In negotiations with the coalition over the weekend, the Social Democrats had demanded the post of prime minister.
Haarde said: "We couldn't accept the Social Democratic demand that they would
lead the government."
Ingibjorg Gisladottir, Iceland's foreign minister and leader of the Social Democrats, was a potential replacement for Haarde.
Gisladottir said a more powerful leadership was needed.
"The government's actions in the last weeks and months were not swift enough," she said.
The Social Democrats said they are considering a possible coalition with the Left Greens.
On Sunday, Bjorgvin Sigurdsson, Iceland's minister of commerce, resigned over his part in causing the economic crisis.
Sigurdsson, a member of the Social Democratic Alliance, said: "I have decided to do this to take responsibility. I realised last night that for me, at least, there is no