seriously.

I understand the urge to make excuses for the single currency. But the evidence really does suggest that there are important advantages to keeping your own currency.