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Monetary and exchange rate policy in small open economies: the case of Iceland


  • Joseph Stiglitz


This paper discusses monetary and exchange rate policy and the financial risks that are involved for small open economies in the current environment of less restricted and increased volume of global capital movements. It then goes on to analyze the policy interventions that are available to reduce and manage these risks. The specific case of Iceland is discussed within this framework. While it might be preferable if the problems posed by global financial instability are addressed by reforms in the global financial architecture, significant reforms are not likely to emerge in the near future. In the meanwhile, countries such as Iceland must take responsibility for their own welfare by managing these risks. That entails actions that reduce the likelihood of a crisis occurring and that reduce the costs incurred when the crisis occurs. Tax and regulatory policies (including financial sector regulation and disclosure regulation) can and should be used both to reduce the likelihood of a crisis and to help manage the economy through a crisis. Such regulations can affect short-term capital flows, which have been at the center of recent crises. There are arguments for the use of price-based interventions and controls imposed through prudential banking regulations. But reducing the risks faced by a country requires even more extensive action: it entails focusing on appropriate bankruptcy codes, exchange rate regimes, and designs of financial systems.

Suggested Citation

  • Joseph Stiglitz, 2001. "Monetary and exchange rate policy in small open economies: the case of Iceland," Economics wp15_stiglitz, Department of Economics, Central bank of Iceland.
  • Handle: RePEc:ice:wpaper:wp15_stiglitz

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    References listed on IDEAS

    1. Angeliki Kourelis & Carlo Cottarelli, 1994. "Financial Structure, Bank Lending Rates, and the Transmission Mechanism of Monetary Policy," IMF Working Papers 94/39, International Monetary Fund.
    2. Redward, Peter & Saarenheimo, Tuomas, 1996. "From policy rate to market rates : An empirical analysis of finnish monetary transmission," Research Discussion Papers 22/1996, Bank of Finland.
    3. Fung, Ben Siu-cheong & Kasumovich, Marcel, 1998. "Monetary shocks in the G-6 countries: Is there a puzzle?," Journal of Monetary Economics, Elsevier, vol. 42(3), pages 575-592, October.
    4. Ben S. Bernanke & Mark Gertler, 1995. "Inside the Black Box: The Credit Channel of Monetary Policy Transmission," Journal of Economic Perspectives, American Economic Association, vol. 9(4), pages 27-48, Fall.
    5. Sims, Christopher A, 1980. "Macroeconomics and Reality," Econometrica, Econometric Society, vol. 48(1), pages 1-48, January.
    6. Gordon, David B & Leeper, Eric M, 1994. "The Dynamic Impacts of Monetary Policy: An Exercise in Tentative Identification," Journal of Political Economy, University of Chicago Press, vol. 102(6), pages 1228-1247, December.
    7. Eric M. Leeper & Christopher A. Sims & Tao Zha, 1996. "What Does Monetary Policy Do?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 27(2), pages 1-78.
    8. Carlo Cottarelli & Angeliki Kourelis, 1994. "Financial Structure, Bank Lending Rates, and the Transmission Mechanism of Monetary Policy," IMF Staff Papers, Palgrave Macmillan, vol. 41(4), pages 587-623, December.
    9. Hannan, Timothy H & Berger, Allen N, 1991. "The Rigidity of Prices: Evidence from the Banking Industry," American Economic Review, American Economic Association, vol. 81(4), pages 938-945, September.
    10. Pesaran, H. Hashem & Shin, Yongcheol, 1998. "Generalized impulse response analysis in linear multivariate models," Economics Letters, Elsevier, vol. 58(1), pages 17-29, January.
    11. Strongin, Steven, 1995. "The identification of monetary policy disturbances explaining the liquidity puzzle," Journal of Monetary Economics, Elsevier, vol. 35(3), pages 463-497, June.
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    Cited by:

    1. Nils Bjorksten & Anne-Marie Brook, 2002. "Exchange rate strategies for small open developed economies such as New Zealand," Reserve Bank of New Zealand Bulletin, Reserve Bank of New Zealand, vol. 65, March.
    2. Juthathip Jongwanich, 2006. "Exchange Rate Regimes, Capital Account Opening and Real Exchange Rates: Evidence from Thailand," Departmental Working Papers 2006-01, The Australian National University, Arndt-Corden Department of Economics.

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