Iceland’s openness to global capital and goods markets has contributed to fast-rising living standards over the past decades. Nonetheless, its unusual status as a very small open economy with an independent currency has left the country susceptible to macroeconomic instability. The banking sector’s collapse of 2008 and 2009 was the latest example, when financial turbulence from abroad was amplified by serious shortcomings in domestic policy. Countries can promote stability without resorting to capital controls or exchange-rate pegs by implementing well-designed frameworks for monetary policy, fiscal policy and financial regulation. In addition, resilience to destabilising capital flows can be bolstered by maintaining precautionary buffers, notably substantial holdings of foreign exchange reserves, as well as ample bank capital buffers and fiscal space.