Iceland looks as if it has been able to survive its banking crisis by
- Devaluing the currency
- Letting a proportion of private bank debt fail.
Though this does raise another difference between Iceland and Ireland. Iceland could default on private bank debt without causing a ripple through the European banking system. If Irish banks defaulted on bank debt it would impact on many other European banks.
External vs Internal DevaluationWhilst Iceland benefited from an external devaluation, Ireland - being a member of the Euro - is having to rely on the more painful process of internal devaluation. Internal devaluation relies on cutting wages and spending to try and regain competitiveness. Unfortunately, the experience of Latvia is not promising. In a nutshell, Latvia tried to retain their currency peg against the Euro, and relied on wage cuts and deflationary fiscal policy to try and regain competitiveness. The result is one of the biggest falls in GDP (-25%) on record. Yet, despite all the pain, unemployment and lower GDP, the real exchange rate has only fallen by 8%.