A report, commissioned by Prime Minister Sigmundur Davíð Gunnlaugsson, outlining the need for a fundamental reform of Iceland’s monetary system, was published today by Progressive Party MP and chair of the Alþingi parliament’s Committee for Economic Affairs and Trade Frosti Sigurjónsson.
The report considers the extent to which Iceland’s history of economic instability has been driven by the ability of banks to ‘create money’ in the process of lending.
“I am very pleased to receive this new report on monetary reform. The findings will be an important contribution to the upcoming discussion, here and elsewhere, on money creation and monetary policy,” the PM commented in a press release.
“Iceland, being a sovereign state with an independent currency, is free to abandon the present unstable fractional reserves system and implement a better monetary system,” Frosti maintained, adding, “Such an initiative must however rest on further study of the alternatives and a widespread consensus on the urgency for reform.”
The foreword to the report was written by Lord Adair Turner, former chairman of the UK Financial Services Authority and chair of the policy development committee of the international Financial Stability Board.
Lord Turner stated that the efforts to make the existing financial system more stable had “still failed to address the fundamental issue—the ability of banks to create credit, money and purchasing power, and the instability which inevitably follows. As a result, the reforms agreed to date still leave the world dangerously vulnerable to future financial and economic instability.”
The Icelandic economy has struggled with inflation and unstable exchange rates. Iceland also suffered one of the costliest banking crises in history, the press release stated.
The report describes how commercial banks in Iceland created far more money than was needed for economic growth and how the Central Bank failed to bring the money supply under control using conventional means.
The report considers various reform proposals and concludes that the Sovereign Money proposal could provide a sound basis for effective reform in Iceland.
According to the Sovereign Money proposal, the state-owned Central Bank would become the only creator of money in the economy. Furthermore, the power to allocate money would be separated from the power to create new money.
The Central Bank would handle creation of money while the parliament would vote on how new money is allocated. The proposal aims to reduce the risk and instability of the monetary system, reduce debts substantially and direct the income from creating money to the state instead of commercial banks.
It is pointed out that further study is needed before Iceland can decide whether to take steps to implement reforms based on a ‘sovereign money’ system.
The full report can be read here.