Laureate Phelps Warns Against EU as Iceland Drops Bid

Should more countries follow the example set by Iceland? Is global austerity working?

Via Bloomberg:

Nobel Laureate Edmund Phelps warned against the dangers of European Union membership as Iceland became the latest nation to question the sense of affiliation with a bloc mired in economic crisis.

Iceland’s new government said yesterday it will halt its EU bid and drop the previous coalition’s goal of euro adoption. Prime Minister-elect Sigmundur Gunnlaugsson, whose Progressives won last month’s vote together with the Independence Party, said he doesn’t want to join a bloc in crisis as his own economy recovers. According to Phelps, the decision is likely to spare Iceland many of the risks plaguing the EU.

Sigmundur David Gunnlaugsson, seen here right, who will take over as prime minister this week, has decided that a January decision to freeze EU membership talks will be extended indefinitely, his political adviser Johannes Thor Skulason said. Photographer: Halldor Kolbeins/AFP via Getty Images

Meyer, Posen, Phelps on Fed, Global Economy


April 30 (Bloomberg) — Laurence Meyer, co-founder of Macroeconomic Advisers LLC and a former Federal Reserve governor, Edmund Phelps, a Nobel Prize-winning economist and Columbia University professor, and Adam Posen, president of the Peterson Institute for International Economics, participate in a panel discussion about the outlook for the U.S. and global economies and Fed leadership. Bloomberg’s Daniel Moss moderates the panel at the Bloomberg Link Washington Summit. (Source: Bloomberg)

“We’re still learning about the European experiment and to what extent it’s going to succeed,” Phelps, 79, said in a telephone interview. “The possibility is not foreclosed that the experiment is going to prove unworkable, unsuccessful.”

The appeal the EU once held to nations seeking economic stability and access to free trade is crumbling as the region fails to emerge from its crisis. The U.K. is now openly questioning its allegiance with the EU while other members like Denmark have distanced themselves from the goal of euro adoption to protect their economies. Iceland, which in 2008 became the first nation to succumb to the global financial crisis, now enjoys faster economic growth than the EU average.

“I can’t believe that anybody’s serious about joining the EU right now,” Phelps said. “It’s like saying: ‘it’s a beautiful house — it happens to be on fire at the moment — we should buy it!’”

Nobel Prize

Phelps, who won the Nobel Economics Prize in 2006 for his theories on the interplay between inflation expectations and unemployment, questions the future of the euro — and the larger EU — after three years of debt crisis have left five nations relying on bailouts.

Since emerging from its 2008 banking meltdown, Iceland’s $14 billion economy has outpaced the euro zone’s and the government has tapped international debt markets twice. Unemployment in the Atlantic island is less than half the average in the euro area and credit derivatives show a smaller likelihood of default than in Italy or Spain, according to data compiled by Bloomberg.

‘Nationalistic Extremists’

Iceland froze EU accession talks in January as parliament awaited the outcome of parliamentary elections. Gunnar Bragi Sveinsson, who was named as the island’s foreign minister late yesterday, wrote an opinion piece for the Frettabladid newspaper in February in which he criticized the EU for characterizing as “nationalistic extremists” those who reject its premise.

Though the winners of April 27 elections say Iceland will survive better on its own, the central bank has argued a free floating krona will be difficult to maintain once capital controls are lifted.

One of Iceland’s main economic hurdles now is to exit its currency controls, according to Bjarni Benediktsson, the leader of the Independence Party and the country’s new finance minister. Euro membership would offer no protection from the kind of capital flight currency restrictions are designed to stem, Phelps said.

“It’s clear that there are huge blanks, huge gaps, in what they’ve done so far” in the euro area, Phelps said in the May 16 interview. “We’re seeing now that each country is subject to a flight of capital, currency flight; flight out of the currency, flight out of bank deposits into other countries.”

Cyprus Lessons

Cyprus in March resorted to the first ever capital controls inside the euro area in an effort to stem a run on its banks. In Iceland, similar controls intended to be temporary following a krona sell-off have now been in place for almost five years.

While any steps closer to the EU and the euro would be ill-advised, Iceland would be better off considering exchange rate regimes that link it to other currencies, including the Canadian dollar or the Norwegian krone, Phelps said.

“It’s certainly worth a look,” he said. “Of course, once you ask that question it leads naturally to other possibilities. What about Australia or Switzerland? Or, by the way, what about the U.S. dollar? I’ve seen worse currencies in the world.”

Iceland should ask itself whether linking its krona to Canada’s dollar would be any better than tracking the U.S. dollar, he said. “Has America grown so unpopular that the dollar is dismissed out of hand?”


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