One of the factors leading them to reconsider EU membership is monetary policy. The Icelandic króna is a very small currency that fluctuates considerably. Switching to the euro would protect them from exchange rate risks with their main trading partner.
One solution for Iceland would be to join the eurozone without becoming a member of the EU, as Kosovo and Montenegro have done. However, this would only be desirable if there really is a deadlock over fishing rights.
I would claim (both by living in Germany and the posted diagram) that for each of these values, most share this value, but not everybody. The problem is that for each value, the stakeholders who do/don't share it can be different. So, a lot of agreements are very complicated.
This is also in my opinion a central reason for the rising anti-EU sentiments in many countries: the more is dicated from above in Brussels/Strasbourg, the more often it happens that in some group who has a really strong opinion on this topic strong anti-EU sentiments will become socially very accepted in this group.
The solution that I would thus propose to keep these anti-EU sentiments not to escalate would be to keep the areas where the EU has any influence to those areas
- where there is an insanely strong consensus over what is "right" vs "wrong" over the whole EU, and
- which are politically rather uncontroversial (i.e. the opposite of being a political minefield).
As a side note, you cannot escape values even when you are only considering "free trade". As an example, influential EU law cases include questions of promoting abortion as a freedom of service, ban on Sunday sales, ban on sex dolls ... Then free trade clashes with other fundamental rights, such as a right to strike. Arguably this tension is exactly the spill-over effect that made EU project successful – integration in one area (originally steel and coal for obvious post-WWII reasons) creates pressure in an adjacent area to integrate as well.
If the króna fluctuates so much, wouldn't that also indicate that demand for the króna just fluctuates a lot? Presumably, in absence of major conflicts between Iceland and its trading partners, as a result of economic imbalances. Those won't go away if Iceland were to join the eurozone, either as a EU member or via the Kosovo/Montenegro route. It might deprive the Icelandic central bank of a valuable tool to stabilize their economy, by weakening or strengthening their currency as economic circumstances demand. This was a big problem for the southern EU economies back in credit crisis times.
Now there are of course many other considerations that might offset this downside to joining the eurozone. I would personally welcome our Icelandic friends joining the EU (if they chose to), but it's good for them to have a public debate about both the up- and downsides first.
> If the króna fluctuates so much, wouldn't that also indicate that demand for the króna just fluctuates a lot?
Yes, relative to the size of Iceland's economy. Average daily ISK turnover on the interbank market is only 4 or 5 million EUR [1]. A single commercial transaction, like the purchase of a new trawler from abroad, can easily be worth 2-3x that amount and cause the exchange rate to spike due to the lack of liquidity.
> Presumably, in absence of major conflicts between Iceland and its trading partners, as a result of economic imbalances. Those won't go away if Iceland were to join the eurozone, either as a EU member or via the Kosovo/Montenegro route.
Part of it would. There is a cost to maintaining your own currency that can drag down the economy.
Counterfeiting is an obvious one, getting software and markets to support is another one, but what parent above you is likely arguing against currency speculators/manipulators.
You need to defend it to keep it relatively stable so it stays as a store of value or your companies will just use dollars or euro anyway. If your currency is so small a firm in New York can force your currency to change by 50% in a night, regardless of the fundamentals of the businesses who use the króna, you have a problem. Using the Euro also means businesses do not have to pay conversion costs or deal with additional accounting issues for tracking the fluctuations in the currency.
Iceland had a debt crisis from 2008-2011. Part of the issue is the currency is small relative to global markets, so investments/speculation/shocks from elsewhere have an outsize impact.
They don't need to join the EU to use the euro. There are countries that use the U.S. dollar even though they're not the U.S. Sometimes it's just de facto use the dollar. There is technically a local currency and people use it when forced to but they would prefer the dollar. If you're a small country, something like the dollar or the euro is probably your best bet because of the stability it affords. The advantage to joining the EU is Iceland gets a little bit of input on how the euro was run versus if you use the dollar of the euro when you're not a member of their respective country you are partially tying your financial stability to something that you have no input or control over.
This means giving up all the advantages of central banking and is generally only done informally by countries experiencing hyperinflation without capital controls. It's a marker of a failed state.
I remember in live TV debates for the 2014 Scottish independence referendum, the Yes leader insisted that Scotland could not be prevented from using the Pound sterling. It's technically true, but a very, very bad idea.
> This means giving up all the advantages of central banking and is generally only done informally by countries experiencing hyperinflation without capital controls. It's a marker of a failed state.
