Download 2.2.1 What

University College Northern Denmark
Financial management program
4th Semester 2012
Final project
Should indexation mortgages in Iceland be
abolished?
The report has been prepared by Guðrún Anna Gísladóttir 4FIEP0212
Signature: _________________________________________________
Supervisor: Niels Karl Jacobsen
Delivery date: 29th of Mai 2012
Number of keystrokes of the report: 82.992
Number of pages of the report: 41.5
0
Table Of Content
PREFACE .................................................................................................................. 3
1 INTRODUCTION.................................................................................................. 4
2 PROBLEM STATEMENT ................................................................................... 5
2.1 DELIMITATION................................................................................................ 5
2.2 METHODOLOGY ............................................................................................. 5
2.2.1 WHAT ............................................................................................................... 5
2.2.2 HOW ................................................................................................................. 6
2.2.3 WHY.................................................................................................................. 7
3. INDEXATION MORTGAGES IN ICELAND ....ERROR! BOOKMARK NOT
DEFINED.
3.1 ICELANDIC AND DANISH MORTGAGE SYSTEM ................................... 8
4. MACROECONOMIC BACKGROUND .......................................................... 12
4.1 WHY WAS IT PUT ON IN THE FIRST PLACE? ....................................... 12
4.2 THE INFLATION ............................................................................................ 13
4.3 SAVINGS AND MORTGAGES...................................................................... 14
4.4 ICELAND IN COMPARISON TO DENMARK ........................................... 16
5. THE IMPACT FOR THE SYSTEM................................................................. 22
5.1 THE GAINS OF INDEXATION FOR THE ECONOMY............................ 22
5.2 THE CURRENT SITUATION IN ICELAND ............................................... 24
6 HOUSE OWNERS ............................................................................................... 31
6.1 HOUSEHOLDS................................................................................................. 32
6.2 DEBTOR’S OMBUDSMAN ............................................................................ 35
6.3 WAGES AND REAL WAGES ........................................................................ 36
7 MORTGAGE COMPARISON, ABOLISHMENT AND INVESTOR’S VIEW ................. 39
7.1 COMPARISON OF MORTGAGES ............................................................... 39
1
7.2 INVESTORS ..................................................................................................... 43
7.3 ABOLISHMENT OF INDEXATION ............................................................. 44
8. CONCLUSION ................................................................................................... 46
BIBLIOGRAPHY ................................................................................................... 48
APPENDIX .............................................................................................................. 52
2
Preface
In my final project for financial management at University College Northern
Denmark I would like to thank my supervisor Niels Karl Jacobsen for guidance and
leading me to the correct path with my project.
I would also like to help my former internship instructor Ármann Sverrisson for the
guidance and helping me find, formulate my problem statement and understanding
indexation.
Statistic Iceland and OECD also gets my thanks for their vital information regarding
inflation, unemployment and other useful statistical information.
Final and last I would like to thank the employers at Static Iceland forever being so
helpful when they e-mailed me some statistic I had hard time finding it.
For me I think this is very important when I think about the future, do I want to live
in a country whereas it takes your all your life to pay off your mortgage? Or do I
want to live in a country where there is a possibility to pay your mortgage and
where there is a mortgage for each house owner’s needs.
3
1 Introduction
Indexation mortgages are typical mortgages that are offered in Iceland to house
owners. For many years’ people have been wondering why these kinds of
mortgages are and why aren’t they abolished. People don’t see the point of having
them and now I want to find out whether indexation mortgages should be abolished.
In order to find an answer one needs to know why indexation mortgages are in the
first place. Then it is important to find out whether indexation is giving more profit
to the investor, macro economy or the house owner.
This report is divided into seven different chapters and then conclusion; the first
chapter explains the project’s methodology. Then the second chapter demonstrate
the Icelandic mortgage system in comparison to the Danish mortgage system. What
is the difference etc. between Denmark and Iceland? The third chapter is regarding
why it was put in the first place and explains the economical situation in the
nineteen-century. Fourth chapter then explains the impact for the economy, the
gains of indexation and current situation in Iceland. After the fourth chapter the
situation of house owners is addressed, wages, debt etc. Then in chapter six there is
a mortgage comparison discussion, the affect of the abolishment addressed and also
investor’s point of view.
4
2 Problem Statement
Should indexation mortgages in Iceland be abolished?
2.1 Delimitation
In chapter 4.4 it is not relevant to compare house prices since no data exist at that
time for Iceland. The only data available is from the 2000 and that chapter is
regarding the past performance of both countries. Also it might be interesting to see
the real wages however there are no information in OECD database. The statistic
Iceland doesn’t have information for such long time either.
This is not a report that is try to answer whether it is possible to abolish indexation
mortgage but whether the Icelandic economy should abolish it.
The statistic in appendix, the author tries to use as much given data as possible, or
for as many years.
2.2 Methodology
So I can answer my problem statement I have to structure my report and keep some
things in mind while conducting it. I need to ask myself three very important
question; what, how and why in order for the project to be done properly. Then I
can see whether I have answered the problem statement with my conclusion.
2.2.1 What
In order to answer the problem statement one needs to go into depths of indexation
mortgages in Iceland or indexation in general. One also needs to compare the
Icelandic mortgage system to the Danish one and see if there are any differences.
One should find out why they were set in the first place. I need to find whether there
are any problems that can occur by having indexation mortgages and also what are
the gains of them.
One needs to look at previous years of inflation and see how Iceland’s economy has
been developing in the past years by using this as its structure in our economy.
While looking at previous years of inflation one also needs to see how the real
interest rate was in order to see if the inflation had any effect on it what so ever.
It is also important to investigate how the Icelandic krona has been developing if
there are given the right information.
5
Knowing if there has been any affect on the economy is also very important, has
Iceland changed by having these types of mortgages or is it still the same. Some
economist say that indexation means that the central bank accepts high inflation and
therefore don’t have such efficient policies.
To do this problem statement one has to compare indexation loans to normal loans
to see if there is any different for the both investors’ point of view and also for the
house owners.
Also one has to see how this affects the house owners, how their real wages is and
their debt situation.
It would also proof very vital to make a theoretical abolishment of indexation. What
would happen?
Then to prove the conclusion data such as reports, new articles, official documents,
and papers from professors, working papers from the Central Bank of Iceland and
some books will be used.
2.2.2 How
How this project will be conducted is by explaining the meaning of indexation loans
and why they are put. In which circumstances are they implemented and when are
they not efficient and should therefore be changed to normal loans. In the report one
will also include the fundamental things that are used in the indexation, or which
indexes are used so the reader can see how it works.
One will go to Iceland’s national bank and look from their given information such
as inflation from the past 20 years and also how the Icelandic kronor has been
developing.. Is the currency deflating or appreciating?
By comparing 2 different mortgages the reader can also see in real if there is any
gain for the mortgage taker. Which loan is cheaper and which isn’t. Which loan is
the investor gaining more and which one has the higher risk? I need to set a table of
both pros and cons with each type of mortgages and see which one is more
profitable.
One has to demonstrate how the economy has been developing in the past years and
therefore show that these mortgages are not helping house owners. Inflation,
unemployment rate, GDP growth, economic outlook will be demonstrated for the
reader. Statistic analyses will also be done to see if there is any connection between
6
inflation and short-term and interest rates or connection between other variables by
using Bewistat.
Real wages and inflation will be compared to see whether house owners’ disposable
income has been decreasing or increasing. Also household’s debt till also be
addressed and therefore the reader can have an overview of their situation.
2.2.3 Why
The reasons why this should be investigated are so many; the author of this report
finds this very interesting as well as many other Icelanders and other people too.
This is relevant to everyone living in Iceland, children, adults, old people and
inventors. As it is mentioned before this is relevant to all Icelanders because our
economy is based on mortgages that go up with the inflation. It is relevant to
children because their parents have loans and earn money. Children are part of a
normal household and the disposable income affects them as well. Also it is relevant
to old people because when the economy is having a high inflation and a crisis
they’ll be the one suffering. Their benefits will be less from the government. When
there is high inflation it could affect their pension since they’ve invested their life
savings in some pension schemes.
For investors it is also very relevant since they are the ones making all the profit and
all the money from this and also some risk. They are having low risk because the
inflation risk is gone while in most countries there is always a risk of inflation when
you make an investment. If these types of mortgages were abolished what would
they do and how would they invest their money.
Another reason is because in Iceland we’re having a financial crisis since 2008. A
lot of people have financial difficulties due to indexation mortgages. It could be
very interesting to know whether these mortgages are better for the individuals in
Iceland or not.
Also relevant is that in Iceland we speak lot about these types of loans and people
often ask themselves this question. It will prove to be very relevant since it has been
years since these types of mortgages were established to know if they are still in
fashion. Every so often people, magazines, unions, pension funds discuss this
matter.
7
3. Icelandic and Danish mortgage system
In order to understand this project it is vital to compare Iceland to another country
to get more vision of the economy or mortgage systems available. By choosing
Denmark we can get an overview of a country that is very stable and efficient. Also
both Denmark and Iceland are Nordic welfare countries and in the OECD.
Iceland’s mortgage system is not like many other mortgage system. The mortgage
system is different in the way that almost all mortgages are indexed and with 40
years as a principal.
Indexation mortgages are mortgages that are a little different. Indexation mortgages
are mortgages that are affected by inflation in an economy. The reason why they are
affected by the inflation is when an investor makes an investment. They want to
make sure that what’s valid 10 DKK today will also be worth 10 DKK in the next
twenty years. Not just an investment with only 10 DKK plus interest rates,
indexation mortgages are much more profitable.
In some economies there is high inflation and therefore the investor is taking a
tremendous risk because the inflation will just eat their investment up. An
investment with risk of 6.5% inflation and interest rate of their investment only
being 5% will not be attractive since their investment is negative by 1.5%. In order
to prevent the inflation risk they choose indexation mortgages or bonds.
A special model is used for indexation mortgages; that is inflation is added on the
principal. To know how much money they have to add, they use a special Costumer
Price Index, which is calculated by each bureau of statistics in all countries. The
Costumer Price Index is an index from different consumer prices in the economy.
