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

• Main Author: Ágúst Shi Jin Hallgrímsson 1982-
• Other Authors: Háskóli Íslands
• Format: Master Thesis
• Language: English
• Published: 2009
• Subjects: Hagfræði; Fjármálahagfræði; Verðlag; Hagfræðistefnur; Kína; Iceland
• Online Access: http://hdl.handle.net/1946/2571

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’.