Thus, the impact of the pandemic on domestic demand was less pronounced. Despite relatively successful public health measures, the large share of tourism services in Iceland’s GDP made the economy quite vulnerable to the economic consequences of global restrictions on travel and tourism services. In 2019 tourism and tourism-related services amounted to about 8% of Iceland’s GDP, a proportion second only to that of Portugal and Spain in the OECD. Reflecting the weight of tourism in exports, Iceland’s exports contracted by 31%, more than in any other OECD country, and service exports shrank by 54% in the wake of restrictive measures taken by all major trading partners. Other tourism-dependent countries such as Greece, Spain and Portugal also suffered severe export shocks. The weight of tourism and the effects of COVID on exports  In 2020, economic activity in Iceland contracted by 7.2%, compared to 4.9% on average in main trading partner countries. The difference may appear smaller than expected given the size of the shock to exports. As a small open economy, Iceland imports a large share of consumer durables, investment goods and tourism services. Therefore, a considerably larger share of shocks to aggregate demand tends to be absorbed by the external sector than in larger, more self-contained advanced economies.
The output gap moved to positive territory earlier that in most OECD countries  Wage growth in Iceland averaged above 7% during the pandemic, a somewhat faster pace than over the preceding decade and much faster than in main trading partner countries. Recently, short-term wage settlements have been concluded that imply that the fast pace of wage growth will continue at least for the coming year. Wage and ULC growth in Iceland has been much faster than among peers  This is worrisome for medium-term inflation prospects, since the buffers that existed in the decade prior to the pandemic, and allowed faster wage growth for several years without commensurate inflationary consequences, have been depleted. The depressed level of relative unit labour costs following the GFC, fast expansion of tourism services exports in 2015 - 2017 and a current account surplus had allowed the króna to appreciate, with moderating impact on inflation. As the buffers are depleted, the relationship between wage growth and inflation is likely to be much less benign in the period ahead than during the pre-pandemic period. The fiscal and monetary dimension of the response to pandemic and war Three factors are likely to have determined the fiscal and monetary response of different countries to the pandemic: i) fiscal and monetary space at the outset, ii) the severity of the outbreak and iii) structural factors that affected the economic impact of the outbreak and restrictions imposed to contain it. On the first two accounts, Iceland was in a relatively good position.