Posts
Mr. Davíð Oddsson, former Chairman of the Board of Governors of the Central Bank of Iceland, former Prime Minister of Iceland, for his study of the effects of increasing money supply while keeping interest rates high.
The Central Bank of Iceland, like many central banks in Europe, operates its monetary policy by inflation targeting. The target rate for Icelandic inflation is 2.5%: since Davíð took over the helm of the CBI in October 2005, the target has only been met in 2 months out of 29 (it was met in 37 out of the previous 55 months). As is normal in such circumstances, and according to the Taylor rule, the central bank has steadily increased interest rates in an attempt to control inflation, up to 15.5% in September 2008.
However high interest rates tend to restrain economic activity, and so are unpopular with politicians such as Davíð. In order to support the Icelandic economy, the Central Bank of Iceland decided to increase the number of krónur in circulation. It did this by lending money to Icelandic banks on the basis of “newly-issued uncovered securities”, the financial equivalent of IOU notes. (see para. 19 of Iceland's Letter of Intent to the IMF)
In classical economic theory, the effects of an increasing money supply and of high interest rates should cancel each other out. However Davíð discovered that, if the money supply is increased sufficiently – the Icelandic króna M3 increased by 52.7% in the twelve months to September 2008, compared to a GDP growth of 5.0% – it will outweigh the effects of high interest rates. At such levels, the study shows, one finds the classical economic response to “printing money”: that is, inflation, currency devaluation and, eventually, systemic economic collapse.
The study has now been halted at the request of the International Monetary Fund, as there are already sufficient data to include in the new editions of undergraduate economics textbooks.
(data from Statistics Iceland, Central Bank of Iceland)
(to be continued)
No comments:
Post a Comment