Don't Blame the Krona by Krugman

One thing that was clear during yesterday’s Iceland conference was that many people here (I’m still in Reykjavik) believe that the floating krona was responsible for the huge capital inflows that set the stage of the crisis. The story they tell is that expectations of a rising krona, combined with relatively high interest rates, drew hot money in via the carry trade. And this story is used to argue that things would have been much better if Iceland had adopted the euro.

I was kind of surprised by this, well, insularity (which I guess is more excusable if you are in fact on an island in the middle of the North Atlantic). For Iceland was by no means unique in its inflow of funds. Here’s the average current account deficit (which is equal to capital inflows) as a percentage of GDP for a bunch of European countries, over the boom years from 2000-2007:

The fact is that there was a tsunami of money flowing from the European core to peripheral economies; Iceland was just part of a broader class that included countries on fixed rates against the euro and some countries already on the euro.

There are valid arguments for euro entry (and arguments against, which I think win on balance). But this isn’t one of them.

Wikipedia - Current Account:

In economics, the current account is one of the two primary components of the balance of payments, the other being the capital account. The current account is the sum of the balance of trade (exports minus imports of goods and services), net factor income (such as interest and dividends) and net transfer payments (such as foreign aid). You may refer to the list of countries by current account balance.

The current account balance is one of two major measures of the nature of a country's foreign trade (the other being the net capital outflow). A current account surplus increases a country's net foreign assets by the corresponding amount, and a current account deficit does the reverse. Both government and private payments are included in the calculation. It is called the current account because goods and services are generally consumed in the current period.^[1]

The balance of trade is the difference between a nation's exports of goods and services and its imports of goods and services, if all financial transfers, investments and other components are ignored. A Nation is said to have a trade deficit if it is importing more than it exports.

Positive net sales abroad generally contributes to a current account surplus; negative net sales abroad generally contributes to a current account deficit. Because exports generate positive net sales, and because the trade balance is typically the largest component of the current account, a current account surplus is usually associated with positive net exports. This however is not always the case with secluded economies such as that of Australia featuring an income deficit larger than its trade deficit.^[2]