Iceland’s economy melted in the autumn of 2008. The world saw the demise of an entire national financial system. An overinflated banking sector collapsed in a week; the exchange rate of the krona plunged 40 per cent against the euro, inflation and interest rates jumped to 18 per cent, the standard of living fell sharply and the unemployment rate went from near zero to nearly 10 per cent. Debt piled up, revenues shrank and expenditure soared.

In late 2008 and early 2009, the outlook was dark. The question seemed not to be whether Iceland would default on its obligations, but when. But from mid-2009 onwards, measures were taken to reduce the fiscal deficit by slashing expenditure and increasing revenues. Iceland’s budgets in 2010, 2011 and 2012 were never likely to meet popular acclaim but their measures were unavoidable. And as a result, the fiscal deficit has fallen to an estimated 1-2 per cent of gross domestic product from 14 per cent in 2008. Since the crisis, Iceland has now twice successfully issued bonds in the international market.

Many lessons have been learnt, several of which are relevant to other European countries. The Icelandic government has pursued the politics of social and economic inclusion. Those on higher incomes have contributed more in absolute terms through the adoption of a progressive system of taxation, while those on lower incomes have been sheltered. Welfare services were cut less than other areas of public spending. The outcome has been as intended: a more equitable net income distribution. Purchasing power among lower-income groups has been better maintained than among those with higher incomes, enabling them to continue as active participants in the economy.