Inflation can be defined as a sustained rise in prices over a certain period of time. When talking about prices, we are referring to the average price of goods and services on the market, i.e. a kind of consumer basket that Statistics Iceland defines for households, not the price of an individual product or type of service. A sustained rise in prices refers to a series of increases over a fairly long period of time, usually twelve months, and not, for example, an increase in one month. Inflation means that the value of money decreases, i.e. fewer goods and services can be obtained for each króna.
What is the inflation target?
One of the main objectives of the Central Bank of Iceland is price stability, defined as a twelve-month rise of 2½% of the CPI (Consumer Price Index). That is the inflation target.
How is inflation measured?
Inflation in Iceland is measured by the staff of Statistics Iceland who check the prices of certain goods and services on a monthly basis. The selection of products and services for this purpose is based on surveys of household consumption in Iceland. The price of this basket of goods and consumption is set on an index, i.e. the Consumer Price Index, which then changes by the same percentage each month as the price of the basket of goods and consumption. The percentage change in the index over a certain period, usually twelve months, is then used as a measure of inflation.
Can inflation be too low?
Yes. The goal is to keep inflation as close to 2½% as possible. If inflation is lower, e.g. close to zero or even negative (i.e. deflation), it could indicate that there is too much of a slowdown in certain areas of the economy with associated rise in unemployment, and then the solution could be to lower interest rates to, among other things, encourage individuals and businesses to consume and invest, e.g. by borrowing for projects that stimulate the economy.
Why is too high inflation bad?
Too high inflation is bad, among other things, because it reduces the purchasing power of money; i.e. people get less for each króna if prices rise. High and volatile inflation can also make various plans more difficult, such as investment plans, which could lead to less employment later on. In certain cases, inflation can also transfer wealth between generations and groups, as happened in Iceland to a significant extent in the latter half of the last century.