OECD Economic Outlook, Volume 2018 Issue 2

Iceland

Growth is projected to slow towards more sustainable rates. Consumption growth will ease as employment and wages decelerate. Exports of goods and services, especially tourism, will weaken after a strong 2018, while imports will decline following slowing internal demand. The residential housing boom will ease and the growth of private investment will weaken. The unemployment rate remains low, at around 3%.

Inflation is creeping up, mainly due to a weaker exchange rate and higher import prices. The central bank raised the policy interest rate and is projected to increase it further to anchor rising inflation expectations. Fiscal policy is projected to be broadly neutral. However, a tighter stance via current expenditure containment would be appropriate as price pressures persist and public debt is declining only slightly. The planned tax relief for low-income earners will strengthen work incentives and make the economy even more egalitarian.

Growth is slowing

Despite strong wage growth, private consumption is slowing because of easing employment growth. Exports of marine products were exceptionally high in 2018, but arrivals at Keflavik airport show weakening foreign tourism. Business investment is recovering from the slump earlier in 2018 but remains weaker than expected as demand momentum is declining. Capital flows remain muted despite a narrowing interest rate differential with other countries. Unemployment remains low and under‑employment has edged down further.

Fiscal policy remains accommodative

The projection includes considerable fiscal spending increases, as planned by the government, in particular for infrastructure that boosts potential growth. Relief on income taxes and social contributions for low‑income earners will strengthen work incentives and help reduce income inequality. Although the budget remains in surplus and fosters inclusive growth, fiscal policy should be more contractionary, especially by streamlining public consumption, to build fiscal buffers. On current policies, public debt will decline only gradually.

Iceland

Source: OECD Economic Outlook 104 database.

Statlink

Inflation is below the central bank’s target but edged up in the second half of 2018, mainly because of wage drift, a weakening króna, and rising import prices. In November, the central bank raised its policy interest rate by 0.25%, the first increase since end‑2015. Rates are projected to rise further to reduce inflationary pressures, which will also help stabilise the króna. Capital inflows to Iceland will ease further as relative rates of return are declining.

Iceland. Demand, output and prices

Statlink

Iceland is one of the most egalitarian economies of the OECD thanks to high employment, low pay and employment differences between men and women and a targeted tax and benefit system. Over the past years, income inequality has declined further. The planned tax and social contribution reliefs for low‑income earners will help make Iceland even more egalitarian.

Growth continues to slow

Growth is projected to slow to 2.8% in 2019 and 2.6% in 2020, owing to weaker exports, weaker business investment and slowing household consumption. Public investment for roads, schools and a new hospital will partially offset the decline in business investment and increase longer‑term potential growth. The small size of the economy makes it volatile and vulnerable, and minor changes to the outlook in the main foreign markets can quickly translate into large internal rebalancing. Risks also remain that a major volcanic eruption could destroy infrastructure and disrupt trade and transport far beyond Iceland.