The True Cost of Adopting the Euro for Iceland’s Economy

The government commissioned four international economists — Hilde Bjørnland, Stijn Claessens, Steinar Holden, and Catherine Mann — to prepare a report on Iceland’s currency options ahead of the 29 August referendum. It runs to 219 pages. I have read all of it. It is a serious, balanced, and honest piece of work, and I want to do something the campaign on both sides has mostly avoided: take it at its word — including where it corrects me.

Let me begin with the corrections, because there are real ones, and a person who only quotes the parts that suit him should not be trusted on the parts that do.

Where the report challenges what I have argued

I have written that the króna is a shock absorber. The report’s finding is more precise, and I should adopt its precision. During routine times — the ordinary volatility of a normal year — the report finds that the króna is the most volatile currency in the Nordic region by a clear margin, and that this volatility “may exceed its absorbing effects.” In episodes of global financial stress, the floating króna “appears to amplify” the shock rather than dampen it, adding an inflationary depreciation on top of a contraction. So the honest statement is not “the króna protects us.” It is narrower: the króna absorbs the rare, large, catastrophic shock, and adds noise the rest of the time. I’ll come back to why that narrower claim is still decisive. But it is narrower, and I was too loose before.

The second challenge is one my series had not addressed at all, and it is the most important finding in the report. Iceland has a competitiveness problem, and it is being driven by wages. Over 2016–2025, Icelandic unit labour costs grew 5.6% a year — roughly double Norway and Sweden, more than three times Denmark and Finland. Compensation per hour in Iceland is now about 70% above the euro-area level. Real wages here have grown 2.4% a year while our Nordic neighbours managed 0.6 to 0.8%. The report calls this, plainly, “a consistent loss of international competitiveness.” I have to accept that, and it changes something I’ve argued — so let me deal with it directly, because it turns out to sharpen my case rather than break it.

The competitiveness finding makes the argument I was already making

I have argued in this series that inflation does not vanish — that in an economy which indexes away every shock absorber, the hidden cost of inflation eventually lands on the competitiveness of Icelandic exporters, the one price no one thought to protect. The report has now found exactly that loss of competitiveness in the data. It attributes it to wages growing faster than productivity rather than to indexation directly — but these are the same machine viewed from two ends. Wages chase prices; prices are propelled by the indexation flywheel; the flywheel is fed by an inflation we have chosen not to defeat; and the bill lands, as I argued, on the cost base of the firms that have to sell into a world that did not inflate alongside us. The report measures the wage side. My series described the price side. They are the same loss.

And here is the part that matters for 29 August: the report is emphatic that this competitiveness problem must be fixed regardless of the currency. Its words, not mine: “Regardless of the monetary regime, reforms or changes that ensure wage growth remains broadly aligned with productivity growth… appear crucial.” It goes further and names wage-setting reform as a precondition for adopting the euro — because a country that enters a currency union with wages running this far ahead of productivity, and then loses the ability to devalue, is left with only one adjustment path: internal devaluation, the Greek and Irish road, where you cannot cut the currency so you cut employment instead. The report says this in as many words, warning that euro adoption “might also make Iceland more vulnerable to boom-bust cycles, as seen in the real estate markets of Spain and Ireland.”

Read that carefully, because it is the whole argument in one move. The Ministry’s own experts are saying: the domestic reforms have to happen either way, and if you adopt the euro without doing them first, you inherit the euro’s worst failure mode. That is my thesis, corroborated by the Yes side’s own report. The euro is not an alternative to fixing what is ours to fix. It is a bet that raises the stakes on whether we fix it.

What the report confirms

Once the concessions are made honestly, the rest of the report reads, again and again, as support for the structural case this series has been making.

On 2008, it settles the argument I was too loose about — in my favour, on the point that counts. The króna fell about 50%, and Iceland’s current account swung from a deficit of a quarter of GDP to balance within two years — “a faster adjustment,” the report states, “than in euro area periphery countries that relied on internal devaluation.” One of its authors’ cited work puts it memorably: the depreciation let Iceland’s real wages adjust through inflation “without a bloodshed,” where Greece and Ireland took the adjustment in unemployment and emigration. So the tail-risk argument stands on the report’s own evidence: when the rare catastrophe comes, a currency that can move is the difference between a hard two years and a lost decade. That is not a claim that the króna is pleasant to live with. It is a claim that it is the cheapest available insurance against the worst thing that can happen — which is exactly what an option is.

On indexation, the report confirms the mechanism this series has spent weeks describing: indexation “embeds” inflationary episodes and blunts monetary policy, so that when the Central Bank raised rates through 2021–24 it landed hard on non-indexed borrowers and had “a much smaller effect on variable indexed rates.” The flywheel is real and the report names it.