The US did not have a central bank until 1914. And there was zero net inflation from 1800-1914. The central bank introduced endemic inflation, which appeared immediately.
By design. Having a slightly positive inflation rate gives you a cushion against deflation, which tends to cause market crashes. A currency I can be confident will lose a couple percent yearly is more useful than one that might be worth wildly different amounts year to year.
If you scroll down a bit on this page, you can see the massive inflation/deflation spikes in ~10yr cycles that existed prior to central banking.
You're completely missing the point. The Fed did a fantastic job, because they could have given a pretty good estimate of that number in 1914. If you had asked someone in 1814 what a dollar would be worth in 1914, hell, 1824, they would have been guessing, and been wildly wrong.
Making sure that the nitwits stuffing their mattresses with dollar bills maintain their net worth is not the goal of our monetary policy, nor is a good goal. The goal is to ensure predictability.
To this end, we can model the price level at some point in time in a way similar to how we model compounding interest: P(t) = P(0) * (1.0 + r)^t. Take P(0) = 1.0, r = 0.032, and t = 2026-1914 = 112. Then, P(112) = 1.0 * (1.032)^112 = 34.05. We've had an average 3.2% rate of inflation in the price level over the past 112 years, give or take.
We can make certain assumptions that the rate of inflation won't be far off from this when we evaluate certain financial risks.
Just as in modeling adjustable interest rates for compounding interest, we can make r depend on t, and at that point, it becomes an ODE problem: dP/dt = r(t) * P(t).
This betrays a lack of understanding of nominal versus real debt dynamics. (And also taxes, but I'll admit that my upbringing has probably given me a unique perspective on Caesar and what it means for us to be able to use his money.)
Of particular note, debt instruments are denominated in nominal dollars, and they're paid back in nominal dollars, but what concerns the creditor is the real value of those nominal payments. Economic growth has this pernicious habit of pushing nominal prices upward, and if the money supply and credit system don't grow commensurate with the resulting increased demand for liquidity, the real burden of existing nominal debts can rise sharply and unpredictably.
This means that borrowers can find themselves underwater on, e.g., mortgages while the nominal obligations remain fixed, and banks will swiftly foreclose on them and tighten credit when considering their balance sheets. Many of the panics of the 1800's included a lot of this very dynamic.
Montenegro unilaterally uses the euro and it doesn't seem to otherwise be a failed state. Besides this being a "marker", what do you think are the actual problems caused? Like why does a small country need its own capital controls when there is a very stable currency available nearby?
The reason for your own currency is you can set your own interest rates to fit your local economy. If you are in a local recession while others are doing well you might want lower interest rates, while others need them higher. Both places are trying to make the same balance of inflation vs stimulating the economy - but they need different answers.
I'm not convinced it is worth it. Generally world economies are tightly tied anyway and so what is right for large currencies is close enough for everybody. The less coupled you are to the world the more important it is that you can be different.
Not significantly. Your point that only failed states decide to use another nation's currency is automatically a failed state is simply untrue. It can be a marker, but it's not an automatic mark. Montenegro is not a failed state.
They don't give up the advantages of central banking at all.
What they give up is political control of their bank. There are advantages to having political control, but often political control is abused - which is why failed states have given up on it as part of their efforts to rebound. The US and EU both have controls in place to limit the power of politicians from making changes for political reasons.
It would, and this has been an issue even with bigger eurozone countries, like Greece.
Basically the same pressure that would have adjusted your exchange rates instead adjusts how much of the fixed-rate currency exists in your country. With fluctuating rates the pain of a financial outflow is more evenly spread than with a government running out of money, unless the government adjusts taxes to compensate.
Joining the Euro is not the panacea that everyone thinks it is.
It comes with some major drawbacks:
- no control of interest rates since these apply to everyone in the Eurozone regardless of the current economic situation of a particular country.
- no more devaluation to get back some competitiveness on international markets
- strict financial guidelines in theory (3% deficit max per year and 60% of GDP/debt ratio)
Finally, the biggest problem as it's been highlighted by many economists is that it spreads the risk to the whole Eurozone which sounds great in theory until you find yourself drowning in debt like Greece was in the 2010s or like France is nowadays.
Because now your government is borrowing in Euros, the markets move very slowly and the full impact of the finances of any Euro government is completely subdued since in the pool of countries that use the Euro there is Germany which is very good and very trustworthy creditor.
Take a look a what happened with Liz Truss in the UK, she made some rather stupid announcements and the markets reacted as they should and that lead to her removal and to a change of plans.
In France by contrast, no such changes have happened despite the fact that the French economy has been going downhill for awhile due to their 5%++ yearly deficits and their 120% debt ratio.
If France still had the Franc, then the markets would have forced the politicians in charge to either course correct and/or eventually to pass on multiple painful but necessary reforms.
Instead what we have is complete political paralysis and many presidential candidates are openly calling for a roll back of more pension reforms, lowering the retirement age to 60, increasing the pay of all the civil servants by 20% and more complete out of control spending.
The supposed EU fiscal rules have never been enforced anyway which means that countries don't really have any incentives to curb their spending since the ECB is always backing them.
Note that a lot of that stuff still exists when you have your own currency, but it gets absorbed into exchange rate movements instead of being an explicit decision. This is both a blessing because it automatically balances, and a curse because you can accidentally shift it in an unwanted way and it may be hard to notice you're doing so.
For instance you can have a different interest rate when you have your own currency, however it will cause your currency value to shift over time in opposition to the interest rate difference. For instance I think New Zealand had 6%ish rates while the mainstream was 3%ish, as a result the NZ dollar devalued by 3%ish per year. If they wanted a stable currency value, they would've had to maintain interest rates comparable to their trading partners. The fact this isn't happening to Japan is a great mystery to economists because it normally does happen.
I agree that interests rates between trading partners have to somewhat match but the issue here within Europe is that Germany is so big that by default what they say goes.
So, if you have Estonia that is in a slump and needs a boost, it can go to the ECB and say, look we need to lower the interest rates but if Germany is happy with the current rates, the likelihood that Estonia gets its way is basically nil.
Right now Germany is feeling the pain and despite the inflation picking up above the 2% target rate again, the ECB has not raised the rates further, why? My hunch is because Germany can't afford it and neither does France.
A monetary union is great on paper, in reality the big fish still eats the small fish. The only difference is that the small fish can try to do something outside whereas in the union it just goes along and hope for the best.
Finally, another big issue with the Euro is that there is no fiscal union between the states. So if a state like France struggles then if a federal Europe was to happen, the states who have money would give it to France in forms of tax transfers but doing so punishes the countries that have made the reforms, that have invested, that have saved money and reduced their deficits and will only incentivized countries which have not done so to continue having deficits in the future.
How would a German politician or Austrian politician explain to his/her constituents that there is no money for new schools or hospitals but there is cash to bail out Italy or France for the nth time because these countries have refused to do what was necessary to reform their country?
In any case, since the exchange rates are no longer providing the feedback that the markets used to give by repricing the currencies that existed before, the markets now use the interest rates of the debt as proxy for their confidence in each European state. Right now, there is a 85bp difference between France and Germany and its widening as time goes on so something will have to give soon.
Either the ECB caves and lower the rates which can increase inflation or France risk triggering a Euro crisis that will be much much worse than the Greek one.
And since a lot more countries are now in the Euro compared to the 2010s, the spread of the crisis will be greater by default.
Why can't Greece just default on its debt? When you can't paper over your insolvency with currency devaluation, you can still be insolvent but you have to deal with it in more overt ways.
They could but then nobody would lend them more euros. If you default in a situation of structural deficit where you can't print more money, then the only alternative is instant spending cuts to balance the budget.
As I understand it, Kosovo and Montenegro adopted the Euro unilaterally, without agreement from the EU. I don't think that'd be (politically) possible for Iceland (?). So the EU would need to agree to this, which also doesn't seem politically possible (?)
There are a whole host of microstates and more or less autonomous overseas territories that use the euro. If Mayotte can use the euro even though the island is on the brink of collapse, I don’t see why that would be a problem for Iceland.
I don’t think this is a problem for the EU – quite the opposite, in fact. It strengthens the euro’s position in international trade, increases the number of users and boosts the volume of trade. More customers for the EU’s financial services sector.
There are a number of countries that unofficially use the US dollar as their currency for major transactions without asking anyone’s permission (Cambodia come to mind).
> If Mayotte can use the euro even though the island is on the brink of collapse
Isn't Mayotte part of France and been for quite some time? I'd guess they switched to the Euro together with France and all the other French territories, but maybe I'm wrong?
Monaco, Vatican and San Marino are however sovereign micro-states that switched to the euros because they already had a monetary agreement with France or Italy.
Not sure how it would affect home mortgages but the majority of icelanders are on mortgage plans that the principal remaining rises with inflation(I forget the name, I left a few years ago) - and will never likely pay them off.
