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Titill

Price Level of Non-tradable Goods in Iceland: Explanations by Economic Fundamentals

Leiðbeinandi
Útdráttur

Most non-tradable goods are much more expensive in Iceland than in China.
During the last decade there had been an observable appreciation of non-tradable
goods in Iceland against those in China. Both the magnitude of the price gap and the
length and monotonicity of the gap enlargement are questionable whether
fundamentals can sustain them. In attempt to answer the question the paper will
introduce economic theories that look at the phenomena from the angle of economic
fundamentals and present data to define the situation and examine relevance of the
theories.
It’ll be concluded that productivity difference in tradable sectors was not the
cause for enlarging non-tradable price gap. However economic fundamental such as
factor endowment can explain to some extent higher non-tradable price in Iceland.
Various facts indicate that a boom started around 1997 and 1998 characterized by
financial sector expansion had led to economic overheating which contributed to
pushing up non-tradable price against tradable goods. This, in turn, caused nontradable
goods in Iceland to appreciate against those in countries that were not
experiencing a comparable overheating. This is a classic demonstration of
unsustainable ‘Dutch disease’. Meanwhile increasing trade deficit helped to magnify
the effect of the ‘Dutch disease’.

Birting
11.5.2009


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