The Little Book of Economics: How the Economy Works in the Real World, Revised and Updated

Chapter Eight

The Price of Economic Freedom

Currencies Reflect a Country’s Economic Character, for Better or for Worse

There was a joke making the rounds of trading floors in 2009 that went like this: “What’s the difference between Iceland and Ireland? One letter and six months.” At the time, these two island nations had a lot in common beyond similar names, and it wasn’t flattering. Both experienced spectacular booms in the early 2000s thanks to banks that grew too fast, and lent too much. In both, the banks then collapsed and economic output shrank roughly 10 percent. In November 2008, Iceland succumbed to the humiliation of an international bailout. Though it took more than six more months (two years, actually), Ireland did, too.

Thereafter, the resemblance ended. By 2012 Iceland’s economy was growing briskly and unemployment had eased to 6 percent. Ireland, meanwhile, was barely growing and unemployment was stuck at 14 percent. The most important reason for their divergent paths is that Iceland had its own currency, the krona. During the crisis its value plunged, which eventually boosted exports and tourism. It also led to higher inflation, which reduced the real value of Iceland’s debts, making them easier to repay. Ireland, by contrast, had given its own currency up a decade earlier and along with ten other countries, including Germany, adopted the euro. Without its own currency, Ireland couldn’t use inflation to reduce its debts or devaluation to boost exports.

The differing ...