It is made from a series of different products that consumer buy such as: food,
alcohol, gasoline, cars, house prices and other products. These changes in Consumer
Price Index indicate how much inflation is in an economy; if it has gone up from
480 to 510 we’ve inflation. If it goes does from 480 to 470 we have deflation. There
are many different formulas to calculate Consumer Price Index in Iceland; the one
used might be different from other countries since in Iceland it is also including cost
of real estate while in other countries it isn’t. 1
To demonstrate the reader how the indexed mortgages are, one can look at graph
3.1. How an indexed mortgage is. The graph shows a mortgage of 20.000.000
1
Statistic Iceland: New base for Icelandic consumer price index
8
million ISK with a 4.10% interest rate and 6.5% inflation. What is interesting is that
the loan is increasing during the five years. It was 20.000.000 in the beginning and
in five years it has increased to 25.918.515. The graph shows that the inflation is
added on the principal causing interest rate to increase and therefore as well. The
interests paid have almost increased by 200.000 ISK in five years. If inflation
suddenly decreases or becomes deflation the mortgage would minimize by that
percentage or have negative real interests. In that case it would be good to have an
indexed mortgage but that situation will rarely happen.
Graph 3.1 How an indexed mortgage is
Indexed mortgage
30000000
25000000
20000000
15000000
10000000
5000000
0
Inflation
1
2
3
4
5
6
0
1300000
1370646
1444405
1521319
1601415
Interest rate
0
820000
864561
911086
959601
1010123
Loan amount 20000000 21086864 22221615 23404903 24637153 25918515
Year
0
1
2
3
4
5
Made by the author
When you take a mortgage in Iceland you almost always take an indexation
mortgage because a normal mortgage has very high interest rate, so high that most
people cannot afford to have it. Therefore people take the cheap mortgage and don’t
maybe think about the consequences of taking that kind of loan. Some people
choose to have a mixture of non-indexed and indexed mortgages by doing that they
will have a more capital in their real estate within some years.
Mortgages that are offered in Iceland with indexation are around 4.10% interest rate
and normal mortgages have 5.65% floating interest rate and 6.65% fixed interest
rate for 3 or 5 years. The interest rate can vary from the banks or the mortgage bank.
Other banks have lower or even higher interest rate than that patricidal bank. As
mentioned before the interest rate for indexation mortgage is 4.10% therefore the
9
debt payment is less and many people take them because a normal mortgage has a
higher payment.
Some banks also have it as a principle that a indexed mortgage can cover 70% of
the official value of the house and the rest of the mortgage will be much more
expensive. The interest rate above 70% of the real house value is 4.95% for indexed
mortgage and then 6.15% normal interest rate and 7.45% for fixed normal interest
rates.2
Another thing that is also different that is the lending period, because of the low risk
for the investor regarding inflation. Therefore the lending period can be up to 40
years.3
In Iceland there is one mortgage intuition that is owned by the government and there
are several banks and saving banks, some of them are owned by the government or
funds.
In Iceland there are two different payment methods for mortgages. One is with even
payments, high interest payment at first and then less and less by each payment;
annuity loan. The other type of payment method is that there is always the same
amount of repayment of the loan but different interest paid; bullet loan. 4
However the Danish mortgage system is far beyond Iceland’s. Frist of, their
mortgages are not indexed. Meaning that it’s cheaper for the house owner to borrow
money because Denmark has been able to keep their inflationary target.
They have three different main types of mortgages; fixed-rate, adjustable-rate and
floating-rate mortgages.
Fixed-rate mortgages are usually with a 30-year principal and will a calling option.
The calling option explains itself by; when you release a mortgage it’s released at a
price of 100 on the bond market. Then the interest rate in the economy change and
therefore the price of the bond will also change to maybe 97 due to the fact it’s less
attractive for investors. When the mortgagee realizes that this has happen, he can
buy the bond or a new bond and repay the old bond. By doing this the monthly
payments or the principal itself will be minimized. The new bond might have higher
interest rates but lower principal or it could have lower interest rate but the same
principal amount.
2
Íslandsbanki : Verðtryggð húsnæðislán - Óverðtryggð húsnæðislán
Íbúðalánasjóður: Lán til kaupa
4
Baldursdóttir, Inga Rós & Björnsdóttir, Birna Kristbjörnsdóttir : Áhrif afnáms verðtryggingar: 6-7
3
10
The adjustable-rate mortgages are mortgages with a market free interest rate. These
types of mortgages usually have lower interest rate and are therefore very popular.
The interest rate is changes every; 1, 3, 5 or 10 year. This is done by the means of
changing the original bond for a new one, the new bond has either lower or higher
interest rate and therefore the interest rate changes. The same principal is with the
adjusted-rate mortgage regarding the call option.
The last type of mortgage in the Danish mortgage system are the floating-rate
mortgages, they can be with or without a cap. The cap ensures that the loan doesn’t
reach high percentage on interest rate that mortgage also costs more money to take.
The floating-rate mortgages change their interest rate every 3 or 6 month of the
year. The mortgagee can also buy these types of bonds on the market with the
calling option.5
The Danish mortgage system is also different from many others because it has
reduced the risk for the bank tremendously. The bank lends the money to the house
owner and then the bank sells the mortgage or the bond to an investor. The bank
gets a margin while the investors get the interest rate. When a bank gets a house
owner that wants 1 million DKK they also give out a bond with the same principle
as the mortgage. Then an investor buys the bonds while the bank is left with perhaps
only 0.5% margin and less risk. 6
Both Icelandic and the Danish tax system are similar they both have tax relief on
interest. In Iceland it is dependant on your income, savings and how much
interested you paid. The max amount you can receive is 400.000 ISK per annum
and it is divided between spouses equally. The interest relief in Iceland is only on
loans and mortgages regarding a real estate you live in. Other loans, overdraft etc.
will not be interest relieved. 7
However in Denmark it is a little bit different, it is dependant on how much your net
capital income is negative. Instead of being only on mortgages and loans regarding
a real estate it can also be overdraft in banks etc. The percentage you can receive is
33% of your net negative capital income. So therefore if you paid 3.000 DKK in
interest last year you can get 1.000 DKK of them paid back.8
5
Realkreditrådet: Main types of mortgage loan
Realkreditrådet: example of match-funding
7 Ríkisskatstjóri: Reiknivél ríkisskatstjóra vaxtabætur - Vaxtabætur almennt
8
SKAT : Marginal tax rates
6
11
There is no wonder why it’s said that the Danish mortgage system is one of the best
in the world. It has 3 different types of loans for house owner, with a calling option
and also 10 years of non-repayments. While the Icelandic model has 2 types of
mortgages, non-indexed and indexed mortgages. With 5-40 year principal and much
higher interest rate than the Danish mortgages.
4. Macroeconomic background
Indexation mortgages in Iceland have been in place since 1979 and now it’s a
question whether they are still doing what they were put to do in the first place.
Now it might be time to reconsider these mortgages. They were put in place by a
special registration 10th of April 1979 called “Ólafslög” and have been modified 7
times in the past decades to meet the changes of the economy. These laws did not
only provide people with indexation mortgages but also indexation savings as well.9
Indexation mortgages were put in Iceland because of good reasons, high inflation
and negative real interest rate on both savings and mortgages. This chapter will
explain why it was put and also explain the macroeconomic background of Iceland.
4.1 Why was it put on in the first place?
Economies are very different from one country to another; some have higher
inflation or unemployment or vies versa. Each country’s economy is unique from
another because of many factors; interest rate, inflation, currency, geography,
sources, labour force etc. Iceland’s economy is very different from others because
of many things.
Iceland has for many decades had fluctuating inflation from 1.5% to over 80%.
Inflation is one of few reasons why indexation loans are in Iceland. Another reason
why they were put in the first place was because the Central Bank Of Iceland
decided the interest rate and it was never kept in equilibrium. Therefore there was
negative interest rate for the public on savings and mortgages bonds.
10
Negative
interest rate on savings cause problems for the public and negative interest rate on
mortgages causes disinvestments and therefore less GDP growth than ought to be.
9
Althingi: Lög um stjórn efnahagsmála o.fl.
Jónsson, Bjarni Bragi: Financial indexation and interest rate policy in Iceland: 10
10
12
4.2 The Inflation
It all started after the World War II or the post war period when Iceland’s inflation
started to grow more and more and then became a problem. From 1945 to 1973
Iceland didn’t have very high inflation the average was just over 9.5% but after
1973 inflation started to peak over 80%. Inflation rose because of many different
factors; international crises and also because of domestic problems. It can be seen in
graph 4.2.1 Inflation in Iceland 1945-2010 how much inflation Iceland has had in
vinnumarkaði
verðtrygging
launaaáhrif
til hækkunar
áfallið
the past og
decades.
It fluctuates
lot and
the highestverðlags.
inflationHvert
is over
80% af
in öðru
1983.leiddi
til hærri
verðbólgu.
Við hámarkið
árið 1983
að skapasttohætta
á að verðbólgan
Iceland
had much
higher inflation
in var
comparison
the OECD
countries væri
or að
komastsometimes
á enn alvarlegra
stig
og higher
kallaðiinflation.
það á aðgerðir
að image
ná henni
(Andersen
more than
70%
One cantil
only
howniður
bad affect
this og
Guðmundsson,
1998). at the time and savings.11
had on investment
Graph 4.2.1 Inflation in Iceland 1945-2010
90
80
70
60
< Iceland
50
40
30
20
10
0
^ OECD countries
-10
1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
Source: Hagstofan: Verðtrygging á fjármálamarkaði
Ísland
OECD lönd
There are few reasons for high inflation occurring in Iceland. In the post-war period
Mynd 1. Verðbólga á Íslandi og í OECD löndum 1945-2010
fishHeimild:
pricesSigurður
went Snævarr
up and(1993),
alsoHagstofa
wagesÍslands
because
of military occupation by the USA and
(2011), OECD (2011).
United Kingdom. Another part is that the USA government refused to let the krona
Verðbólgan
miðlungsstig
varthe
á því
biligovernment
til árisins 1989
en meðaltal
appreciatekomst
in theápost-war
periodárið
due1984
to theogfact
USA
benefited
by
tímabilsins
varinum
það bilthe
25%.
niður á and
lágt the
stigkrona
árið 1990
og stöðugt
it. Then
1949-50
rateVerðbólgan
of exchangehjaðnaði
was discharged
appreciated
verðlagcausing
ríkti fráinflation
árinu 1994-1998
og Guðmundsson,
1998).the government and
again. In (Andersen
1960 a drastic
decision was taken,
the1999
labour
unions
decided to
have
unemployment
therefore
Árið
jókst
verðbólgan
aftur
enlower
tímabilið
1999-2010and
myndi
samt inflation
sem áðurwent
flokkast
up again
because
of theirsamkvæmt
cross-connection.
The policy
in Iceland
was bad because
it þar
sem tímabil
lágrar
verðbólgu
viðmiðunum
Andersen
og Guðmundsson
(1998)
sem meðalverðbólga tímabilsins var 5,9%.
