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Most of Iceland’s inflation has come via the exchange rate, which has been protected by capital controls since plunging 80% offshore against the euro at the end of 2008. Gunnlaugsson says any efforts to scale back existing currency restrictions will only take place at a pace that safeguards krona stability.

“It is a problem that can be solved, and can be solved quite fast,” Gunnlaugsson said.

The krona has appreciated around 10% against the euro over the past 12 months. Still, today’s rate of about 157 per euro compares with an average of 88 in 2007, a year before the island’s financial collapse. It slid 0.04% to 157.02 as of 12:50 p.m. in Reykjavik.

To support households, Gunnlaugsson in November unveiled a plan to provide as much as 7% of gross domestic product in mortgage debt relief. The government intends to finance the plan, which the OECD has criticized as being too blunt, partly by raising taxes on banks.

Increased political stability will mean more investment, more jobs, more creation of wealth

Iceland’s hard-line against banks and their creditors has prompted warnings that the nation may struggle to find an investor base once capital controls are lifted. That hasn’t stopped the government issuing two dollar bonds since 2008.

Gunnlaugsson’s welfare pledge comes as other Nordic governments reassess their commitment to state-funded programs. Denmark has scaled back its universal welfare program as more citizens are means tested. In Sweden, a government that has delivered multiple rounds of income tax cuts looks set to lose elections this year as voters pine for a return to more state spending. Krugman this month cautioned Scandinavian governments against pushing through further cuts. According to Gunnlaugsson, government support and economic growth go hand in hand.

“First and foremost we of course want to see stability,” Gunnlaugsson said. “Increased political stability will mean more investment, more jobs, more creation of wealth, so that we can continue to maintain the Icelandic welfare state.”

Bloomberg.com