From The BBC:
The first real casualty of the credit crunch is Iceland.
Its failure was caused by two distinct factors, the first entirely predictable, and the second less so.
The predictable element in Iceland’s failure is linked to the actions of its central bank.
Over the past years, Iceland has pursued a policy of inflation targeting, similar to the UK.
This means the central bank targets inflation, raises interest rates if inflation is above the target, and lowers them if inflation is below target.
Such a policy has a sound foundation in economic theory and is often appropriate for large countries.
In the case of Iceland it was disastrous.
Wasted opportunities
Throughout the period of inflation targeting, inflation was above its target rate, resulting in interest rates exceeding at times 15%.
In a small economy such as Iceland, high interest rates both encourage domestic firms and households to borrow in foreign currency, and also attract currency speculators.
This led to large infl…
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