11Andersen,
S. & Guðmundsson,
of iceland:
2-4
Fram
kemur íPalle
skýrslu
Carey (2009)Már:
frá Inflation
OECD and
að disinflation
verðbólgan
hefur sveiflast
meira hér á
landi en í Evrulöndum. Staðalfrávik ársfjórðungslegrar árlegrar hækkunar samræmdrar
vísitölu neysluverðs2 yfir fjögurra ára tímabil til síðasta ársfjórðungs 2007 var 0,9% í
13
Evrulöndum en 3,0% á Íslandi. Tölurnar eru nánast þær sömu og fyrir átta ára tímabil þar á
was political policy when it should have been a monetary or fiscal policy. 12 In 1973
there was an oil crisis in the whole world and Iceland very pendent on oil at that
time being. These are the causes of high inflation in Iceland for the past decades and
when we think about the past and compare it to the future we can see that these
reasons will probably not happen again. This will be discussed in other chapters6
4.3 Savings and mortgages
When inflation is so high as can be demonstrated in graph 4.2.1 Inflation in Iceland
1945-2010 it causes problem for the economy. High inflation causes interest rate to
go up otherwise investments have negative interest. When interest rate go up people
cannot afford them and private consumption goes down and savings increase. This
is of course what is supposed to happen but in Iceland it didn’t. Until 1984 the
authorities were responsible for all interest rate decisions and therefore interest rate
was rarely in equilibrium. The interest rate market wasn’t free like in most other
countries. When the central bank decides the interest rate they can be either too high
interest rate or too low. Both of these have bad consequences, too high and
investment go down and therefore GDP as well. Too low and savings will be less or
even negative therefore people weren’t motivated to save their money. Too low
interest rate was the case in Iceland.
When inflation is 6.5% and you can get 4% for your money deposit in the bank
you’ve an annual negative interest rate of 2.5%. These were the problems before
Iceland decided to have indexation. People were not motivated to save their money
because it lost value in the banks. In graph 4.3.1 Deposit bank interest rate and
inflation we can see the interest rate in comparison to the inflation at the time being.
Some years the interest rates are below the Consumer price increase or the inflation,
which means negative interest rate. From 1986 interest rate started to become
positive after 7 years of indexation had been put. So perhaps it wasn’t just the
indexation that helped the negative real interest rate to become positive but the fact
that the Central Bank of Iceland did not decide interest rates anymore.
12
Jónsson, Bjarni Bragi: Financial inflation and interst policy in Iceland: 8
14
Graph 4.3.1 Deposit bank interest rate and inflation
Source: Financial indexation and interest rate policy in Iceland
To demonstrate how much money was lost in savings, deposits and notes; savings
were around 40% of the GDP in 1971 but in 1980 it had declined to 20% of the
GDP. Pensions also declined by a similar ratio at the same time. To fund the gap the
government had to lend money abroad, to start with, it was only 10% in the
seventies, 20% in the eighties and in the mid-nineties it had went up to 50% of the
GDP but in 1993 it started to decline.
When a country like Iceland is having high inflation for decades one can ask how
did people manage to save for real estate. Well simply by having compulsorily
savings; every working person had to save money.
13
The compulsorily savings
were put in 1957 and each working person from 16-25 had to give 6% of their
salary to savings. When they did that they got a special saving stamp, which they
collected, in books like normal stamps collectors would do. In order to get the
savings paid out people had to go to a college, buy a house or get married. 14
Another problem of high inflation is that the value of money decrease, people who
have spent all their life saving for pension might find that what they have worked
for is almost gone or worth less than nothing. Investments lose their value because
the investment has to give more return than inflation or there is a negative
investment. Mortgages in the past had sometimes-negative real interest rate.
Therefore many people thought amongst themselves that it was cheap to buy a
13
14
Jónsson, Bjarni Bragi: Financial indexation and interest rate policy in Iceland: 10-11
Þjóðviljinn: Tilkynning frá félagsmálaráðuneytinu um skyldusparnað
15
house since inflation was above interest rate. By looking at graph 4.3.2 Real interest
rate on domestic credit we can see that some of the real interest rate is under the
line. Being under the 0% line only means one thing negative interest rate. This
demonstrates that from 1970s till almost 1883 there were high negative rate of
domestic credit. After the indexation mortgages and loans were put in use real
interest rate started to become positive.
Graph 4.3.2 Real interest rate on domestic credit.
Figure 8
Real interest rates on domestic credit
M.kr.
20
Marketable bonds
Investment loan funds
Bank credit
Total credit
10
0
-10
-20
-30
1960
1965
1970
1975
1980
1985
1990
1996
Source: Financial indexation and interest rate policy in Iceland
age accruals on the dominating Treasury bonds, and the same weighted, due to imperfection
of data for other bonds, into the credit system total. The remaining chief subsectors of bank
Therefore
ofloan
high
inflation
with interest
rate
not
equilibrium
anddic-that
credit andbecause
investment
funds
often coincide
remarkably
well,
notin
least
in the extremes
tated by
inflation,real
theirinterest
commonondenominator.
Thecredit,
banks tend
to show was
higherput
results
when
causing
negative
savings and
indexation
in Iceland.
interest rates were reactivated or inflation subdued, whereas loan funds with more indexed
Iceland
have
maybe
controlled
their
better
with other
loans could
first show
more
even results
and from
1979economy
lead the way
of recovery
of realpolicies,
rates. Withand
opportunity
afforded
to the banks
by the
interest
rate liberalization
of 1984-86 these relathentheonce
again other
external
factors
helped
increased
the inflation.
tions get turned upside down, reflecting greater risk and actual credit losses in bank operations. By their weights these two subsectors between them dictate the total average real interrate of in
the comparison
credit system. to Denmark
4.4 est
Iceland
The period under review can be subdivided with reference to active interest rate policy as
In order
proof that
Icelandand
didthereby
have to
difficulties
want oftoreal
compare
to another
well astoresistance
to inflation,
its results inI terms
interest it
rates.
From
these
criteria
four
subperiods
can
be
discerned:
1.
Period
of
inadequate
nominal
interest
ratesdid
welfare state such as Denmark. By means of that we can see if the indexation
and incipient indexation coupled with considerable inflation resistance over the first decade to
save1971;
Iceland
from high
inflation
andother
highdemand
debt or
was itwith
unnecessary.
2. Suppressed
interest
rates and
policies
a lapse into a great inflation
bulge
and
only
emerging
partial
indexation
up
to
the
comprehensive
legislation
1979; 3.
The first topic and most important one is inflation since it was the
root ofofindexation
Adjustment period of indexation with inadequate real interest rates until the stepwise interest
in Iceland.
rate liberalization of 1984-86; and 4. Free market formation of interest rates from 1986, with
without indexation
and under
considerable
threatDenmark
of renewedand
direct
intervention,
as severe
By or
analysing
graph 4.4.1
Inflation
in Iceland,
OECD
total we
can see
supply shocks were encountered in some of these years. During this last phase of developthat Iceland had very high inflation from 1976 till 1991. When we look at the graph
ments the nature of indexation changed considerably from a policy measure of administrative
we control
can seeto that
Denmark
very market
low inflation
a freely
availablehas
financial
norm. in comparison to Iceland. Denmark
The results of these different phases of policy appear clearly in figure 8. Negative real
interest rates of 24.4 per cent in 1974 and 15-16 per cent in 1973 and 1975 was simply horrendous, and almost as strong adjectives could be used about negative outcomes of around and
16
over 10 per cent in a few more years. Almost as serious was the fact that continuous negative
interest rates over all but four years from 1961 to 1983, or a total of nineteen years, was sap-
is often underneath the OECD total inflation. Meaning that Denmark was doing
better than the average OECD countries while Iceland was doing very terrible. So
without any doubt Iceland had high inflation whereas Denmark had low inflation.
Graph 4.4.1 Inflation in Iceland, Denmark and OECD total
Source:
OECD
–
Consumer price – Annual inflation
Now when we have seen the inflation development we might want to know how the
unemployment rate is since they are connected to each other. Or some economist
believe so, this is called the Philips curve. High inflation causes low unemployment
and vies versa. To prove that theory the author made regression analyses of inflation
and unemployment rate. In appendix 1.3 the R square is only 0,17598 so therefore
the unemployment rate can only be explained by 17.6% of the inflation. This means
that there are many variables that can affect the unemployment or the inflation. But
on the other hand the p-value is below significant level or 0.05 so we accept the null
hypotheses meaning that these two variables are dependant on each other. The pvalue for one-sided test is 0,010874 and for two-sided testing it is even more robust
or 0,005437. However even if they are connected to each other that does not mean
0% inflation causes 0% unemployment rate. There will always be unemployment
rate due to structural unemployment.
Graph 4.4.2 Unemployment rate % of labour force demonstrate what could be
anticipated; higher unemployment rate for Denmark and very low for Iceland. In
chapter 4.2 The Inflation I mention that the government and unions in Iceland had a
policy of low unemployment rate this is clearly shown but the price of low
17
unemployment rate is of course high inflation. In Denmark on the other hand the
inflation is very low and unemployment rate is relatively high. Denmark had
sometimes unemployment rate 10% above Iceland, maybe Iceland should have
switched their policy into higher unemployment. On the other hand that can of
course in the long-term cause higher structural unemployment.
Graph 4.4.2 Unemployment rate % of labour force
Source: Statistic Iceland & Statistikbanken
An economy like Iceland that has had tremendous inflation for many years and
therefore it might also seem interesting to see how the GDP growth rate was in
comparison to the Danish economy. When looking at graph 4.4.3 GDP growth rate
of Denmark, Iceland and OECD – total we can see that Iceland’s GDP growth is
very fluctuation in the beginning and higher than the others. Denmark seems to be
following the OECD total but a little bit below. Therefore the Danish economy is
much more stable than the Icelandic one. The Danish business cycle has less
fluctuation and probably there is less effect on the economy when there is a
recession.
After analysing these 3 main factors for the both Iceland’s and Denmark’s economy
we come to the conclusion that Denmark had higher unemployment rate and
therefore lower inflation and vies versa for Iceland. Iceland also had higher
fluctuations in their business cycle in comparison to the Danish economy. Last
century Iceland had a very high growth rate and paid it perhaps with high inflation
such as 84% in 1983.
18
Graph 4.4.3 GDP growth rate of Denmark, Iceland and OECD – total
Now to have a better
the
comparison
of
Iceland and Denmark
we
also
need
to
consider the long-term
interest rate. We can
assume that in Iceland
there was high longterm
interest
rate
because of anticipated
Source: OECD – Nominal GDP growth – forecast
high inflation and we can also assume that in Denmark long-term interest rate were
less than in Iceland due to lower inflation.
