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Post-Crisis Iceland: Miracle or Illusion?

July 12, 2010

Paul Krugman recently wrote that Iceland had experienced a “Post-Crisis Miracle,” driven by devaluation and capital controls.  He based his conclusion on the figure below, which compares Iceland’s change in real gross domestic product (GDP) with that of Estonia, Ireland, and Latvia since the 4th quarter of 2007.

But is Iceland’s post-crisis “miracle” real?  No.  It is an illusion created by the starting date Krugman chose for his figure.  If we shift it back just one quarter – the quarter before Latvia and Estonia’s GDP peak – Iceland’s performance no longer stands out, as shown below.

And if we move the starting date back to the beginning of 2000, Krugman’s story collapses entirely.  As shown below, Latvia and Estonia had much larger booms; their busts correspond.  Iceland and Ireland’s build-up was far less dramatic, as has been their fall.

Iceland’s massive devaluation improved the country’s trade competitiveness, while imposing huge losses on its krona-based savers.  Ireland’s inability to devalue protected its citizens’ euro-based savings, but has forced it to improve competitiveness in other ways, such as through wage cuts.  Of the lessons that can reasonably be drawn from Iceland’s experience over the past decade, the benefits to tiny statelets of having a currency to debase is hardly one of them.

Krugman: The Icelandic Post-crisis Miracle
FT Brussels Blog: Ireland vs Iceland
Jackson: Iceland After a Year of Financial Crisis

Post a Comment 18 Comments

  • Posted by Foodor Jobs

    Here goes Krugman again. When will this guy learn his lesson?

  • Posted by mpower

    Perhaps the miracle is that Iceland still exists at all?

    Iceland threw out the international banksters & deleveraged their economy, yet the sun rose in the east, chickens laid eggs, and life went on…

    Compare the Iceland experience (tame, benign) with the “end-of-the-world” scenarios sold to americans by Paulson/Geithner/congress when they extorted trillions in public funds to bail-out Wall St.

    The US can and should do EXACTLY what Iceland did… throw out the banksters and the rigged markets, and start over with a sound money system. The world will not end, the sun will rise… we’ll just have a few less criminals (banksters) among us as a new day dawns.

  • Posted by Osman Aziz

    It is typical for an individual as delusional as Krugman to cut the data in such a manner as to serve his own needs. He is an archetypical Keynesian who is incapable of seeing the world from any other lens.

    This interesting analysis shows how such a policy could undermine the US’s ability to ever truly recover from the ongoing crisis. Devaluation/quantitative easing and policy centric maneuvering will only exacerbate the problem and undermine the savings incentive needed to spur some manner of innovation that can pull the US out of recession.

    Unfortunately, for the likes of Krugman, he suffers from a macro/god delusion-esque complex where he believes that he can (as politicians and many economists do) manipulate micro variables using macro policy. Unfortunately, Krugman isn’t a practitioner of history either, because if he was, he would realize that the two are unrelated.

  • Posted by epok

    great job in representing the facts! thats always the challenge with statistics/charts – you can make it work to support whatever your argument is if you pick the ‘right’ timeframe.

    if only the rest of the public can dig deeper into the studies and facts, before drinking wall st’s koolaid…


  • Posted by Jimbo

    Very interesting, nice work

  • Posted by Rob

    So you should use pre-crisis data to look at post crisis Iceland? Wow this is hacktackular even for CFR.

    If you even had a small sense of economics you would realize that devaluing one’s currency is a wage cut.

  • Posted by Mummi

    mpower does good by pointing out the real-life non-financial side of the story, and how the financial elite that crashed the icelandic economy are being thrown out of power. The main obstacle at the moment seems to be the presence of the IMF which has its fingers in everything and will not allow any kind of “sound” financial reform, however plans are being laid out to throw them out too and replace the old system with something that actually makes sense!
    And yes, other nations might learn a few things by looking at our situation.

    The real miracle here is the fact that the icelandic people have survived for 20 months after losing 90% of our banking system. In fact the payment systems and day-to-day operations have been running smoothly ever since these few days in october 2008. However there has been no new lending or substantial investment in the economy, only debt collection and reposession of debt collateral (i.e. people losing their homes). Despite these troubles there has been no substantial upsurge in homelessness, thanks to strong social cohesion. This has nothing to do with money or statistical charts, and everything to do with human values!

    How this tiny island-nation in the North-Atlantic managed to survive for almost two years (and perhaps even longer) without an effective financial system, is the kind of stuff modern day legends are made of. In the future, books will be written about this period and stories told to grandchildren.

    Greetings from Iceland.

