18. Iceland Should Replace Its Central Bank with a Currency Board

Fredrik Andersson and Lars Jonung describe Iceland’s economy and list the possible currency regimes. They ask which is the best monetary policy regime for Iceland and conclude that a flexible exchange rate with an inflation target can be ruled out because such a system has served as a shock amplifier. They find that Iceland can only maintain a domestic inflation target over the long run through capital controls. But the authors consider such controls to be very costly and likely to increase corruption. Instead of a floating regime, they find that a fixed exchange rate regime is the preferred choice. But as a microstate, Iceland is not able to create sufficient credibility for such a regime, which leaves a monetary union as a solution. But since full euroization is not an option for Iceland because it is not a full member of the European Union, nor will be a member in the foreseeable future, the preferred monetary union alternative is, in their view, a currency board, accompanied by a wide-ranging reform package to foster fiscal stability, wage and price flexibility, and financial stability.