Public sector price hikes pressure Iceland's economy, economists say

Iceland's central bank has raised its key interest rate by 0.25 percentage points to 8%, marking the third consecutive increase. The Monetary Policy Committee announced the decision, signaling ongoing efforts to curb inflation.

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The Monetary Policy Committee announced in the day an increase in the bank's key interest rates by 0.25 percentage points. The bank's key interest rate will therefore be 8%. This is the third consecutive rate hike.

Central Bank Governor Ásgeir Jónsson identified rising taxes and public service costs as the main reasons for increasing inflation, in addition to the geopolitical situation in the Middle East. However, economist Konráð S. Guðjónsson argues that public sector price hikes have been poorly considered and underestimated, particularly a recent increase in vehicle import duties.

Guðjónsson stated that if these public sector price increases had aligned with inflation targets, inflation itself would be measured lower. He pointed to various other public sector cost increases, such as for heating and university registration fees, noting that these accumulate. He asserted that when adjusted for these systemic changes and mileage fees, increases in certain index items have surpassed inflation itself.

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Rising prices for taxes and public services are the main reason for rising inflation, along with the situation in the Middle East.

"It is natural that pressure builds up for all sorts of price increases when the state has been operating in the red for many years," Guðjónsson commented. He added that general inflationary pressure and wage agreement increases also affect the public sector. "So, it is really what we are seeing."

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The increase in vehicle import duties was very poorly considered and underestimated, besides being announced on short notice. It is obvious that the increase did not succeed as intended.

Guðjónsson concluded that if public sector price hikes had been in line with inflation targets, inflation would be lower, and wage agreement conditions might have been met later in the month. However, given the current inflation rate of 5.3% in July and existing forecasts, he considers this outcome impossible.

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It is natural that pressure builds up for all sorts of price increases when the state has been operating in the red for many years.