On the promise of lower interest rates — the centrepiece of the Yes economic case — the report is far more sober than the campaign. It finds that euro adopters saw their cost of capital fall by 25 to 100 basis points, with an Iceland-specific estimate around half a percentage point. That is real, and I concede it: joining would modestly lower the risk premium. But it is a fraction of what “interest rates will come down to European levels” implies to a family with a mortgage, and the report pairs it immediately with the redenomination risk that took Greek yields past 40% in 2012 and blew out Italian and Spanish spreads. A modest, one-time convergence, bought at the price of a tail risk you can no longer devalue your way out of. That is not a lower cost of capital. It is a repricing of the same risk from the exchange rate onto the sovereign.

And one finding almost no one has quoted, which deserves to be central: the report finds that the króna’s volatility is “largely self-contained” — that its own movements “explain very little of the variation in output, inflation, or the policy rate.” Sit with what that means. The instability Icelanders feel does not come from the currency itself. It comes from external shocks and from our own domestic structure — the wages, the indexation, the procyclical fiscal policy the report also documents. Abolishing the króna would remove some noise. It would not touch the actual sources of our volatility, because the currency was never the main source. You do not fix a house with a cracked foundation by changing the thermostat.

The one honest way to summarise 219 pages

The report’s real conclusion is not “adopt the euro” and it is not “keep the króna.” It is that this is a genuine trade-off — the currency is costly in calm years and valuable in crises — and that the decisive problems are domestic and must be solved either way. Wage-setting, indexation, fiscal discipline: the report says, repeatedly, that these determine Iceland’s fate under any currency. That is the same thing I have been saying, and it is the same thing the referendum obscures. We are being asked to debate the currency when the government’s own experts have told us the currency is secondary to reforms we can make ourselves, tomorrow, without anyone’s permission.

And a word about fear

There is one more argument I want to address, because it has become the emotional centre of the Yes case and it deserves a direct answer. A former Deputy Governor of the Central Bank has argued, thoughtfully, that the world has changed — that with an unreliable America, a resurgent Russia, and the Arctic newly contested, Iceland must anchor itself in Europe, and that this security logic should carry the day.

I want to be careful here, because the facts he cites are true. The strategic environment has changed. I will not pretend it hasn’t, and anyone voting No who waves that away is not being serious.

But notice what the security argument does to a debate. It raises the stakes to survival, and once a question is framed as survival, disagreement starts to feel reckless. Fear, doubt, and uncertainty are powerful precisely because they foreclose argument rather than open it — and a population made anxious about its safety will tend to concede whatever it is told safety requires. A decision this permanent — the surrender of the currency, the central bank, and ultimately a measure of self-government — should not be settled by the feeling that we dare not say no. It should be settled on its merits. So let me answer it on the merits.

Every specific thing the security argument asks for is already available without political or monetary union. Cybersecurity, sanctions coordination, Arctic policy, intelligence sharing, defence cooperation, critical-infrastructure resilience — Iceland can deepen all of it, and largely already has, through NATO, the EEA, Nordic defence cooperation, and its bilateral ties. None of it requires the euro. None of it requires surrendering the fishery. And the proof is standing right next to us: Norway. Norway sits inside the entire Western security architecture — a founding NATO member, deeply integrated with the EU through the EEA, woven into Nordic and European defence — without being an EU member and without the euro. Its security is not visibly worse for the choice. If the changed world truly demanded accession, it would demand it of Norway first, and Norway has looked at the same map we are looking at and declined, twice, while thriving.

Iceland is a European democracy. It shares Europe’s values, trades with Europe’s markets, and stands with Europe’s democracies against exactly the threats the Deputy Governor names. None of that is in question, and none of it is what the referendum is about. You do not have to join a monetary and political union to be a committed European any more than Norway does. The security case is a real case for cooperation. It has been dressed up as a case for accession. They are not the same thing, and we should not let the seriousness of the first smuggle in the second.

Where this leaves me

I have conceded what the report made me concede: the króna is noisy in normal times, and Iceland has a real, wage-driven competitiveness problem I had not given its due. I am more persuaded than before that this problem is urgent.

But the report has also told me, in the government’s own commissioned words, that the cure for it is domestic and required under any currency; that the 2008 depreciation genuinely spared us the fate of the euro periphery; that the interest-rate gain from the euro is modest and comes bundled with a tail risk we could not escape; and that our volatility does not come from the currency in the first place. On the security question, Norway has already shown that a proud, safe, European democracy can have every alliance that matters without surrendering its currency or its waters.

So I read the report and came away more confident, not less. The work that Iceland needs is the work only Iceland can do. On 29 August, that is what I am voting to get on with.