Nominal interest rate system might suffer while indexed loans gain ground

Ásgeir Jónsson governor of the Central Bank says that a nominal interest rate system based on non-indexed loans with variable interest rates will not work if the instability of the Icelandic economy continues.

But he is not ready to give up on the system, saying that indexed loans are in danger of gaining more ground in the current environment. The central bank has raised interest rates eleven times since last summer, and the interest rate is now 6.5 percent.

Inflation won't disappear by itself

He admits there are pressures on the nominal interest rate system.

“I had imagined a nominal interest rate system that could work and that it could be a basis for an active monetary policy and that we would be able to stabilize. But such a system will not work if inflation does not go down. If such inflationary conditions continue, the consequences will be that we will again see largely indexed loans. I believe it would be very unfortunate, but at the same time we are looking at inflation of 9.9 percent and it won’t go down itself,” Jónsson tells “

A payment cap could be a way

He mentions that the only way to maintain a nominal growth system is to stabilise public finances and to introduce sensible wage increases in a labour market based on purchasing power.

“I can point out that there are some designs of the nominal interest rate system. For example, you pay interest up to a certain level, but the excess goes to the principal. That would include a certain amount of a credit limit. That could strengthen this system,” Jónsson says.

He says it is understandable that people find it difficult to watch payments rise so quickly, although principal will fall in the future.

Would you say, then, that the current nominal interest rate system is not working?

“We’re need to see what happens. I think that if we can get price stability back, I believe we shouldn’t give up on this system at all. But the longer inflation is, the harder it will be to keep up,” says Jónsson.

Hard debate and everyone under pressure

Debate has been intense following the Bank’s latest interest rate increase. Jónsson says he has an understanding of the criticism, which stems from the nominal interest rate system, where people are suffering because of the inflation.

“This change where people were moving to nominal interest rates changes the whole discussion about inflation. It wasn’t such a hard debate about inflationary trends when people had inflation-indexed loans. People naturally feel the effects of the inflation now. I think that explains this tough debate now. As a result, the members of the labour market are under pressure as well as the government.”


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