In graph 4.4.4 Long-term interest rate Iceland and Denmark we can see how the
both Danish and Icelandic long-term interest rates on 10-year government bonds
have been developing in the past 24 years. The Danish interest rates in the long run
are going down while the Icelandic ones fluctuate with the business cycle much
more. It is clear when there is a crisis in Iceland because interest rates change by 4%
as in Denmark they change with 1%. It is also very obvious that the Icelandic
economy should be trying to do a better because Iceland is a Nordic country like
Denmark. However the Central Bank of Iceland’s policy isn’t very efficient.
Graph 4.4.4 Long-term interest rate Iceland and Denmark
The long-term interest rate
are however not effected by
the inflation so much that
can
be
explained
by
appendix 1.1 where as the
adjusted R square is only
Source: OECDLong-term interest rates
19
0,090627 or that only inflation can only explain 9.1% of the long-term interest rate.
That means that there are more than 90% of the long-term interest rate are not
explained by the inflation. Also the p-value is above the significant level or 0.05
meaning that the independent variable does not show a significant relationship with
the dependent variable. In other words the independent variable does not reliably
predict the dependent variable in the calculations.
However the short-term interest rate are dependent on the inflation in Iceland. This
can also be demonstrative by appendix 1.2. In appendix 1.2 the adjusted R square is
0,569128 or that 56.9% of the short-term interest rate are explained because of the
inflation rate. The p-value is also below the significant level or 0.05 or it is
0.000282 and robust. So we accept the fact that short-term interest rates and
inflation are connected. Therefore if inflation in Iceland is high it will causes shortterm interest rate to shift to equilibrium. In graph 4.4.5 Short-term interest rate
Denmark & Iceland we can see how the interest rates have been developing in the
past two decades.
Graph 4.4.5 Short-term interest rate Denmark & Iceland
Source: OECD – Short-term interest rates
Now the short-term interest rates in Denmark and Iceland do fluctuate a lot during
1988-2011. There could be many different reasons why and one is mentioned before
such as inflation. In 1988 Iceland had more than 30% interest rate while Denmark
had a bit over 8%. The difference is more than 22%, now that is a lot for short-term
interest rates. By looking that this graph it is also clear that Iceland has in overall
higher short-term interest rate than Denmark, apart from 1992-1994.
20
Now when this chapter has talked about various parts of the economy; inflation, and
unemployment and interest rate. It vital to know how the household’s disposable
income was and how it developed. Perhaps one of the countries did have more
percentage changes than the other. Also the real household disposable income can
show how the economy has been developing, when there is crisis; the disposable
income might become less or when there is very high inflation as well.
Graph 4.4.6 Real household disposable income percentage changes show what is
mentioned.
Graph 4.4.6 Real household disposable income percentage changes
Source: OECD – National accounts at a glance
In this graph it can be seen how the economy has been developing. For example
when there was 83% inflation in 1983 the real household disposable income in
Iceland went below the average. The average over the period is 6% in Denmark
while it is 7% in Iceland. After 1987 the real household disposable started to
fluctuate less and become more stable in some sort. It was in 2009 whereas both
Denmark and Iceland had negative percentage by 3.35% in Denmark and 7.12% in
Iceland.
So not only did Iceland have higher inflation than Denmark, but also higher GDP
growth, short-term and long-term interest rate and higher average real household
disposable income percentage change. However Denmark did have higher
unemployment rate than Iceland.
21
5. The impact for the system
This chapter will discuss the gains of having indexation mortgages for the macro
economy. The chapter will discuss macroeconomics such as; inflation, the Icelandic
kronor, GDP growth and how the economy has been developing in the past ten
years. The economic outlook will also demonstrate.
5.1 The gains of Indexation for the economy
After years of high inflation, negative real interest rate one might hope that the
situation might have turned better. It did turn better but it took some time for the
economy to adapt to the new situation and also to apply new registration. As
mention in chapter 4.2 the authorities decided the interest rate until 1984. Therefore
the effect didn’t happen till 5 years after the indexation was put on in n 1979. By
looking at graph 4.3.2 Real interest rate on domestic credit in previous chapter it
shows that real become positive in 1984. The same situation can also be
demonstrated in Graph 4.3.1 Deposit bank interest rate and inflation where as the
inflation becomes less and interest rates go above the inflation and become positive.
It wasn’t till 1986 were the authorities gave the market forces full control of the
interest rate and things started to look better and prosper. 15
Now when interest rate were positive on both savings and mortgages one might
think that the GDP growth might increase because if higher S and I. Graph 5.1.1
GDP growth of Iceland 1945-2010 shows how the GDP growth has been in Iceland
for the past decades. The average is 3.8 but might be declining or becoming more
stable. If we look at the graph we can see that high GDP growth hasn’t been since in
the seventies apart from 2004 and 2005. Iceland became more stable than it was
after indexation.
15
Jónsson, Bjarni Bragi: Financial indexation and interest rate policy in Iceland: 12
22
Graph 5.1.1 GDP growth of Iceland 1945-2010
Source: Made by self & Statistic Iceland - Overview of Gross Domestic Product and Gross National
Product 1945-2011
It is clear that the business cycle in Iceland fluctuates by a smaller volume apart
from 2007 whereas there is a recession and today Iceland is recovering. Indexation
might have made the Icelandic economy more stable than before when there was
some years 15.3% to -5.5% GDP growth rate. After legalizing indexation the
highest rate of GDP growth was 8.5%. Now this could have the affect that the
Icelandic economy is more stable when there is crises, one can assume if indexation
hasn’t been in 2008. Iceland would have been in worse place than it is.
Another thing the indexation might have played a role in is the short-term interest
rate decreased after the legislation of indexed mortgages, but in chapter 4.4 under
graph 4.4.5. Short-term interest rate Denmark & Iceland it can be seen. It is clear
how the interest rates start to become less from 30% in 1988 to a much lower rate or
15% in 2008 whereas there was crisis, if we compare two years of big inflation and
crises.
The most important thing of indexation was of course to make inflation become less
not +80% as it was. In chapter 4.2 The Inflation is a graph 4.2.1 Inflation in Iceland
1945-2010. In that graph we can see that few years after indexation the inflation
starts to become less and less. But still it’s above OECD, which is also
demonstrated in the graph. However as mentioned previously indexation wasn’t the
only part of this. But also the fact that the Central Bank of Iceland didn’t control the
23
interest rate anymore. After the market forces got control of the interest rates
inflation starts to become less and less. Inflation became less than 10% from the
nineties to the twenty first century apart from one year, 2009.
So the economy has gained; positive real interest rates on savings and loans. More
stable GDP growth and lower short-term interest rate.
If indexation hadn’t been on savings and mortgages a large sum of investments,
pension and private savings would have been lost in the 2008 crisis. Luckily
because of indexation these things were not lost because of negative real interest
rate.
5.2 The current situation in Iceland
After explaining why indexation was put in Iceland and the gain for the economy at
that being of the ninetieths century we might realize that at those time things were
very bad and unstable. Today Iceland is different and therefore it might be suitable
to ask whether indexation on mortgages is relevant or not. Also ask us whether the
house owners, investors or society are gaining from having this. Who’s gaining the
most and who’s paying the price? Next chapter will discuss the current situation in
Iceland and the economic development.
After the registration of indexation loans in Iceland the economy started to improve
and prosper a little by little as mentioned before. In this part of the paper we are
done discussing about the nineteen century and will concentrate on the 21st century.
How Iceland has been developing and the future plans. I will discuss the crisis a
little bit.
It was first in 2001 that the Iceland allowed its kronor to be floating for the first
time. Therefore the Central Bank of Iceland switched to an inflation target. Their
inflationary target was to have inflation 2.5% and was inspired by many other
countries. However the inflationary target was exceeded and over the period of
2001-2005 inflation was twice over the target. Reason behind the high inflation was
because of the currency exchange rate. The Icelandic kronor had been very strong
and therefore people were consuming a lot of goods. Suddenly consumer goods
were cheep to buy and therefore people started consuming more. 16
16
Michelis, Andrea De: Iceland: challenging times for monetary and fiscal policies economics
department working paper no. 726: 6-7
24
Graph 5.2.1 Icelandic kronor against Danish kronor can show us how the Icelandic
kronor have been developing in the past 12 years. Reason choosing DKK kronor is
because I chose Denmark to be Iceland’s comparison country rather than USD.
Graph 5.2.1 Icelandic kronor against Danish kronor
Source: Oanda – Historical exchange rate
It can be seen that the Icelandic kronor were quite strong in the beginning of the
period against the DKK. The average of the period is 0.0746, lowest point is 0.0396
and highest point is 0.1073. Then suddenly on the graph the Icelandic kronor fall
against the Danish but that was when the crisis hit Iceland in 2008. The Icelandic
kronor went down or depreciated against the Danish kronor in 2008 because of
financial crisis in Iceland. It hid the lowest point in the end of September 2009 at
the rate of 0.0396.17
The falling currency only meant one thing, inflation must have gone more up than
before since Iceland is dependent from goods and service abroad. It is very hard for
Iceland to subsidy goods while they can still subsidy for groceries because of their
fishery and agriculture.
Graph 5.2.2 Inflation in Iceland, Denmark and OECD total shows inflation from
2000-2011. The graph proves our theory; first it shows that Iceland had higher
inflation than Denmark and therefore higher inflation than OECD in total in the
entire period. It shows that Iceland’s kronor development and inflation are
17
Oanda: Historical exchange rates
25
connected since when the kronor fell the inflation started to rise in 2007-2008. By
looking at the graph we can also see that the Central Bank of Iceland has been doing
a poor job and they need to upgrade their policies and also the government needs to
take some actions.
Graph 5.2.2 Inflation in Iceland, Denmark and OECD total
Source: OECD
It is also important to look at inflation in comparison to of course unemployment
rate. It is mentioned before why it is, high inflation causes low unemployment rate.
So by looking at the graph 5.2.2 Inflation in Iceland, Denmark and OECD total we
can assume that Iceland had low unemployment rate in the beginning of the 21 st
century. Then in 2009 it started to increase a lot while Denmark might have had
normal unemployment rate in the beginning and then slightly increased in 2009
because of the world’s financial crisis.
As assumed regarding unemployment rate it started to increase in 2008-2009 but
was both quite low for both countries. This is demonstrated in graph 5.2.3.
