Icelandic Rate Hike Mandated By IMF
October 28, 2008
What a difference thirteen days make! Back on October 15th, the Central Bank slashed its benchmark rate to 12% from 15.5%, citing difficult market conditions and heavy job losses and predicting a very sharp economic contraction. In the meantime as three Icelandic banks failed and foreign exchange trading ground to a halt, the government negotiated a $2 bn loan from the IMF. A key stipulation of that accord was a rate hike of 600 basis points to 18% today. The IMF remedy for economies that run out of money is well traveled, rotate activity away from domestic demand and toward exports, impose a draconian monetary policy to reduce inflation, and eventually relax that monetary vice as restored confidence in the currency and subsiding inflation allow. Sometimes the strategy works. Sometimes it doesn’t. And sometimes even when the plan is effective, one is left to wonder if a less painless approach might have been just as effective. For now, Iceland will be in the minority of economies where macroeconomic policy is still subordinating economic growth to the fight against inflation.
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