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Separating the Wheat from the Chaff: Icelandic and Irish Policy Responses to the Banking Crisis

Authors

  • David Howden

    Assistant Professor of Economics
    1. St Louis University – Madrid Campus
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    • This paper builds on and extends arguments made in Howden (2012). Research funding was generously provided by the Mercatus Center. The author would like to thank Devin Bowen for excellent research assistance, and two anonymous referees for helpful comments.

Abstract

When the stories of the Icelandic and Irish crises are told, they are framed as if one country did everything right to exit recession and the other country everything wrong. This article assesses their recovery policies and finds that the truth lies somewhere in between. By allowing its banking system to suffer substantial losses, Iceland shielded its citizens from the costly debt overhang apparent in Ireland. Ireland's commitment to open capital markets and price deflation has allowed trade flows to remain robust, and relative prices to realign to signal sustainable production plans to entrepreneurs. These responses provide a roadmap for other small open economies with large financial sectors entering similar crises in the future.

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