Unemployment rate Iceland and Denmark The Danish unemployment rate is higher
than the Icelandic one and it takes the economy more time to recover rather than the
Icelandic one. One reason why Iceland unemployment rate in going down so fast
might be because many Icelanders have moved abroad. People perhaps believe that
26
the crises will be for too long or that their disposable income is too low for the
standard in Iceland.18
Graph 5.2.3 Unemployment rate Iceland and Denmark
Source: OECD
One other thing that might have had effect on the employment rate in comparison to
the Danish. Is that many people in Iceland are moving to Norway, Denmark and
Sweden. This causes the labour force to increase each year. In 2011, 6.982 people
moved abroad, while 7.759 in 2010 and 10.612 in 2009. In these three years the net
migration was negative by 8.373 people. Now this does not sound very much but in
Iceland there are only 319.575 people. The net increase in population in Iceland
from 1st of January 2011 to 1st of January 2012 was only 0.4% or 1.123, which is
also very low. Reason of that is also because of the negative migration. Iceland’s
population growth from 2005-2007 was over 2%. So that indicates what the effect
the business cycle has on the population growth. People moving abroad can cause
the labour force to decrease so therefore the unemployment rate might have
decreased too. 19
Now when one has mentioned inflation, unemployment rate and the currency it is
also important to see how the house prices were developing in the 21st century. It is
most likely that house prices did in the period increase because Iceland had a
booming period, then in 2008 Iceland hit the crises. Table 5.2.4 Increase and
18
19
Icenews: Large increase in people moving abroad away from Iceland
Statistic Iceland: Population development 2011: 1 & 9
27
decrease of house prices 2001-2011 shows how much increase and decrease had
been in Iceland during the 21st century. Total increase during the period was 66%
while there were 2 years of decrease of house prices.
Table 5.2.4 Increase and decrease of house prices 2001-2011
Year
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
Total
increase
In/decrease house prices
Index
4.57%
10.43%
9.51%
22.20%
14.39%
8.56%
5.85%
-10.75%
-3.11%
4.42%
.
110.6
115.9
129.4
143
183.8
214.7
234.8
249.4
225.2
218.4
66.08%
228.5
Made by the author by using Statistic Iceland figures
It is clear that house prices in Iceland have increased a lot, even after the crisis in
2008. House prices have kept hand-in-hand with the inflation in Iceland and the
business cycle. By having indexation mortgages the mortgages in Iceland will
increase during high inflation like happen in 2008-2010. When mortgages have
increased so much it can causes the housing market to become very slow or few
houses being sold. This of course should cause house prices to go down, but in
Iceland it should have gone much more down than it did hence there was a
tremendous booming period for many years and the business cycle needs to correct
it somehow.
Now the economic situation in the 21st century has been addressed and now we
might want to know how the 2013 will be. By looking at graph 5.2.5 Iceland’s
economic outlook 2008-2013; it shows the private and government consumption.
Exports and imports and its net exports. It also shows the consumer price index,
unemployment rate, current account balance and general government gross debt.
The first thing we can look at in the outlook is the GDP at market price. Now this is
the sum of the gross values added of all resident producers at market prices plus
28
taxes and less subsidies on imports. Now the GDP at market prices has been
developing and will develop as followed from 2009-2013; in the first two years of
the period it was negative by 6.8% and 4% however the last three years it will start
to recover once again by a sum of 8.9%.
Graph 5.2.5 Iceland’s economic outlook 2008-2013
Source: OECD Economic outlook.
The second thing that is also important to discuss is the private consumption.
Private consumption is the consumption of the household’s in the economy of goods
and services provided. The private consumption in Iceland tells the same story as
the GDP at market price. In 2009 it went down by 14.9% and also in 2010 but only
by 0.4%, now in 2011-2013 it went up by 9.5% but that is still not enough to cover
the crises. Apart from the crises in 2008 and so on, the IMF made Iceland do a tax
29
reform in 2010. This tax reform increased taxes a bit and therefore this would of
course hit the private consumption. They increased the VAT by 1% for example.
20
The government consumption is also very important when it comes to
macroeconomics. It provides the information about how much the government is
spending on for example building roads, construction, new schools etc. Giving jobs
to the citizens in the economy. Sadly the government consumption was negative
from 2009-2012 or by 6% and will recover in 2013. This is not normal for a
government not to spent more during crises. The reason for this is because the IMF
came to Iceland and made of course reforms. In 2008 Iceland asked for money from
the IMF and the procedure for IMF is that countries asking for loans have to follow
special reforms. One of IMF’s known reforms is to cut government consumption.
The amount Iceland got was 2.1 billion USD from the IMF and 3 billion USD from
countries such as; Denmark, Finland, Norway, Sweden, Russia and Poland. In 20122015 Iceland will start to repay these loans this will of course also have impact for
Iceland. Reason for this loan was due to the fall of the Icelandic kronor.
21
So now what’s interesting is the exports and imports and therefore net exports.
Exports are goods and services that are exported abroad to other countries and
imports are well goods and services that are imported to Iceland. In Iceland during
2009 or the crises period a typical thing happen for a country in crises. The imports
start to be less or in this case -24% and exports start to increase by 6% in 2009 and
from 2010-2013 exports will have been 10.7%. However it is not enough to look at
the exports but we have to look at the net exports they might tell another story. The
next exports from 2009-2013 were from 14.2% to -1.5%. So after 2009 when the
economy starts to recover very slowly and private consumption starts to increase.
The net exports start to become negative due to higher imports of goods and service.
Now having an appreciated currency the exporting companies are gaining a lot. But
sadly Iceland doesn’t have too many exports goods and services. By exporting it
could help Iceland get out of the crises even faster.
Negative net exports will of course cause that in Iceland there is higher demand to
buy foreign currency than to buy ISK kronor. So therefore this in the long run will
affect the Icelandic currency, the higher demand for foreign currency the more the
20
Escolano, Julio et al: Iceland: Improving the Equity and Revenue Productivity of the Icelandic Tax
System: 10
21
Forsætisráðuneytið: Alþjóðagjaldeyrissjóðurinn samþykkir efnahagsáætlun og lán til Íslands
30
ISK have to depreciate against another currency such as DKK or USD. However
this can cause the Iceland’s competitiveness on the world’s market to increase
The consumer price index or in other words inflation is very important when one
looks at economic outlook. This tells us how much prices have increased or
decreased in the economy. There is no use to go to great details regarding this due
to the fact this is discussed earlier.
The general government gross debt is the debt of the government such as; currency,
bills, short-, medium- and long-term bonds and loans. This is measured as a
percentage of the GDP. In Iceland it has increased very much but in the period it
will start to decline slowly in 2013. 2009 it is 120% of the GDP and reaches the
highest point in 2010 or 128.3% then onwards it starts to decrease to 124.7% in
2013.
The current account balance included all the transactions abroad and domestic on
things such as earnings on foreign investment minus payments made to foreign
investors and cash transfers. This is another thing that has hit the Icelandic economy
very had because it is negative by 32.6% during the entire period. Now the current
account balance being so negative in these years will of course have effects on the
ISK kronor.
Due to this the Central Bank of Iceland and the parliament was forced to put capital
control on the Icelandic kronor. On 29th of November 2008 at night the parliament
accepted laws of extensive capital currency control. However in these laws it said if
one did not return foreign currency it could cause imprisonment. That is return
foreign currency after a trip abroad the Spain or something similar. Other things in
these laws were that foreign trade of goods and services should be made in other
currencies than the Icelandic kronor. If this would none been done the ISK kronor
would have depreciated against other currencies too much causing way too high
inflation. 22
6 House owners
Now when we know how the economy has been developing in the twenty first
century it might be a good question to ask our self whether these kinds of mortgages
are the right ones to chosen.
22
Samtök atvinnulífsins : Gjaldeyrishöft hert á Alþingi
31
By having indexation loan the central bank is accepting high inflation and helping
the economy while it should rather try to control the high inflation with their
policies. It was proved before that the Central Bank did not keep their inflationary
goals.
As mentioned before indexation gives the investor zero inflationary risk while it also
gives the house owners zero risk of losing their savings. Indexation mortgages and
bonds have provided the households or the people of Iceland pension, a safer pension
than ever before. The means of this non-inflation risk is that the risk is taken on the
mortgagee by adding it on the principal.
6.1 Households
The impact of the crisis in Iceland might have left some effect on the households
since they are one of the most vital parts of the economy. They consume the goods
and service that companies manufacture and get wages as well. It might be
interesting to see how the households have been dealing with the situation so far.
In Iceland there were 126.000 households in 2009 with an average of 2.5 persons.
When the economy has been developing has it has been it might start to cause
problems for the households. Households are the most important factor of the whole
economy. Once they start to have trouble the whole economy is in stake.
“In the statistic Iceland SILC survey 2009, 7.1% of households said they
were in arrears on mortgage or rent payments in the past 12 months and
10.3% of households was in arrears on other loans during the same period.
In 2009, 39% of households were struggling to make ends meet. Around
15% of household said that housing cost was heavy burden and similar
proportion said that payments on other loans were a heavy burden. Just
below 20% of households could not meet unexpected expenses of 130.000
ISK with the usual household budget in 2009.”23
By reading that it is clear that an average household in Iceland is struggling. When
39% of households are having problems to make ends meet something is going on
in the economy. On average in 2010 Icelanders spent 18% of their disposable
23
Statistic Iceland: financial status of households 2004-2009 : 2
32
income to housing costs. While in Denmark they on average spend 28.6% of their
disposable income. However in 2010 9.6% of Icelanders had overburden housing
cost while in Denmark this proportion was 21%. Even though Denmark spends
more of their disposable income on housing cost Icelanders could be having more
serious difficulties than the Danish population. 24
It is clean that what has happen in the twenty first century, the crises in Iceland is
starting to have some effect of the average household. The households are starting
to have difficulties with paying mortgages, loans and rent. Then it is clear that these
expenses are too high while real wages are too low at that time. In graph 6.1.1
Flexibility of households to meet expenses 2004-2009 it is clear that households do
have difficulties to meet up with unexpected expenses or make ends meet in 2009.
In 2007 the difficult to make ends meet started to raise while it wasn’t till 2008
whereas Can not meet unexpected expenses starts to increase as well. Now both
were at the time just below 30% and a little above 25% then in 2009 it increases to
almost 40% and 30%. There are still lot of people in Iceland that are having
financial difficulties. A reason for increase in these figures is due to high inflation, it
caused normal house goods to increase and therefore mortgages also increases.
Increasing mortgages have the same effect on rent, rent in Iceland is indexed and
therefore becomes higher and higher each year. Increasing costs for rent, mortgages
and goods can cause real wages to decrease.
Graph 6.1.1 Flexibility of households to meet expenses 2004-2009.
