Mishkin report missed Iceland woes

I had pointedto a superb paper by Buiter et al which help understand Iceland’s woes. In this paper, Buiter says that Iceland strategy of having a large international banking system was always going to be a problem and any analysis on Iceland  would have conveyed the same result.

This was clear in July 2008, as it was in April 2008 and in January 2008 when we first considered these issues. We are pretty sure this ought to have been clear in 2006, 2004 or 2000.

On seeing the reference list, I realised Mishkin (and Herbertsson, Univ of Iceland) had presented a report to Iceland Chamber of  Commerce in 2006. The report acknowledged that banking sector is very big compared to Iceland economy but Iceland will sail through as it has strong macroeconomic fundamentals.

 The authors examined “three traditional routes to financial instability”: financial liberalization with weak regulation and supervision, severe fiscal imbalances, and imprudent monetary policy. “None of these routes describe the current situation in Iceland,” they state.

The economists do recommend four policy measures to bolster confidence in the Icelandic economy and financial system, including consolidating financial supervision inside the Central Bank, encouraging more disclosure by Iceland’s commercial banks, minimizing the influence of housing price fluctuations on inflation measures, and a more formal fiscal rule by the government to dampen the Icelandic business cycle.

The report in pdf is available here. A brief of the report is here. A brief of discussion between the authors and Iceland Chamber of Commerce is here. WSJ Blog ( I somehow missed it) on 17 Oct 2008 pointed Mishkin was paid $134,858  for preparing the report. 

One thing is for sure. This crisis will change a lot of things for time to come. I think Prof Mishkin would need to revisit quite a few concepts. He is a leading advocate of inflation targeting which needs to be revisited.  His theory of international lender of last resort also needs to be revisited. He also is an avid supporter financial globalisation and we have seen the recent problems with this ( I don’t mean financial globalisation is bad, my problem is its negatives are mentioned pretty casually which makes the analysis biased).