Thorvaldur Gylfason is one of Iceland’s most respected economists. He holds a PhD in economics from Princeton University and is currently Professor of Economics at the University of Iceland. He was an economist with the International Monetary Fund in Washington D.C. from 1976-1981 and is one of the editors of the European Economic Review. Since Iceland’s economic collapse he has been one of the most lucid and outspoken contributors to the debate on how to reconstruct Icelandic society. His is the name most frequently mentioned as the man people would like to see take over as director of the Central Bank of Iceland, or as Minister of Finance.
You have made no secret of your opinion that the current cabinet should resign. What sort of government do you see as an alternative, particularly at this time, and is it wise to hold elections in the midst of the current crisis?
As I see it, there are three main ways forward. One would be for the cabinet to resign and the Prime Minister to call new parliamentary elections in which case the President of Iceland would ask the current cabinet to continue in a care-taker capacity until a new government can be formed after the elections. This has occurred several times in the past. In this case the elections would have to be held as soon as possible, within weeks, almost surely an unattractive prospect at least in the eyes of the Independence Party that leads the present coalition government and that, because it is widely considered to hold prime political responsibility for the crisis, is expected to suffer a massive loss of support at the polls if elections are held any time soon. The Independence Party has been the largest political party in Iceland throughout the history of the republic and now faces the prospect of landing in third place.
Another possibility would be for the cabinet to resign and for the leaders of all five parties represented in Parliament to form a national government. It is unlikely, however, that all parties would agree to this strategy. This has never been done.
A third option is that the cabinet resign and the leaders of the two coalition parties agree not to try to form a new government with majority support in the Parliament but rather advise the President to form an extraparliamentary government comprising individuals who do not sit in Parliament and may or may not be affiliated with any of the political parties. This has been done once before, in 1942-44.
There are three main arguments for the third method in the current situation. First, an extraparliamentary government is more likely to inspire confidence among the public and perhaps also abroad, given the deep distrust that many Icelanders feel for the political class, government and opposition alike, in view of its co-responsibility for the crisis with the banks and with big business. In second place, an extraparliamentary government would not have to call new elections as soon as possible but could, with the consent of Parliament, continue to serve the rest of the term if necessary, that is, until the spring of 2011, an argument that should appeal to those who fear political turmoil, or loss of support, if new elections were called in today’s charged and possibly volatile atmosphere. Third, an extraparliamentary government, if left in peace by the Parliament, could accomplish quite a lot even without new legislation because many of the things that now need to be done can be done without new laws – such as, for example, (a) replacing the leadership of public institutions such as the Central Bank and the Financial Supervisory Authority; (b) making certain that the IMF program in place is properly implemented and supported by growth-friendly reforms and signals, including an application for EU and EMU membership; (c) reorganizing the three banks that failed and putting them on a firm footing; and (d) appointing an international commission of inquiry to investigate the origins and the aftermath of the banking crisis. Iceland has a strong executive branch that would give an extraparliamentary government adequate elbow room for reform unless the Parliament chose to sabotage the reforms.
You are one of the advocates of Iceland joining the European Union. Do you see that as the solution to Iceland’s current predicament?
No, EU accession is no panacea, and never was. Iceland’s entry into the EU and EMU has, however, in my view, become inevitable now in order to restore confidence in the Icelandic economy at home and abroad.
The arguments for joining the EU and the EMU are political as well as economic. The economic rationale has to do with the benefits of increased efficiency for living standards stemming from closer integration with the rest of Europe – through lower food prices, lower interest rates, keener competition, a stable currency, among other things. A weakened economy, even only temporarily, has a greater need than a strong economy for the economic boost to be expected from EU membership.
The political rationale for EU membership is a different matter. One of the main purposes of the EU is to be a forum of shared sovereignty to reduce risks. The sharing of sovereignty is unacceptable to many Icelanders, especially those who have exercised their unfettered sovereignty to drive Iceland’s economy into the ground. Had Iceland become a member of the EU at the same time as Austria, Finland, and Sweden in 1995, as it should have from my point of view, the current crash would have been significantly less likely to occur. By announcing its intention to apply for EU and EMU membership without further delay, the government would signal to the world financial community that it intends to get back on its feet as quickly and effectively as possible and that it wants to reclaim its status as an equal and trusted member of the international community.
What would you say to those who point out that Iceland will lose control over its resources, such as its fishing grounds and fresh water reserves, if it joins the EU?
Icelandic opponents of EU membership have stressed that the EU’s Common Fisheries Policy and the sharing of fish with foreigners that it might entail is unacceptable to Iceland. But there is a simple solution, as I described in print almost twenty years ago: sell the fishing rights on a level playing field. That way, Iceland would gain if foreign fishing firms were willing to pay a higher price than Icelandic firms for Icelandic fishing permits. And that way, foreigners would not have to be granted free access to Icelandic waters which, of course, would be out of the question in any case. Equal access to the Icelandic market for fishing permits would preclude discrimination by nationality, thereby making it unnecessary to contemplate other ways in which foreign vessels might be granted access to Icelandic waters and fish resources.