Source: statistic Iceland: financial status of household 2004-2009
24
Statistic Iceland: Ráðstöfunartekjur og húsnæðiskostnaður 2011- Disposable income and housing costs 2011: 1-9
33
Now people owe so much in their houses, they have lost millions of kroners if they
didn’t buy them with 100% mortgage rate. People who bought their houses with
some assets have lost them due to increase in mortgages. Those house owners won’t
sell their houses unless it’s worth the mortgage payment. This of course can cause
house prices to go up because people do not want to owe money of a sold house.
People are not willing to accept a price underneath their debt and their debt has
increased more than the real house price. This the author knows by her internship
placement in Iceland at a real estate firm.
After the crisis in there has been a contraction in household’s expenditure. Not only
are households struggling more to make end’s meet but also they have consumed
less than they did before. Expenditure was 17% less in 2010 than they were in 2008.
The most contraction in expenditure was in furniture or 45%, traveling and traveling
costs were contracted by one third and leisure by 28%. However expenditure
regarding houses, electricity and heat did not contract. Another interesting thing is
for example in 2008 only 9% of average household did not own a car but in 2010 it
increased to 15%. This might indicate that people do not afford car nowadays than
they did. So households are trying to spent less money on things that aren’t very
important such as luxury. 25
When households are starting to have difficulties to meet expenses that can indicate
that their debt has increased a lot. The ratio household debt to income rose on
average from 38% points to 138% in advanced economies such as; Denmark,
Iceland, Ireland, Netherlands and Norway. The household’s debt in some countries
peaks too more than 200% of household’s income. Now when this starts to happen
this will of course cause people to go bankrupt, foreclosures etc.
Graph 6.1.2 Household’s financial position 2000-2011 indicates how the
development has been for the Icelandic households.
25 Statistic Iceland: Rannsókn á útgjöldum heimilanna 2008-2010 – Household expentiture survey 2008-2010 : 2-9
34
Graph 6.1.2 Household’s financial position 2000-2011
Source: Taken from IMF paper: Dealing with household debt p. 105
Now in 2000 the debt and assets were very low then in 2002 they started to increase
till 2007. Whereas assets started to decline but debt however started to increase
more. Now assets are increasing once again in 2011 and debt declining a bit. It was
not until 2010 where the debt started to decrease that could be due to the debtor’s
ombudsman and the 110% way (see next chapter). If these two principals were not
made the situation could have been worse in Iceland than anticipated.
6.2 Debtor’s ombudsman
The debtor’s ombudsman was put in place in in august 2010 due to the financial
crisis in 2008 and is underneath the welfare ministry. The main goal for the debtor’s
ombudsman is to help people who are having loan and debt payment difficulties.
The ombudsman should help people to put their debt payments and their loans in a
better condition. The ombudsman should keep the debtor interest in mind not the
creditor’ with as fair means as possible. The duty of the ombudsman is to be a
person who makes the contract between debtor and creditor of credit relief or other
similar means.
One of the things that the debtor’s ombudsman did was called the “110% leiðin” or
the 110% way. The government made a contract with all banks and saving banks in
Iceland. The contract was concerning people who owed more than their estate’s
value was. So therefore it got the name 110% way. A relator valuated the house and
then gave the information to the bank then if it was less than the mortgage of the
35
house it could be reduced to 110% of the real estate’s value. If the mortgage was
12.000.000 ISK and the real estate’s price value was only 8.000.000 ISK the debt
had to be reduced to 8.800.000 ISK. This was valid till 1st of July 2011 and to
everybody that owed more than their house was worth. Graph 6.2.1 The 110% way
of the Debtor’s ombudsman also demonstrates how this method works. 26
Graph 6.2.1 The 110% way of the Debtor’s ombudsman
ISK
110% way
Buying price
Market value
Mortgage
ISK
0
Mortgage
24000000
10000000
Market value
18000000
20000000
Buying price
19000000
30000000
110% way
19800000
Made by the author
In the graph the buying price was 19.000.000 ISK and the real market value was
only 18.000.000 due to decrease in house prices in 2010. Now the mortgage has
gone up due to inflation more than the real market value and is set at 24.000.000.
Therefore the ombudsman can help that household by minimizing the debt to
19.800.000 or 110% of the real market value.
6.3 Wages and real wages
Indexation mortgages are affected by inflation but there are also many other factors
that are affected by the inflation such as wages. If inflation is high in Iceland wages
also need to be raised in order for the real wages not to decrease because of high
inflation. Therefore the author will demonstrate how the wages index has been in
the last two decades. In table 6.3.1 Wage index 1989-2011, annual increase, CPI
index and percentage increase it can be seen how the wage increase has been in
26 Umboðsmaður skuldara : Um umboðsmann skuldara & umsækjendur um greðsluaðlögun og 110% leiðin
36
Iceland since 1989 till 2011. The index started in 1989 at 106.3 and more than two
decades later it has gone up to 401.3. Inflation has big part of this because real
wages should be in hand with the economy. If the wage index didn’t increase by
each year the real wages would therefore be less by each year.
Table 6.3.1 Wage index 1989-2011, annual increase, CPI index and percentage increase
Year
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
Total
increase
Wage index
Annual increase
CPI index
CP % increase
106.3
126.7
21.1
116.1
9.2
145.5
14.8
125.8
8.4
155.4
6.8
129.5
2.9
161.2
3.7
131.3
1.4
167.8
4.1
132.9
1.2
170.3
1.5
138.9
4.5
173.2
1.7
147.8
6.4
177.1
2.3
155.8
5.4
180.3
1.8
170.4
9.4
183.3
1.7
182
6.8
189.6
3.4
194.1
6.6
199.1
5
211.3
8.9
212.4
6.7
226.4
7.1
222.6
4.8
239.1
5.6
227.3
2.1
250.3
4.7
234.6
3.2
267.2
6.8
244.1
4
292.7
9.5
260.6
6.8
319.1
9
273.7
5
345
8.1
307.7
12.4
358.6
3.9
344.6
12
375.8
4.8
363.2
5.4
401.3
6.8
377.7
4
295
137.4
251
134.3
Source: Statistic Iceland
It is also demonstrated how much the CPI has been at the same time. It started at a
rate of 126.7 and in 2011 it was 377.7. The total increase in wage index is 295 for
and 251 for the consumer price index. The percentage increase is very similar or
137.4% for the wage increase while it is 134.3% for the CPI. This shows that the
wages are in hand with the inflation in Iceland. So when the mortgage loans
increase people should be able to pay it due to wage increase. It also shows that
wages have increased more than inflation over the period. This will cause that the
37
real wages have increased in 20-year period but not a lot. Increase in real wages
might cause higher inflation due to higher private consumption.
Real wages can fluctuate with the business cycle a lot due to contracts between
labour unions and the confederation of employers. When the unions make contracts
they usually are valid for some year period. So when suddenly inflation increases
the unions can demand a new contract and if not considered they can put on union
strike. When comparing CPI and wage increase as mentioned before it is important
to look at the real wages to be sure that the information given are correct and valid.
In graph 6.3.2 Real wages increase and decrease 1989-2011 shows how the
development has been in the Icelandic economy. The graph shows how the real
wages have been fluctuation over more than twenty years. In the beginning of the
period real wages were negative and then they became positive again. Then from
1995-2008 real wages have been increasing more and more till the crisis hit Iceland
in 2008. Real wages have then been decreasing by -7.3% in 2009 but in 2011 they
were increasing with 2.6%. On average over the period real wages have been
increasing by 1.13% each year. Meaning that the buying power should be increasing
over the period.
Graph 6.3.2 Real wages increase and decrease 1989-2011
2011
2009
2007
2005
2003
2001
1999
1997
1995
1993
1991
10
8
6
4
2
0
-2
-4
-6
-8
-10
1989
%
Real wages
Annual
increase
Average
Source: Statistic Iceland & author
So the average household in Iceland is having more difficulties than it had before
2007. Even thought real wages increase by each year of 1.13% on average however
these effects are because of negative real wages in 2008-2009 of 11%. Disposable
income is increasing in the future. Wages are following the inflation in the long run
38
so fluctuations in the business cycle should not affect the households in the long
run. It kind of seems irrelevant to have indexed mortgages if real wages always
follow. If inflation is high or by 6.5% then the unions want the wages to increase by
6.5% and therefore cause even more inflation. Cost-push inflation will then occur
and inflation will just be in the economy for as long as wages and inflation follow
the same trend line forever.
7 Mortgage comparison, abolishment and investor’s view
In this last and final chapter the conclusion of the report will be found. The matter
of comparison of mortgages will be addressed. The mortgage that is cheapest for the
house owner will be found.
Then the next chapter will discuss what could happen to the economy if indexation
mortgages are abolished, that will be all theoretical. The final chapter will then
discuss the investor’s point of view and who are the investors.
7.1 Comparison of mortgages
To know whether the house owner, investor and the society is gaining the most by
having indexation mortgages we have to consider another alternative such as nonindexation mortgages. It is not relevant to make a comparison of exchange
mortgages due to the fact in 15th of February 2012 the Highest Court of Iceland
made verdict that they were illegal. However still today nothing has happened in
Iceland for house owners with mortgages in foreign currency. The banks are trying
to find the right solution for this problem or what other say try to stall the problem.
Another reason why I do not find these mortgages fitting is because the currency
exchange rate, some part of the government wants to change to EUROS and there is
no official currency exchange rate of the Icelandic kronor at this time being.
The banks were sued due to the fact that they tried to unlawfully obtain interest of a
paid debt. Where the mortgagee could show a receipt of final payment of the debt
and therefore no need for further interest payment. 27 So this chapter I will go over
the difference of the indexed and non-indexed mortgages and find out which one is
best by which means.
27
Efnahags- og viðskiptaráðuneytið : Áhrif gengisdóms Hæstaréttar frá 15. Febrúar 2012
39
The interest rates for non-indexed mortgages are a bit higher because for the
investor they’re taking more risk or the inflationary risk. A higher risk means that
the investment has to give more back. Non-indexed mortgages have interest rate of
5.65-6.6528 or even higher. It can differ from banks to banks and also customers.
However indexed mortgages are caring less risk and therefore the interest rate of
them can be less. The interest rate for indexed mortgages is 4.10% a bit less or a bit
more. 29
But it isn’t fair to only talk about the interest rate that the house owner has to pay
while comparing these two loans because the principle for indexation mortgage is
that the inflation is added on the principal. Therefore a person taking the more
expensive mortgage or with high interest rate could end up paying less money
because of no inflation added on the principal.
