Negative coverage of the banks and Icelandic economy went hand in hand at this time, both temporarily eroding international investor confidence. The reputation of Iceland’s economy and banks was tarnished. From an Icelandic perspective, the first months of 2006 were therefore characterised by a currency depreciation, falling equity prices and international discussion about the viability of Icelandic banks and macroeconomic imbalances in Iceland. A massive economic downswing was even predicted, possibly comparable to the southeast Asia crisis of the late 1990s. This was a development we had not particularly expected or prepared for. Interestingly, not only did Iceland feel the tangible effects of changes in sentiment in global financial markets – the turbulence in Iceland also reverberated through a number of distant countries with which we have no business contact. This shows that Iceland had become integrated into the global financial market. It was obvious that the Icelandic banks and authorities faced a major challenge that called for a serious response. The banks responded with greatly increased communication about their activities, financial position and other targets of criticism. They made various reforms, answered other points in detail, slowed down their expansion, tapped new credit markets and, last but not least, refuted predictions that the turnaround in external conditions, weaker króna, lower Icelandic equity prices, higher finance costs, etc. would have to dent their profitability severely.
Nor can we forget that the 2009 recession also disclosed a series of weaknesses in the institutional arrangements for the euro. Membership of the Economic and Monetary Union provides for extra stability and resilience. Unsurprisingly, then, at the height of the crisis when the very survival of the monetary union and the euro were in doubt, the wave of mistrust affected us most forcefully. That said, strictly domestic factors played a substantial role in the source and development of the crisis in our economy. This was because unsustainable imbalances built up, even in the absence of an international crisis, and our vulnerability to external shocks thereby increased. BIS central bankers’ speeches  1  I shall now briefly review some of these imbalances. During the prolonged expansionary phase before the crisis broke, heavy losses in competitiveness built up as a result of the growing divergence of our prices and costs relative to those of the euro area countries, with which the exchange rate had been set at the onset of monetary union. This was the outcome of the continuous pressure exerted by domestic spending on plant capacity, driven by very loose financial conditions, whose expansionary effects were not countered by a more restrictive economic policy stance, most specifically in respect of budgetary policy or supply-side policies. The financial counterpart of this excess spending was the accumulation by Spanish households and firms of excessive debt.