Published March 18, 2011

It appears that the Central Bank of Iceland needs to be deprived of its financial independence. The bank’s enthusiasm to continue its campaign of high rates, speculative carry trades, and swift removal of capital controls is based on faulty reasoning and poor planning; plans that are being reformed without further information.
It is apparent, given the current economic conditions in Iceland, that if capital controls were to be lifted in one step, a significant amount of Icelandic krónur (ISK) would instantly flee to become foreign currency. In a closed meeting that took place on October 7 (entitled ‘The way out of capital controls’), Central Bank Deputy Governor Arnór Sighvatsson demonstrated that they are indeed aware of this:
“The group of so-called impatient investors is not a fixed size but extremely variable by expectations of economic developments in Iceland on one hand and the situation on global markets on the other,” Arnór remarked at the meeting.
One should bear in mind that “impatient investors” are both foreign and domestic. As Arnór points out, expectations about economic developments in Iceland will affect the size of capital leaving the ISK. Most Icelanders have noticed that economic developments in Iceland are extremely poor, leaving one to assume that the Icelandic government has increased the size and numbers of “impatient investors” with their lacklustre performance. Furthermore, the Central Bank has expanded this capital by feeding it ridiculously high interest rates at the expense of Icelandic homeowners and taxpayers. 
To make matters worse, even more capital joins this pool over time when so few investment choices are available in ISK. It is natural for capital to seek favourable havens, and unfortunately, the government is not supporting local capital investment as the current coalition and has been unable to support any industrial construction or investment possibilities in Iceland.
BLACKOUT
The reason the Central Bank cited for temporarily halting the outflow of ISK was to prevent “even greater depreciation of the ISK.” Capital controls were then incorporated in the current form on November 28th, 2008. The Central Bank’s report on “Removal of Capital Controls” states:
“The main assumption to be able to execute a plan for removal of capital controls is that investors assess the risks of investments in Icelandic assets less than they have done so far.”
This “main assumption” seems to be forgotten, as little has been done to decrease possible risk of investing in Iceland. The Central Bank argues that this should be done by compensating risk with high interest rates. In what other way could this have been done? One example is by invigorating the Icelandic economy and offering attractive local investment opportunities. Unfortunately, the government and the Central Bank seem to have ignored the wonderful opportunity that capital controls offer, i.e. to cut interest rates to negative real rates, despite its obvious benefits. This would offer Icelandic companies and families ISK financing on favourable terms, easing the path not only for increased construction and economic development throughout Iceland, but a lighter public debt burden via refinancing of current loans. To not utilise the benefits of capital controls while paying for its cost shows just how ill planned our monetary policy has been.
It is odd to blame capital controls for dwindling foreign capital, when, at the same time, the government has repeatedly rejected all kinds of investments such as data centres, plants and private hospitals.
OOPS! … I DID IT AGAIN…
Political debate must take place in the Parliament about the future monetary structure of Iceland. These matters must be discussed before the Central Bank officials begin removing capital controls. It is obvious that the free-floating króna experiment—that began in March of 2001, when the ISK was floated with inflation targets and lasted until November 2008, when capital controls were re-incorporated—has failed spectacularly. As economic Nobel laureate Rubert Mundell pointed out in a recent interview, there are several wealthy individuals who could easily derail the ISK if they so fancied, via capital flight. The conclusion is that the tiny ISK has no grounds to be free-floating. According to Mundell, it doesn’t really matter to what currency we link ourselves, as long as we link.”