By looking at graph 7.1.1 A normal mortgage of 25 years we can see how a normal
mortgage is with a 25-year principal. Interest rate on that mortgage are 6.65%,
which are the highest, offered by the commercial banks. The interest rate is
becoming less and less by each year that passes. The repayment is therefore
increasing by each year consequently. This principal means that each year a house
owner pays their mortgage they’re increasing their capital in their real estate. Of
course the house owner pays higher interest rate but the real interest rate on indexed
mortgage can even be much higher. Reason being is we add inflation to the
principal and therefore the interest rate of indexed mortgages is higher in the long
run. Interest rate of 4.10% per annum plus 6.5% inflation rate added to the principal
each year will consequently increase the interest rate of the mortgage while a
normal mortgage’s principal will decrease by each payment.
28
29
Íslandsbanki: Óverðtryggiðir vextir
Íslandsbanki: Verðtryggiðir vextir
40
Graph 7.1.1. A normal mortgage of 25 years
Made by the author
Now it will be demonstrated how the 3 different loans look when there is 2.5%
inflation. It will be a mortgage of 20.000.000 ISK kronor with a principal of 40
year. We assume that the entire period there will be the same interest rate and same
inflation therefore. Of course over a period of 40-year this is highly unlikely to
happen but in order to compare them the same principal has to be. Today in Iceland
inflation is 6.5% so these figures are not acceptable and therefore they are
factionary at some extinct.
In table 7.1.2 Comparison of 3-interest rate mortgages are three different mortgages
mentioned. The first is indexed mortgage with 4.10% interest rate, a normal with
5.65% interest rate and the third with 6.65% interest rate.
The table shows how much the first payment is for each mortgage is. It is not a
surprise that the indexed mortgage has the lowest payment for the first year while
the normal mortgages have higher payment. However the last payment for an
indexed mortgage is more than double increased from 1.033.136 to 2.885.641. But
still the normal mortgages have the same payments. This shows the effect of only
2.5% inflation can do for a mortgage over 40-year period. One can only ask how the
inflation is in the long-run when the Central Bank of Iceland has not meet their
inflationary goal since they set them. If inflation is only 2.5% in the long run there
is no need for indexed mortgages however so in that sense this is not valid.
The total payment however shows something different; it shows that an indexed
mortgage isn’t so expensive in the long run and that the normal mortgage with fixed
interest rate of 6.65% for 3-5 years is the most expensive one. Even though the
average payment of the indexed mortgage is higher than all of them.
41
Table 7.1.2 Comparison of 3-interest rate mortgages
Mortgages
Payment 1 year
Last payment
Total payment
Average payment
Inflation 2.5%
Indexed 4.1%
Normal 5.65%
1033136
2885641
31253960
1756084
1271053
1271053
30842139
1271053
Normal 6.65%
1439599
1439599
37583966
1439599
Made by the author using official interest rate from Íslandsbanki
However if this were a real situation, it is likely for the interest rates to be less with
only 2.5% inflation so these numbers are only made up. If inflation is kept 2.5% in
40 years it might be likely to abolish indexed mortgages and have normal interest
rate. It could be less expensive for the house owner. This is based on the
comparison to the Danish interest rates. But in chapter 4.4 Iceland in comparison to
Denmark it shows that the Danish interest rates are low and both long-term and
short-term interest rates are declining.
After explaining how the difference can be of the 3 mortgages with only 2.5%
inflation it might be right to consider how the situation has been in the past 10 years
or so. Inflation has not been so low and therefore this is not acceptable. Therefore it
would be very relevant to show another table that compares indexation mortgages
with inflation of 2.5% and 6.5%. Reason being is in 40-year period the business
cycle will fluctuate a lot and inflation too. When there is crisis the interest rate
might be lowered and vies versa.
In table 7.1.3 Indexation mortgages with different inflation we can see two
mortgages with the same interest rate. The mortgages principles are 20.000.000 ISK
kronor over a period of 40-year. The average payment when the inflation is 6.5% is
4.8 million and it is more than 3 million ISK kronor more than when the inflation is
only 2.5% or 1.7 million in average payment. What is interesting is also the total
payment is more than 35 million ISK more. Not a surprise at all the last payment is
also very high or 11.7 million ISK more. Reason for such a high last-payment is the
interest rates are 4.1% and then the loan increase with each year of 6.5%. Each year
that passes increases the mortgage while it should be decreasing because of repayment. The re-payments do not cover the increase by each year so therefore the
loan increases by each year. Therefore the payments left increase so the mortgage
42
can be paid off at the end of the period and the last year a lump sum has to be paid
else the mortgage will still continue.
If inflation is 6.5% over a period of 40-years every single year wages might keep in
hand with the annual inflation. So maybe the real increase is none if that is the case.
Table 7.1.3 Indexation mortgages with different inflation
Index mortg. 20. millions
Average payment
Total payment
Last payment
Inflation 2.5%
Inflation 6.5%
Difference
1756084
4800263
-3044179
31253960
66881575
-35627615
2885641
14578027
-11692386
Made by the author
But one might ask is it fair for the house owner to bare all the risk of inflation or
should it be divided between the investor and the house owner himself. When
inflation in a country such as Iceland is so high it will of course cause disinvestment. Could the inflationary risk be divided between the house owner and the
investor? Some say that it is not fair for the house owner to bear all the risk and that
they should bear 4% of the inflation perhaps. Then it’s a mutual goal for both
investor’s and house owner to keep inflation low because they will have to pay for
it.
However there are other countries that have dealt with the same situation without
perhaps using indexation. Indexation can causes the Central Bank of Iceland to
accept the high inflation rather then trying to control the inflation by their tools.
Also the government has to take means in their own hands, they have to find the
right unemployment rate since it affects the inflation. The government might have
to think about the long-term affects of low inflation and increase the unemployment.
7.2 Investors
As an investor you always want to make a profitable investment and perhaps with a
medium, low or high risk and therefore with similar profit, low, medium or high. As
demonstrated in previous chapters, investors in Iceland took tremendous risk; high
inflation and not high interest rate.
Now who are the investors in Iceland? The investors are mostly the banks and the
pensions funds. They try to obtain as much profit for their shareholders and also the
Icelandic people paying into the pension schemes.
43
In Iceland there are proximately 32 pension funds with 190.000 pension funds
participants. This means that 2/3 of the Icelandic population is an investor in any
form of the Icelandic economy in 2010. The pension fund’s assets were in 2010
1.909 billion ISK at the end of the year. The biggest pension fund is called
Lífeyrissjóður Starfsmanna Ríkisins or The Pension Fund for the Government
Workers. 30
Now when most of the Icelandic people are investing in pension funds it might
proof interesting for them to invest in indexed mortgages rather then non-indexed
mortgages. They want what their’ invests in to be worth the same when they are
going to retire, especially whereas the situation has been in Iceland. However isn’t
that like taking money from one pocket to another? A little bit but people aren’t the
only ones making the entire profit.
In February 2012 the pension fund’s assets increased by 49,5 billion ISK or 2.3%.
This is the most increase of assets in the last 3 years. The pension’s funds pure asset
is 2.182 billion ISK in 2012 and that is 134% of the GDP of last year. So the
pension funds are making tremendous profit while the households in Iceland are
having difficulties. 31
7.3 Abolishment of indexation
Now after considering how the house owner are, the development of the economy
the abolishment of indexation will be discussed.
Maybe the investors could make even more profit in the long run if they stopped
having indexation mortgages available. Since 1984 the interest rate have been
decided by the market forces this might help the economy much more.
The situation could develop into this; the Icelandic government puts new laws in
Iceland for abolishment of indexation laws. Now I will not terminate what the
government will 100% do but I can perhaps elaborate what could happen.
This could have the consequences of interest rates going very much up. Now lets
theoretically terminate that the interest rate would be the same as inflation plus
interest rates. Now today in Iceland the inflation is 6.5% and the interest rate on
indexed mortgages are 4.1 so the interest rates would go to 10.6% perhaps.
30
31
Landssamtök lífeyrissjóða : Um samtökin
MBL: veruleg hækkun á eignum lífeyrissjóðanna
44
At an interest rate of 10.6% of a mortgage for 40 years few or almost no people will
afford these mortgages. Now when people cannot afford these loans there could be
some consequences; people will stop buying real estates and investments will go
down, higher unemployment rate, GDP growth down and disinflation.
Now real estate prices are then declining because suddenly people pay 10.6%
interest rate of a house, that’s way too expensive. The housing market will therefore
recover at a certain number and that will be the new equilibrium. Meaning the index
will be set at a new number perhaps from 218 to maybe 110. Reason for house
prices declining is they are too expensive for people to buy them.
When house prices decline by such a number this will cause high deflation but the
author does not believe that this will be for the long turn. It will only be till the
equilibrium is found. This causes another crises and it is not known for how long
time it might take for the economy to recover or adapt. These are the worst things
regarding this.
When house prices go down this causes deflation in the economy. Therefore
indexed mortgages will not be higher than the house price of the real estate. So the
whole economy will be reset in some state. In other words if a mortgage is taken out
at a price of 20.000.000 and suddenly there is disinflation by 5%, the mortgage will
therefore decrease by 5% per annum.
Now when there is deflation, interest rates will therefore also not be 10.6% anymore
because the inflationary risk will be negative. The new interest rate could be for
example 2% but we don’t know. At that time the new equilibrium will be found
once again and house prices start to become stable. People will start to buy houses
and everything will be set to normal. People with indexed mortgages will however
still have to pay their mortgages. Perhaps the government could then order the
banks to change these mortgages to normal ones if requested by the mortgagee.
During this reform period unemployment rate will be high. Companies will not
afford to have high employment. But when the equilibrium is found the
unemployment rate will start to decrease and the crises might be gone. When the
equilibrium is set the government has to increase their consumption to make sure
that unemployment rate decreases and private consumption increases as well. Once
when private consumption is up the investments and employment will also increase.
Then when these both have increased the government can cut their consumption.
45
Then the big issue is; can the Central bank of Iceland keep the inflationary goal.
Now it is more motivated to keep the inflationary target elsewise the interest rate
will increase too much. Too high interest rates will cause the house prices to decline
once again till they’re in the equilibrium.
The flaw of indexation is however if the inflation increases it will not have the same
effect on the house prices because it causes them to go up when they should go
down. Increase in inflation causes people not to sell when they should and
mortgages to increase.
However there are some good things by having indexation of course apart from the
inflation risk for example; if the government wants to cut the private consumption
they can increase taxes. Increasing taxes will cause people’s disposable income to
decrease even more due to higher inflation and therefore higher mortgage payments.
It might be attractive for investors in long term not to use indexed mortgages.
