New Working Paper on small open economies in the vast ocean of global high finance
Working Paper no. 73, “Small open economies in the vast ocean of global high finance” by Bjarni G. Einarsson, Kristófer Gunnlaugsson, Thorvardur Tjörvi Ólafsson, and Thórarinn G. Pétursson has been published. This paper builds on the authors’ earlier work on the long history of financial boom-bust cycles in Iceland, the identification of the Icelandic financial cycle, and the extent to which it is driven by global financial conditions. This paper presents the main findings of the earlier studies in a brief, accessible manner and shows how small open economies like Iceland are subjected to the strong forces of global high finance.
Iceland has a long history of violent cycles of economic exuberance and hardship, of which the recent financial tsunami is only the latest example. We show that this boom-bust pattern is driven largely by low-frequency co-movement of various financial variables; i.e., a common “financial cycle”. This cycle is much longer than the typical business cycle, with significant differences in economic performance over its different phases. Indeed, almost all of the cycle’s peaks coincide with some type of financial crisis. We find that Iceland is no island in the ocean of global high finance, as we uncover strikingly strong spillovers from fluctuations in global financial conditions.