Icelandic fishing firms oppose this market-friendly solution because thus far they have been granted free access to Icelandic waters, even if they are defined by law as a common property resource. The boat owners do not welcome the prospect of having to pay for the quotas. They will have to lay down their opposition to fishing fees that were actually written into Icelandic law in 2002, but remain quite modest. The fishing industry is smaller than many realize: in 2007, it accounted for 7 percent of Iceland’s GDP.
There was considerable controversy around Iceland taking a loan from the International Monetary Fund. You were in favour of the loan … what would you say to those who claim that countries are often worse off after accepting the terms of the IMF?
They are mistaken. On the whole, as I see it, the IMF has done a lot of good around the world over the past sixty years or so. The Fund has helped member countries not primarily by dispensing short-term loans to stabilize currencies and ease balance-of-payments difficulties, but perhaps even more importantly by giving sound economic advice and thus strengthening the hand of local reformers who often, without expert help from abroad, would be unable to convince the political authorities of what needs to be done.
The IMF employs good and well-educated economists with lots of practical economic policy experience from around the world, and they share the views of local experts on a wide range of policy issues. Economists actually agree among themselves more often and about more issues than they are sometimes given credit for. The Iceland program now in place is a good example. Almost all Icelandic economists who have commented on the program in public debate have declared themselves in agreement with the major ingredients of the program, given that the government was unwilling to announce an immediate application for EU membership. Such an announcement would have made it possible to consider the possibility of fixing the exchange to avert the danger of a further temporary decline of the króna, but this option was not on the table, so the program had to be organized around a flexible exchange rate.
The fiscal policy aspects of the program as well as the acceptance of temporary capital controls demonstrate the Fund’s flexibility and its ability to learn from the criticism that it received in the past. My impression is that the IMF program enjoys wide public support in Iceland, partly because the deeply unpopular government is perceived as dragging its feet. Individual ministers even speculate in public, thoughtlessly, one would hope, about the possibility of introducing policy measures such as multiple currency practices that directly contradict the program. But the so-called IMF program is, in fact, the Icelandic government’s program, duly signed by the Finance Minister and the Governor of the Central Bank on behalf of the government. It is their program, and it is, therefore, their responsibility to ensure that the program is implemented as intended in accordance with the agreement between the government and the IMF.
You have said that both the Central Bank of Iceland and the Financial Supervisory Authority made grave mistakes in the lead-up to the economic collapse. Briefly, what were those mistakes and, in your view, how should those institutions shoulder responsibility?
The Central Bank made a series of blunders, as could be expected from a central bank governed by a self-appointed former Prime Minister without economic expertise (imagine George W. Bush whisking Ben Bernanke aside and appointing himself in his place without any criticism, not even from political opponents).
Among the most serious mistakes were the following:
1. The Central Bank reduced reserve requirements and then stopped using them to accommodate the wishes of the commercial banks when it should instead have increased reserve requirements to restrain the rapid expansion of domestic credit from the banking system.
2. During the long upswing in economic activity the Central Bank neglected to increase its foreign exchange reserves in tandem with the rapid increase of short-term foreign indebtedness of the commercial banks.
3. The Central Bank failed to reach both of its chief objectives stipulated by law: most of the time it failed to keep inflation on, or even close to, the officially announced inflation target of two and a half percent per year, and it likewise failed to ensure stability of the financial system.
4. The Central Bank did little to ease the liquidity crisis until, at a late stage, it negotiated swap agreements with other Nordic central banks.
5. Apparently not realizing the gravity of the situation despite repeated warnings, the Central Bank showed no signs of seeking technical assistance from other Nordic central banks that have built up world-class expertise in handling troubled banks and banking crises.
6. The Central Bank was not given access to a currency swap agreement in mid-2008 among the Federal Reserve Board in Washington, D.C., and the central banks of Denmark, Finland, Norway, and Sweden, apparently – this has not yet been officially acknowledged – because they all advised Iceland to seek assistance from the IMF and Iceland refused.
7. The Central Bank was too hasty, and worse, may have acted out of political spite when it took over Glitnir and set in motion the events that led to the collapse of the other two banks, Landsbanki and Kaupthing, within a week.
8. The Central Bank ought to have impressed on the government in early 2008 the need for assistance from the IMF rather than oppose such a request.
The Central Bank even made a desperate, almost comical attempt to secure emergency assistance from the Russian government apparently in an attempt to avoid having to turn to the IMF; perhaps the Russians also told the Icelandic authorities that they needed help from the Fund. Also, it has been reported in the British press that the UK Prime Minister, Gordon Brown, advised his Icelandic counterpart as early as April 2008 to seek IMF assistance.
In view of these events, it is astonishing that the Icelandic Prime Minister continues to praise the performance of the Central Bank and declare full confidence in the bank. Many wonder why. The governor is increasingly referred to, even in government circles where more and more officials are beginning to “sing,” as Iceland’s J. Edgar Hoover.
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