Iceland The Worlds Smallest Currency Area and Its Implications in the Current Financial Crisis
Iceland today is suffering from a prolonged financial crisis due to the collapse of Icelandic currency and banking system, as an after shock of the global recession that began in 2008. Iceland financial problems have far ranging repercussions no only to it fragile economy but also to those developed countries, like the U.S. and UK that invested heavily in the country, . Its three internationally beleaguered Icelandic banks , Glitnir, Landsbanki and Kaupthing , have been on rcceivesrhip and their financial assets have been frozen. According to Asgeir Jonnson, Head of Research and chief economist at Kaupthing Bank , Iceland, last September 20, 2009, the biggest private bank of Iceland collapsed because of financial bubble burst.
What has led to the collapse of the economy of Iceland Iceland as a country has today the smallest currency rate when pegged against the U.S. dollar. The value of one krona (Iceland currency) to US dollar as of January 27, 2010, is 0.00824 USD. This means that for every 100 krona, Iceland only gets 0.82 USD, a fact that is lamentable. Obviously this is very alarming and has serious repercussions to the Icelandic economy, and to the world. If this continues, Iceland might suffer a massive national bankruptcy. Indeed, because of the smallest currency rate of Iceland, this has greatly affected international trade and those countries that have investments in Iceland. The fact that Iceland is the worlds smallest currency area had affected the country prior to and during the current financial crisis. Going into an in-depth study of the factors that led to the downfall of the Icelandic economy is worthy of scholarly research since it can provide concrete and doable actions for Icelandic policy makers and the courses of action to alleviate the impact of this financial debacle.
According to Rao (2006), more recent studies, based on large cross section, that include many small and developing countries, have found strong evidence of an effect of exchange rate variability on trade. It is therefore apparent that in order to find solutions to the financial problems buffeting Icelands economy, a flexible an efficient coordination of monetary and fiscal policy should be put in place and if possible, to seek more foreign funding, like from the IMF and it Nordic neighbor countries. It is also recommended that Iceland should adopt the Euro Area. By seeking entry to Euro area, it will be able to gain full access to the reliable discount window of ECB, eliminate the exchange rate risk and open access to the large euro capital market. As early as July, 2009, it was already apparent that joining a full membership with the European Union, w ill provide a global foreign currency because the Euro Area becomes the foreign currency lender of last resort. Iceland has to decide now to save its economy.
Hence, a research on how these potential solutions can be effectively implemented is urgently called for in order to save the Icelandic economy from further financial collapse.