That may not be in the cards anytime soon, but at least it has surfaced as a potential option, along with EU membership, to be considered by Icelandic referendum. Matt Yglesias questions whether this might be a mistake.
I see the creation of the euro as a big mistake, and in general I favor flexible exchange rates, but on this question there is a plausible case for Iceland joining up with the euro.
First, Iceland cannot defend itself and does not want to rely only on the United States. European Union membership helps out on that front, and the EU has at least been claiming that new members also will be euro-using members. Fishing rights are a big deal for Iceland, and maybe the country will decide it does better within EU structures.
Second, and more to the macroeconomic point, very small countries do not always do well with floating rates. For instance, no one suggests that every household should have its own currency. Iceland, with a population of about 330,000, may be small enough to make this comparison at least a bit apt. Keep in mind the biggest exports are tourism, fish, and aluminum products, not much else. Using the euro may help tourism a bit, while I suspect the fisheries and aluminum smelters can get by with a mix of a) not employing that much labor anyway, and b) making wages more flexible if need be, rather than needing a floating rate to stay competitive.
Another way to put the point is this: floating rates are most useful as a protection against nominal shocks, not real shocks. But when an economy is sufficiently small, real shocks tend to be the more significant problem because usually there is not so much diversification.
On the macro front, so what if Iceland becomes the north Atlantic version of how Panama, Ecuador, and El Salvador stand pegged with respect to the U.S. dollar? Those economies have various troubles, but fixed exchange rates are fairly low on those lists.
Not long ago, the Icelandic economy was hit by a massive shock from capital flight, which in turn stemmed from a banking and real estate collapse. Capital controls were imposed, in part because the flow of funds whiplash was so large relative to the size of the Icelandic economy. Relying on continental, euro-denominated banking from Dutch, German, and other suppliers may well be a better option. A true EU banking union, if one ever comes, would be better for Iceland yet. In other words, in the eurozone Iceland might be better protected against at least some real shocks.
I don’t have a firm view here, so it is fine to think of my conclusion for Iceland as agnostic. I ‘m just saying you can be a euro skeptic, and favor Icelandic euro membership, without fear of contradiction. The European countries that should not be in the eurozone, such as Italy and Greece, are much bigger than Iceland and are also more economically diversified.