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
going back."