Economic evolution

From liberal trade to a controlled economy and on to European integration

The first three decades of the last century were characterised by rapid growth, interrupted only by World War I. This growth occurred in the context of fairly liberal economic policies. In the wake of the Depression and World War II, however, Iceland, like many other countries, became entangled in a web of trade barriers, capital controls and a complex system of multiple exchange rates, which led to serious distortion of the price mechanism and misalignment of real exchange rates.

A radical departure from these policies occurred in 1960, when barriers to trade were lowered considerably in conjunction with a large devaluation of the króna, leading to more efficient allocation of resources. Trade barriers were lowered further when Iceland became a member of the General Agreement on Tariffs and Trade (GATT) in 1964 and the European Free Trade Association (EFTA) in 1970. They were lowered still further when it became a founding member of the European Economic Area (EEA) in 1994, which integrated Iceland and other EFTA member countries (except Switzerland) into the internal market of the European Union (EU).

Episodes of inflation and disinflation

A distinguishing feature of Iceland’s economic development in the post-World War II era was the high and variable rate of inflation. Inflation surged in the 1970s, reaching a peak in 1983, when the 12-month rate briefly exceeded 100%. The inflationary tendencies were explained by the combination of structural features of the economy, which generally made attaining price stability a difficult task, and excessively accommodative policies. Through a combination of tighter monetary and exchange rate policies, income policies that managed to achieve a wide-ranging consensus on the need to reduce inflation, and broad-based structural reforms, inflation was brought down to the rate prevailing in major trading partner countries in the early 1990s.

Economy of Iceland,Central Bank of Iceland