After reading Gareth’s blog post on Central Banks: First Order Thinkers?, I wondered whether any central banks are practicing second order thinking. So I combed the globe to find a central bank that looks deflation in the eye and raises interest rates, rather than lowering them. And I didn’t have to venture far from Gareth’s Scandinavian examples.
Located on the western side of the Norwegian Sea, we find the Nordic island nation of Iceland. Its central bank has maintained relatively high interest rates over the past five years.
And the results speak for themselves. Iceland has a relatively healthy GDP growth rate.
And Iceland’s unemployment rate has fallen rapidly over the last five years.
Perhaps Iceland’s recent prosperity isn’t simply a linear function of high interest rates. The country is tiny, with a population not much bigger than Wollongong. It had an impressive financial implosion less than a decade ago. Perhaps the high interest rates are needed merely to access foreign capital.
And the country has benefited from a booming tourism industry, coupled with buoyant fixed investment. Maybe I’ve missed something. And who knows what will happen should the poll-leading, anti-establishment Pirate Party win this week’s election.
But its monetary policy at least hints at the view that second order thinking might have the desired impact in a low growth world.
6 thoughts on “Found: A Central Bank that is a Second Order Thinker”
40% devaluation since ten years ago.
Putting up interest rates won’t result in a falling currency, quite the opposite. I know something that probably will (or at the very least reflate the currency): helicopter money.
Professor David Stuckler’s work which contrasts Greece and Iceland, suggests that iceland’s spending on areas with a high fiscal multiplier (e.g. Health, education) has contributed to the prosperity. Greece, which was forced to adopt severe austerity measures in the same areas , continues to be in dire straits with an increase in all the wrong statistics (suicide, HIV infection) and a pessimistic population.
Could you post a reference for that one?
The mere presence of high interest rates does not in and of itself indicate second level thinking. I’d argue that it is more likely to be a first order consequence of what Seth Klarman calls the “depression mindset” (i.e., fiscal and monetary prudence), which is the positive side effect of economic depressions.
I think the previous governor of India’s central bank may have also fallen into this category.
It seems like this article confuses cause and effect. Is the economy of Iceland really a result of monetary policy or is monetary policy set by the results of the economy? Interest rates in Iceland are kept high because the economy has good GDP growth and falling unemployment. If setting monetary policy resulted in GDP growth and falling unemployment, then governments would only have to turn the economy over to central bankers and not worry about fiscal policy, taxation, factor mobility or any of the other stimulus measures that they are constantly implementing.