Was there an Icelandic miracle?

A somewhat esoteric debate has broken out between the Council on Foreign Relations' Geoeconomics team and Paul Krugman over Iceland's performance since the economic crisis. Krugman says it's done better than the Baltic states of Lithuania, Latvia and Estonia, while the CFR team thinks it's done worse.

On the surface, the dispute sounds extremely dull and technical, but the implications are pretty important. Lithuania, Latvia and Estonia all had pegged their currencies to the euro when the crisis hit and Estonia proceeded to adopt the euro in 2011. If Iceland, which has kept its own currency throughout and allowed it to fall in value to fight the recession, outperformed the Baltic countries, then that's powerful ammunition for people like Krugman who argue that adopting the euro has made it harder for countries to recover by preventing them from charting their own monetary policy course. More generally, it's evidence for the view that the European Central Bank and Federal Reserve should tolerate more inflation for the sake of growth. If the approach worked in Iceland, after all, why can't it work elsewhere?

Not so fast, CFR says. If you look at how the countries have performed since their economies bottomed out, Estonia and Latvia have grown much faster than Iceland. Nonsense, Krugman replies. Iceland fell much less far from its economic peak to its trough than the Baltic states did, because of better policy.

Let's take a look at Krugman's claim. Icelandic GDP peaked in the third quarter of 2007, and the Baltic countries' peaked in the fourth quarter. So how did they (plus Ireland, which I'll include for further comparison) do since then?

From the data, then, it appears that Krugman is right. Iceland had a less severe downturn than any Baltic state, and a much less severe downturn than Estonia or Latvia, so it only makes sense that it would have a slower recovery - there was less to recover from! So in the great Iceland/Baltic skirmish of 2012, it looks like Iceland comes out on top.

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