This collapse was rooted in the vast amount of foreign debt carried by Iceland. Only 10% of the total credit in our system was in our local currency; 90% was in foreign currency or inflation-linked loans. With depreciation of the krona, these loans increased in size.
Iceland has a small, open economy where most goods are imported. Depreciation of the krona does not, therefore, lead to a direct increase in the competitiveness of the country because all imports immediately rise in price and exports are more or less fixed. We have learned, painfully, that you cannot devalue a country to prosperity, and it is virtually impossible when all loans are more or less in foreign currency.
Now, four years after the financial collapse, Iceland remains in a tough spot. People’s income has dropped by about a quarter in real terms since before the collapse, but their debt has almost doubled. So how do we find a way out?
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