What do these complex economic terms mean?
Complex Economic Concepts
Economic concepts can often seem complex and difficult to understand what they really mean. They appear regularly in news and discussions about economic affairs, but many people don't quite know what lies behind them. We want to help you understand common concepts that are good to know, such as inflation, policy interest rates, economic growth, and indexation.
What is inflation?
Money is a unit of measurement that is constantly changing. Inflation is when you cannot buy the same thing for the same money as you could a year ago. It doesn't just mean that one or two entities have raised prices, but that prices in society as a whole have increased and the króna has therefore decreased in value.
Example: Last year a liter of milk cost about 200 krónur, but this year it costs 230 krónur. You therefore get fewer goods for the same money as before. This is called inflation.
How do policy interest rates work?
The Central Bank is a kind of "bank of banks" and it can decide what terms it offers other banks when it provides them with loans. By doing so, it can influence the economy, and this is done through policy interest rates. The Central Bank also has the role of keeping inflation in check and preventing negative economic growth.
If policy rates are raised, loans become more expensive, people and companies spend less, and the economy slows down.
If policy rates are lowered, loans become cheaper, people spend more, and companies invest more. This stimulates the economy, but inflation can also increase and the króna can weaken.
It's as if the Central Bank is trying to maintain a balance on scales, not too fast and not too slow.
What is economic growth?
Economic growth measures the change in gross domestic product, which refers to all goods and services produced for final use by households and businesses. If production increases from the previous year, it's called economic growth. If it decreases, it's called negative growth or contraction.
Example: If Iceland produces goods and services worth 3,000 billion last year and 3,150 billion this year, then economic growth has been 5%. Economic growth therefore tells us whether the economy is expanding or contracting.
How does indexation work?
Indexation works like a specific insurance on either money that already exists or money that was loaned. It ensures that your money maintains its purchasing power despite inflation.
Example: If you have 1,000 krónur in a bank account and inflation is 10%, you would get 1,100 krónur the following year. This way you can buy the same things for your money as before. Similarly, if you lend someone 1,000 krónur, the debt amount also increases in line with inflation, so you get repaid what corresponds to the real value of the money you lent.
Indexation is therefore like a defense system against your money losing value over time.
Share article:
