It is likely, though, that the flexibility of the króna has facilitated adjustment to severe downturns under certain circumstances, such as the collapse of the herring stocks in the late 1960s and the steep contraction following the 2008 financial crisis. The possible reasons for this are explored in the above-mentioned chapters. It is too soon to draw any final conclusions, however, and research beyond the scope of this report or conventional economic analysis is needed in order to shed light on why the objectives of low inflation and economic stability seem so elusive in Iceland, and why undisciplined stabilisation policy and an environment of loose financial regulation and supervision was allowed to flourish during the pre-crisis years. However, as is pointed out in the report, the ineffectiveness of independent monetary policy and the possible procyclical influences of floating currencies are not uniquely Icelandic phenomena, nor are they due solely to flawed stabilisation policy. To some extent, they can also be attributed to exchange rate volatility where, as with any other asset price, expectations and speculation play an important role. In addition, there are indications that smaller countries have more difficulty than large ones in pursuing independent monetary policy while they are becoming more integrated globally. In this context, it is worth noting that, prior to the financial crisis, Iceland was by far the smallest country in the world with a floating currency. Further discussion of the possible reasons for small countries’ vulnerability to such problems can be found in Chapters 9 and 13.

This report was originally intended to explain in detail what EU membership and participation in the Economic and Monetary Union (EMU) would entail as regards exchange rate and monetary policy, and to analyse the pros and cons of Iceland’s membership in the EMU. In 1997, the Central Bank of Iceland published a similar report, entitled The Economic and Monetary Union of the European Union – EMU (available in Icelandic). Much has changed since then. During the decade and a half of the EMU’s existence, it experienced success for much of the period, followed by the current severe crisis. Iceland faces a much more decisive assessment of the pros and cons of EMU membership than it did in 1997. As a result, it is timely to issue a new report on this topic. This publication is considerably broader in scope than the earlier one, as it also contains an analysis of the advantages and disadvantages of other options, including an exchange rate peg within a defined fluctuation band, a currency board, or adoption of another currency. Some of these options have been the focus of recent public discussion as alternatives to euro area membership through EU accession or the current flexible exchange rate regime. Consequently, these options should be analysed just as other possible solutions are. The possibility of retaining a flexible exchange rate regime while making relevant changes to the economic policy and financial regulatory framework based on recent experience was discussed in the Central Bank’s 2010 report entitled Monetary policy in Iceland after capital controls.