Central Banks Defend Krona

In the early months of 2008, the Icelandic Krona continued its downward slide, ultimately losing 26% of its value. Inflation is nearing 12%, the economy is in tatters, and there is a crisis of confidence affecting the banking sector. Having already raised interest rates to 15.5%, the Bank of Iceland was out of options. Perhaps out of concern that the turmoil in Iceland would spread to continental Europe, the Central Banks of Norway, Sweden, and Denmark were impelled to act. Their assistance took the form of a swap agreement, which provides Iceland with access to €1.5 Billion in emergency funding.As soon as the news broke, the Krona appreciated nearly 5%, as some semblance of confidence in the country's still-fragile banking sector was restored. Despite the emergeny funding, Iceland is far from being in the clear. The country's national debt remains problematic, as evidenced by a recent downgrading of its credit score. If Iceland were ever to make use of the funds covered under the swap agreement, investors would probably rush for the exits and send its currency on another downward spiral. The New York Times reports:Iceland, a country accustomed to booms and busts, probably cannot escape an especially painful adjustment this time, as it digests years of heavy borrowing from abroad. Public and private economists differ mainly on the length and depth of the contraction.