Been reading up on Keynes's Liquidity Preference Theory (LPT) and plotted the graph below using data from the Central Bank of Iceland.
Notes and coins in circulation in Iceland has more than doubled as a % of GDP since September 2008. Last data point is January 2012.
The LPT rests on the fact that despite "no one outside of a lunacy asylum" would keep his wealth in money according to the classical theory of interest and money, we nonetheless do. The distrust that people have on their own expectations on the future push people to keep part of their wealth in highly liquid assets in order to "lull our sense of disquietude" of the future. And if the level of uncertainty was high or, somewhat similarly, our level of confidence in our own expectations of future course of events was low, the public and investors would be compelled to keep a high proportion of their wealth in interest-free money, due to their explicit level of liquidity.
Well, ain't that the case in Iceland! Uncertainty of the future is high; unemployment is at historical highs and investment in capital-assets is likewise at is lowest point ever. People urge for liquid assets even though the rate of inflation is currently at 6.3% and the demolition of the purchasing power of notes and coins equivalent, or thereabouts, to that.
Wonder if the proponents of unilateral foreign currency adoption in Iceland consider this? What happens if we don't have the ability to print the cash that the public's liquidity-preference demands?
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