Not sure for a small country like Iceland if it make sense to use Euro over having control over their currency. Things could get super expensive overnight and it would work when things are smooth, but in current political climate you never know when the next financial crisis going to happen and don’t think they want Brussels to dictate their monetary policy
During the 2010 debt crisis there was much talk of profligate Greece being "thrown out" of the euro zone. In this dark scenario Greek civil servants would get their pay rises in worthless drachma, but Greek homeowners would be left with unpayable euro mortgages. But nobody ever talked about the Montenegro option (similar to Ecuador and USD). I never understood this. What was stopping Greece from defaulting and keeping the euro anyway?
The Greek state didnʼt just need to get rid of the huge amount of old debts (what a default would have been good for) and was not interested in the currency in itself (keeping the euro outside the euro zone) but needed a lot of more money: new loans and the further payments for being in the euro zone.
This money was needed for public expenditure and to keep the Greek banking system running.
The biggest creditor banks of the Greek state were, in fact, Greek (ca. 50–60 bn. Euro).
The biggest foreign creditor banks were French (ca. 42 bn. Euro).
Accordingly, France was for more financial support (for Greece) to be payed by all EU member states.
The German banks were only a distant third (ca. 25 bn. Euro). But the German state was the biggest donor among the EU member states.
That is why Germany and some other net contributors e.g. the Netherlands were not too keen on keeping Greece in the EU zone at all costs. For them, the solution you named (“defaulting and keeping the euro”) would have been the rather advantageous, but not for Greek nor for other powerful member states. Nor for the Greek oligarchs – remember, Greek is a country of only about 10 million people who were not that well off – in whose hands may have ended most of the 360 bn Euros of the old debt? They liked the toxic fairy tales Varoufakis was telling (married to a member of the Stratos family).
> profligate Greece being "thrown out" of the euro zone. In this dark scenario Greek civil servants would get their pay rises in worthless drachma, but Greek homeowners would be left with unpayable euro mortgages
That was indeed the "mainstream media" (I so hate that expression but it does apply) opinion. The reality is more prosaic: German (and French, but mostly German) banks would be screwed if those debts were defaulted upon.
Look at the GDP per capita of Greece since 2010. Looks like staying in the Eurozone didn't do them much good either...
> Greek homeowners would be left with unpayable euro mortgages
Just fyi, Hungary had a ton of homeowners with loans in EUR and CHF and when the HUF collapsed the rates became untenable and the government just said "eh, fuck the banks, let's keep the previous exchange rate". The banks survived too.
It's a hard political decision but not an impossible one.
(Disclosure: I deeply disliked that government for other reasons and didn't have a loan, it was just interesting to see populism in action without obvious downsides materializing)
So a Greek default would have created an EU political crisis. Greece would have been in the doghouse. Perhaps the other members would have suspended its structural funds, or even voting rights. Seems impossible it would have been thrown out of the EU, there's not even an obvious way to do that. All very unpleasant, but then there was clearly an upside for Greece. It just seems interesting that the scenario was never really entertained or gamed out in the media.
It was though? I remember a default being a real option in the media.
But in the end, it was clear that unlike in Iceland, bankruptcies were not considerable, and so a bailout was going to happen. The only question was how the bailout would be structured.
Yanis Varoufakis made his name back then by going against the grain and proposing a hairsplit, but instead an approach was chosen where Greece never really defaulted, but its population was harshly punished for it.
The whole point of leaving the Euro would have been so the government could continue to pay its civil servants and other bills by printing the money. It would also have used printed Drachma to buy Euros and use those to repay its debts.
Reintroducing the Drachma was a "solution" to the political problem of cutting spending by creating hyperinflation, not anything else. So it makes no sense to default and keep using the Euro. The reason for defaulting is because you don't have enough euros....
> One solution for Iceland would be to join the eurozone without becoming a member of the EU, as Kosovo and Montenegro have done.
This only makes sense if the primary concern is native (Icelandic) politicians being unable to responsibly manage their currency. Otherwise, there's no advantage over just maintaining a stable exchange rate with the euro.
Well, Kosovo and Montenegro haven't joined the Eurozone. They just use the Euro, but they have no influence in the monetary (?) policy.
Edit: I'm not the first one to point this out, so to add some new information: both of them used Deutsche Mark prior to Euro, Montenegro even under the union with Serbia.
Kosovo and Montenegro adooted the Euro unilaterally, but various micro countries use the Euro through special treaties (Monaco, San Marino, Vatican etc). Iceland is 10x larger but this in principle possible.
One solution for Iceland would be to join the eurozone without becoming a member of the EU, as Kosovo and Montenegro have done. However, this would only be desirable if there really is a deadlock over fishing rights.