Investors using indexation say it’s to avoid inflationary risk however it can also
cause the central banks to not use their monetarily or fiscal policies up to it’s
potentials. In the short term abolishing indexation will cause the economy to have
probably even higher recession but one has to think about the long term for the
economy in whole.
8. Conclusion
The conclusion of this project is very divided into two different ways both for the
investors’ point of view and also house owners. They have different things in stake
but of course it has to be weighted which house owner’s best interest in mind.
In comparison with the loans the conclusion was that the indexed mortgage was
cheap, when there was low inflation. However when there is high inflation it
becomes very expensive for the house owner. The question is, is it fair for the house
owner to bear all the inflationary risk while the investor does not have to bear any of
it. It does not seem very right for the house owner to bear it all. Even if his wages
increase with the inflation but that is because they have to.
I say they should be abolished on the grounds that it might become better for the
economy in the long run. Iceland doesn’t suffer from inflation above 10% like it did
in the ninetieth century and had different situation now. Now is not the time to do it
but perhaps in the future when the economy has recovered from the 2008 crises.
46
If indexation wouldn’t be in Iceland it would just cause interest rate to be higher
however. Too high interest rates will cause that people won’t buy houses and house
prices will therefore be less and causing deflation. When house prices have
decreased at some point people will be able to afford them even if the interest rates
are high. Now the economy might have had deflation for some time but in the long
run it might pay off.
In the long run there is less inflationary risk if indexation is abolished, since
increase on house prices can cause even more increase and higher inflation due to
indexation.
Indexation is like a dog, it bites it own tail and runs around in circles. There is no
way out unless drastic measures are taken and the right thing to do is to abolish
indexation. Indexation is like a cost-push inflation added on each other, year after
year.
If it is not possible there could be set some kind of rules of indexation, that it is only
up to 4% of inflation per annum that is added on the principal. The house owner
should bear the first 4% of inflation and then the investor rest of it. Then the whole
society has to try to keep inflation low and everybody wins, not just the investors
but also house owners.
47
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verðtryggingar. Háskólinn á Akureyri. 2010
Escolano, Julio et al. Improving the Equity and Revenue Productivity of the
Icelandic Tax System. International monetary fund. 2010.
Jónsson, Bjarni Bragi. Financial indexation and interest rate policy in Iceland.
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Michelis, Andrea De. Iceland: challenging times for monetary and fiscal policies
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Websites:
Alþingi. Lög um stjórn efnahagsmála o.fl. - Legislation on economic policy, etc.
Taken 2nd of Mai 2012
http://www.althingi.is/lagas/136b/1979013.401.html
Efnahags- og viðskiptaráðuneytið. Áhrif gengisdóms Hæstaréttar frá 15. Febrúar 2012 The depreciation of debt Supreme Court of 15 February 2012
48
Taken on the 21st of Mai 2012.
http://www.efnahagsraduneyti.is/frettir/frettatilkynningar/nr/3522
Forsætisráðuneytið. Alþjóðagjaldeyrissjóðurinn samþykkir efnahagsáætlun og lán til Íslands - The
IMF approves the reform and a loan to Iceland.
Taken on the 21st of Mai 2012.
http://www.forsaetisraduneyti.is/frettir/nr/3271
IceNews. Large increase in people moving abroad away from Iceland
Taken on the 10th of mai 2012
http://www.icenews.is/index.php/2009/05/22/large-increase-in-people-movingaway-from-iceland/
Íbúðarlánasjóður. Lán til íbúðarkaupa – Loans for owner occupied housing.
Taken 11th of mai 2012.
https://www.ils.is/einstaklingar/lan/lan-til-ibudarkaupa/
Íslandsbanki. Verðtryggið húsnæðislán – Indexation mortgages.
Óverðtryggið húsnæðislán – Non-indexation mortgages
Taken 2nd of Mai 2012
http://www.islandsbanki.is/einstaklingar/lan/husnaedislan/verdtryggt-husnaedislan/
http://www.islandsbanki.is/einstaklingar/lan/husnaedislan/overdtryggt-husnaedislan/
Landssamtök lífeyrissjóða. Um samtökin
Taken on the 22nd of Mai 2012.
http://www.ll.is/?i=86
Mbl. Veruleg hækkun á eignum lífeyrissjóðana – Tremendous increase in pension fund’s assets.
Taken on the 23rd of Mai 2012.
http://www.mbl.is/vidskipti/frettir/2012/04/10/haekkun_a_eignum_lifeyrissjodanna/
OECD. Statistic from A to Z
Taken on various dates.
49
http://www.oecd.org/document/0,3746,en_2649_201185_46462759_1_1_1_1,00.ht
ml
Oanda. Historical exchange rates.
Taken on the 10th of Mai 2012.
http://www.oanda.com/currency/historical-rates/
Realkreditrådet. Main types of mortgage loans
Taken on the 11th of mai 2012
http://www.realkreditraadet.dk/Danish_Mortgage_Model/Main_types_of_mortgage
_loan.aspx
Ríkisskatstjóri. Reiknivél ríkisskatstjóra. Vaxtabætur & Vaxtabætur – Almennt.
Taken on the 21st of Mai 2012.
http://www.rikisskattstjori.is/reiknivelar/nidurstodur/vara_reiknivel_vaxtabota_2.as
p
Samtök Atvinnulífsins. Gjaldeyrishöft hert á Alþingi – Tighten currency control by the Althing.
Taken on the 23rd of Mai 2012.
http://www.sa.is/frettir/eldra/nr/4460/
Skat. Marginal tax rates.
Taken on the 21st of Mai 2012.
http://www.skat.dk/SKAT.aspx?oId=1880409&vId=0
Statistic Iceland. Financial status of households 2004-2009
Taken on the 20th of Mai 2012.
http://www.statice.is/Pages/444?NewsID=5164
Statistic Iceland. New base for the Icelandic consumer price index.
Taken 2nd of Mai 2012
http://www.statice.is/Pages/1102
Umboðsmaður skuldara : Um umboðsmann skuldara – About debtor’s ombudsman.
Taken on the 17th of Mai
50
http://www.ums.is/um-umbodsmann/
Þjóðviljinn. Tilkynning frá félagsmálaráðuneytinu um skyldusparnað – An announcement from the
social ministry of mandatory savings.
From December 1958.
Taken on the 15th of Mai 2012.
http://timarit.is/view_page_init.jsp?pageId=2783182&lang=en
51
Appendix
1.1 Regression analysis of inflation and long-term interest – correlation between
two different variables. Using OECD database and Bewistat
HOVEDTAL FRA REGRESSIONSANALYSEN
(Resultaterne er angivet med en præcision på 6 decimaler- værdier under decimalgrænsen angives med ~ 0)
Responsvariabel: Inflation
R-kvadreret
Justeret R-kvadreret
Standardafvigelse
Observationer
0,147463
0,090627
3,196139
17
(Determinationskoefficient)
Varians = 10,215302
KVADRATSUMMER OG F-TEST
Regression
Residual
I alt (SAKy)
Frihedsgrader
1
15
16
Kvadratsum
26,504006
153,229535
179,733542
F-værdi
2,59454
p-værdi(ss)
0,128071
KOEFFICIENTER OG KONFIDENSINTERVALLER
95%-konfidensintervaller
Koefficienter Standardafv. n. grænse
ø. grænse
Skæring
-2,965416
4,82287
-13,24512
7,314288
Long-term interest rate 0,888739
0,551752
-0,287293
2,064771
KOEFFICIENTTESTS
Skæring
Koefficienter
-2,965416
Long-term interest rate 0,888739
t-stat
-0,614865
p-værdi(ss)
tosidet
0,547858
p-værdi(ss)
ensidet
0,273929
H1
tosidet
b0 ≠ 0
H1
ensidet
b0 < 0
1,610757
0,128071
0,064035
b1 ≠ 0
b1 > 0
52
1.2 Regression analysis of inflation and short-term interest – correlation between
two different variables. Using OECD database and Bewistat.
HOVEDTAL FRA REGRESSIONSANALYSEN
(Resultaterne er angivet med en præcision på 6 decimaler- værdier under decimalgrænsen angives
med ~ 0)
Responsvariabel: Inflation
R-kvadreret
Justeret R-kvadreret
Standardafvigelse
Observationer
0,596057
0,569128
2,200031
17
(Determinationskoefficient)
Varians = 4,840135
KVADRATSUMMER OG F-TEST
F-værdi
22,133996
p-værdi(ss)
0,000282
Standardafv.
1,682845
0,173417
95% confidence
n. grænse
-6,393563
0,446241
ø. grænse
0,780234
1,185499
Koefficienter
t-stat
p-værdi(ss)
tosidet
p-value
ensidet
H1
tosidet
H1
ensidet
Skæring
-2,806664
-1,667809
0,116089
0,058045
b0 ≠ 0
b0 < 0
Short-term interest rate
0,81587
4,704678
0,000282
0,000141
b1 ≠ 0
b1 > 0
Regression
Residual
I alt (SAKy)
Frihedsgrader
1
15
16
Kvadratsum
107,131521
72,60202
179,733542
KOEFFICIENTER OG KONFIDENSINTERVALLER
Skæring
Short-term interest rate
Koefficienter
-2,806664
0,81587
KOEFFICIENTTESTS
53
1.3 Regression analyze of two different variables – regression line of unemployment
rate and inflation. Using OECD and Statistic Iceland’s database and Bewistat.
HOVEDTAL FRA REGRESSIONSANALYSEN
(Resultaterne er angivet med en præcision på 6 decimaler- værdier under decimalgrænsen angives med ~
0)
Responsvariabel: Unemployment rate
R-kvadreret
Justeret R-kvadreret
Standardafvigelse
Observationer
0,203447
0,17598
2,034639
31
(Determinationskoefficient)
Varians = 4,139754
KVADRATSUMMER OG F-TEST
Regression
Residual
I alt (SAKy)
Frihedsgrader
1
29
30
Kvadratsum
30,662613
120,052871
150,715484
F-værdi
7,406868
KOEFFICIENTER OG KONFIDENSINTERVALLER
95% confidence
Koefficienter Standardafv. n. grænse
Skæring
3,456624
0,472386
2,490486
Inflation
-0,050058
0,018393
-0,087677
p-værdi(ss)
0,010874
ø. grænse
4,422763
-0,01244
KOEFFICIENTTESTS
Skæring
Inflation
Koefficienter
3,456624
-0,050058
t-stat
7,317366
-2,721556
p-værdi(ss)
tosidet
~0
0,010874
54
p-værdi(ss)
ensidet
~0
0,005437
H1
tosidet
b0 ≠ 0
b1 ≠ 0
H1
ensidet
b0 > 0
b1 < 0