Jónsson: Social covenant crucial for Iceland's price stability
Ásgeir Jónsson, Governor of the Central Bank of Iceland, reflected on 25 years of inflation targeting at the 65th Annual Meeting. He highlighted the persistent challenge of establishing a social covenant for price stability.
The elusive social covenant
Governor Ásgeir Jónsson began by recounting his experience as a young economist at the 1995 wage negotiations, colloquially known as the 'Grouse House' talks.
He observed that all 70,000 workers received the same pay rise, a practice at odds with economic theory.
This historical context set the stage for a discussion on Iceland's persistent inflation challenges.
Jónsson referenced Bjarni Bragi Jónsson's 1982 theory, which attributed inflation to the absence of a social covenant guiding interest group interactions.
Instead, Iceland relied heavily on indexation, leading to a 'rock face equilibrium' where wages, loans, and fees were automatically adjusted for inflation.
This system, while ensuring impartiality, also perpetuated inflation spirals, with the króna undergoing frequent devaluations.
The 1990 national reconciliation agreement attempted to establish a new social covenant, underpinned by a fixed exchange rate and interest rates as a policy instrument, initially reducing inflation from 20% to 1.5% by 1992.
From fixed peg to inflation target
The failure of the 1995 wage agreements led to renewed instability, culminating in Iceland's pivotal shift in 2001.
The nation abandoned its fixed exchange rate peg, adopting a floating exchange rate and an inflation target, and legally enshrined Central Bank independence.
This year marks 25 years since that regime change.
Governor Jónsson highlighted that despite adopting standard monetary policy practices, Iceland's performance is hindered by the persistent absence of a social covenant for price stability, unlike its Nordic neighbors.
He contrasted the post-COVID inflation surge: while European real wages contracted, Iceland's fractured labor unions secured short-term agreements, resulting in an 8.8% pay hike.
This fueled inflation above 10% in early 2023, compelling the Central Bank to raise its key interest rate to 9.25%.
A unique path, persistent challenges
Iceland's economic history reveals a persistent struggle for price stability, largely due to the elusive social covenant.
Ingrained indexation and fragmented wage negotiations continue to fuel inflation, despite modern monetary policy frameworks.
This highlights the profound difficulty in altering deeply embedded societal behaviors, even with clear economic lessons from the past.