The Central Bank of Iceland has published the working paper "What sets the trend? The evolution and drivers of Icelandic trend inflation" by Bjarni G. Einarsson, economist in the department of Economics and Monetary Policy, and Thórarinn G. Pétursson, deputy governor for monetary policy.
The paper uses Bayesian methods to estimate a model of trend inflation in Iceland, allowing for stochastic volatility in both the trend and cyclical components of inflation and a time-varying persistence of deviation of inflation from its trend. The results show that although trend inflation has fallen and become more stable since the mid-1980s, most of the improvements in overall inflation performance in Iceland reflect a decline in the volatility and persistence of the cyclical component of inflation. At the same time, the results suggest that the share of overall inflation dynamics accounted for by the trend component has significantly risen in recent years. The paper also finds that the trend continues to be more volatile than in other advanced economies, largely reflecting less firmly anchored inflation expectations and, more recently, the interaction of weakly anchored inflation expectations and large global supply shocks.
The working paper can be accessed here: