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.
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