The Rise and Fall of the Icelandic Economy

Iceland became the first developed country in 30 years to request help from the IMF in 2009. While the depths of its recent recession are well studied, the causes of its origin are still misunderstood. This paper looks at two factors: (1) the blanket guarantees provided to the Icelandic banking system by various public agencies, and which fostered an environment of excessive risk taking; (2) a faulty inflation-targeting framework by the Central Bank of Iceland, which resulted in a credit binge engulfing the small island. While the first factor explains why Iceland´s banking sector grew as large as it did, the second accounts for the magnitude of the imbalances in both the real and financial sectors