The analysis in our study suggests that although Iceland’s economy does have some imbalances that will eventually be reversed, financial fragility is currently not a problem, and the likelihood of a financial meltdown is low. However, the possibility that multiple equilibria might occur suggests that policy measures to bolster confidence in the Icelandic economy and financial system would be beneficial. We suggest four such measures: 1) financial supervision might be more effective if it were consolidated inside the Central Bank; 2) Iceland’s commercial banks should be encouraged and should also see that it is in their own interest to disclose more information about their activities; 3) the inflation measure used for the inflation target should minimize the influence of housing price fluctuations, and; 4) the government should implement a formal fiscal rule to dampen the Icelandic
business cycle. These measures are by no means exhaustive but could help improve the future stability of the Icelandic economy.
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