  • Posted by PJenkins

    With apologies for coming late to the discussion, the reference to your second graph states:

    “But is Iceland’s post-crisis “miracle” real? No. It is an illusion created by the starting date Krugman chose for his figure. If we shift it back just one quarter – the quarter before Latvia and Estonia’s GDP peak – Iceland’s performance no longer stands out, as shown below.”

    Iceland’s performance “may no longer stand out” in the sense that its performance is not the best. But as the graph to which you refer clearly shows, its performance has been dramatically better than those of Latvia and Estonia. Iceland’s peak to trough fall in output was half that of Latvia and substantially below Estonia’s. It strikes me as odd that you attempt to derive a conclusion from a chart that it clearly does not support.

  • Posted by Josh

    I think the bubble comparison should be measured in terms of the private debt (particularly banks, perhaps also public included) because Iceland’s debts/balance sheets of the banks grew much faster than GDP. That is why they didn’t have the option to bail them out, the banking sector was many times larger than the nation’s entire economy.

    While I agree Krugman’s analysis is overly simplistic, the analysis here seems flawed as well. I think many would have said the banking system in Iceland was in worse shape than Ireland in the aftermath of the crisis.

  • Posted by Abram Wollert

    While I agree with the basics in Geo-Graphics » Blog Archive » Post-Crisis Iceland: Miracle or Illusion? , I think the positive sentiment around today is a concequence of a false set of circumstances. The demand for consumer loans is still poor and there is no improvement in the housing sector. The developed countries are surviving on their politicians ability to just borrow and spend into their countries which is unsustainable. Regards, Abram Wollert.

  • Posted by Thomas Zaslavsky

    Is it significant that Iceland’s (and Ireland’s) standard of living before the financial boom was far higher than Estonia’s or Latvia’s? Would that have made it easier for the latter to show large percentage improvements pre-crisis, which then partly disappeared post-crisis? In other words, I wonder if percentage comparisons are misleading given that the economies were and are so different. The part of Krugman’s point that Iceland’s default has not harmed them compared to the countries that didn’t default, seems to be supported. If he claimed that Iceland is in great shape — which he does not — that wouldn’t be supported by the data or comments.

  • Posted by Cod

    What relevance is data from many years before devaluation in your attempt to show that devaluation is not a solution? None at all – just a silly attempt to prove a point when you have no facts to support you.

  • Posted by Alex

    There’s a reason economists prefer comparing data regarding countries in relation to their peaks.
    Iceland is just way wealthier than Latvia. The US would be always dead last just because we’re rich. This doesn’t make any sense.

  • Posted by Haris Lykovitis

    I just “fell” in your website today doing a web research on financial crisis.
    Please allow a comment:
    No matter how long you go back in time (years or quarters alike) you cannot alter the data that form the curve.
    How come that your curve for Iceland in fig.1 be different from the curve for the same country in fig.2 ? That is, in fig 1 for X= 2009Q3 we get y = between -5% and -10%. In fig.2 for X= 2009Q3 we get y = between -10% and -15%. Who’s cheating here?

  • Posted by Peter Field

    Haris:,Y is % change, therefore it changes as the start value changes. The absolute value for any point is constant, but if you change the reference value, the % change is different.

  • Posted by MkeC

    This post is a bit of a train wreck.

    First-off, the “The Icelandic Miracle” is phrase that is used to mock people who claim devaluation is not a legitimate stabilization tool after an economic shock. Re-read the post (“Iceland is, of course, one of the great economic disaster stories of all time…”). If you are seriously arguing that there has not been an economic miracle in Iceland since 2007 no one is taking the other side.

    Second your legitimate extension from 2007 Q4 to 2007 Q3 does absolutely nothing to refute the devaluation point. It just shows that Iceland and Ireland are at relative parity. That does not imply devaluation is not an effective stabilization tool. The performance of Iceland relative to Latvia and Estonia remain as evidence (not proof!) that devaluation is a legitimate tool.

    The other extension, to 2000 is a waste of everybody’s time (you might as well go to 1000 BC while your at it). It is so far beyond the shock or the response that it adds absolutely no information at all. Certainly it is not evidence that devaluation is not effective.

  • Posted by TV

    It still looks like to me, even in figure 2, that Iceland was doing much better than Estonia and Latvia — so you appear to agree with Krugman on that? And the Irish data you did not fully plot, but Q1, 2010 was a recession quarter for Ireland, with GDP shrinking by 1% — which begs the question why you chose not to plot it. And, why stop in Q1 2010? You can find GDP data through 2012…

  • Posted by Cyberqat

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