Frequently asked questions

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Frequently asked questions about the Icelandic CPI

 

What is the consumer price index (CPI)?

The CPI is the most common tool for measuring general price changes, i.e. inflation. The CPI measures monthly price changes of a fixed basket of goods and services which form the base of the index. The basket is made up of the estimated expenditure on goods and services of an average household over a whole year. It is not meant to  measure volume changes of household consumption or changes in expenditure patterns.The CPI is compiled in accordance with international standards.

For what purpose is the CPI compiled?

The main purpose of the CPI is to measure inflation, i.e. changes in the value or purchasing power of money. For comparing specific expenditure or income over a period of time it is necessary to be able to differentiate between changes in nominal and real terms (i.e. price and volume changes) and base the comparison on unchanged purchasing power (value) of money. Furthermore, inflation is one of the main measures of stability in the economy.

Is the CPI based on legislation?

Yes, the CPI is based on the Act on the Consumer Price Index no. 12/1995 (with subsequent changes). The Act prescribes that the CPI shall measure changes in prices of private household consumption and that it shall be based on the findings of a household expenditure survey.

How is the index base determined?

The household expenditure survey of Statistics Iceland is the main instrument for establishing the base of the CPI. Since the beginning of the year 2000, the household expenditure survey has been continuous, i.e. it has been ongoing every year the whole year through. The base of the CPI is renewed every year.

How is the methodology for compiling the CPI determined?

According to the Act on the Consumer Price Index, Statistics Iceland shall establish the index basket on the basis of a household expenditure survey and other available sources and decide on the methodology for compiling the CPI. The methods applied by Statistics Iceland are based on international recommendations and instructions and are fully harmonized with the methods recommended in EU regulations. Since 1992, Statistics Iceland has participated in comprehensive international cooperation together with world leading index experts ensuring that the compilation of the CPI is in accordance with mainstream methodology.

For how long has the CPI been compiled?

The CPI has been compiled since 1922 but was at the outset calculated back to the year 1914. The index basket was first based on a consumer expenditure survey in 1939. In the last few years, the methods used for the basing and the compilation of the CPI have undergone radical changes. The index is now rebased annually and the index is therefore subject to a continuous renewal.

How is the household expenditure measured?

Statistics Iceland carries out a continuous household expenditure survey. This is a sample survey involving 1,200 households every year. Results for three years household expenditure survey are used for annual rebasing of the index.

How often is the index basket renewed and what are the main sources for that?

The index basket is renewed (the index is rebased) in March every year. For that, Statistics Iceland utilizes the results of a household expenditure survey as well as various other sources available at the time of the renewal, such as data on new car registrations, information on real estate valuation for calculating owner occupied housing cost, sales data from the State Alcohol and Tobacco Company (government monopoly), data on private insurance from the Financial Supervisory Authority, data on lotteries and on VAT turnover.

How is the regular CPI compiled?

The CPI is compiled every month. Statistics Iceland collects data on prices of some 3,500 items of goods and services in the whole country for approximately one week in the middle of each month. Some 18,000 price quotations are utilized for the calculation. Price data are collected through visits to grocery and clothing stores, through e-mails and faxes from a large number of firms, price data are observed on firms’ websites and some 300 firms render price data over the telephone. In addition to this, data are obtained directly from the databases of various firms and institutions. The sample of outlets is selected for each component of the index, either randomly or on the basis of data on turnover. The selection of goods and services in the basket is based on the household expenditure survey.

How are CPIs calculated in other countries?

Other countries compile their CPI’s in very much the same way as is done in Iceland. In all developed countries, the CPI’s are based on household expenditure surveys and the baskets are renewed at regular intervals, annually or every few years. The CPI’s are calculated on a fixed basis with a household basket of goods and services being used as the index base. The most common practice is that the basket reflects annual expenditure. Most countries compile their CPI’s every month. Such CPI’s are used as measures of inflation all over the world.

Do changes in consumption affect the CPI?

No, changes in buying patterns of this type have an impact on household expenditure (cost-of-living) but not on consumer prices.The consumer price index does not measure volume changes of the index basket but rather the price changes of the goods and services which the basket contains. A fall or an increase in household consumption does therefore not have an impact on the results of the calculation of the CPI. It is well known that when purchasing power rises households have a tendency to buy more expensive goods than before and that many households will meet a fall in purchasing power by switching their purchases from expensive to inexpensive items. For example, if a household substitute expensive steaks with inexpensive processed meat it does not constitute a price reduction in the CPI as these are not comparable goods. The same applies if purchasing power rises, leading households to switch to more expensive items (buying steaks more frequently than before), that it will not be measured as a price rise in the CPI.

Do changes in buying patterns affect the CPI?

Yes, a switch in the purchases of households away from relatively high price supermarkets towards low-price stores may have an impact on the CPI. Although the economic situation changes households will continue to buy many of the most common consumer goods, but their prices may differ substantially between shops. Many households will adapt to reduced purchasing power by becoming more price sensitive and actively seek out the lowest available prices. This does not constitute a change in consumption but rather a change in buying patterns. Statistics Iceland monitors changes in the weight of different outlets in the household expenditure survey and renews the weights of outlets every time the index is rebased. The outlet weights are used in the calculation of price changes of everyday items in the CPI every month.

What is meant by purchasing power?

Purchasing power measures how much of goods and services can be bought for the wages and salaries earned. Unchanged purchasing power, from one year to the next, means that the household can buy a basket of goods and services of the same size as the year before. Purchasing power is most often calculated as the change in wages and salaries relative to the change in the CPI. Purchasing power increases when wages and salaries rise more than prices but decreases when the rate of inflation is higher than the rate of increase of wages and salaries.

What is done if a good or a service disappears?

If an item of goods and services is not available but is expected to become available soon again or it is not possible to replace it immediately in the basket, the price is kept unchanged from the previous month. This method is one which is accepted and applied internationally.

What is done if an outlet closes?

If a shop or another point of sale is closed down the calculation of the CPI will utilize price changes of goods and services in the outlets which are still in the sample. Statistics Iceland renews the samples as soon as outlets or items become unavailable.

How are increased non-monetary housing payments treated in the compilation of the CPI?

A real estate price index is used in the calculation of user cost of owner occupied housing. The housing market prices are based on sales contracts that include payment arrangement details. The cash price is calculated as the present value of the contract price at a given nominal rate of interest or a rate of return, dependent on the means of payment. In housing trade, real estate or liquid assets may constitute a part of the payment for the purchase of a dwelling. Around mid-year 2008, these types of housing transactions became increasingly common, and at the present time (March 2009) the share of housing purchase contracts involving non-monetary payments constitute 25-30% of all housing purchase contracts. For the calculation of the housing component of the CPI, the assumption of the required rate of return, which is based on the rate of inflation and the highest real mortgage rates, has been changed every month since October 2008. The required rate of interest for such transactions is around 25% in March 2009 which entails that the nominal value of the real estate used for payment in housing purchases is reduced by one quarter when calculating the present value of the sales price. 

Will Statistics Iceland react to changes in consumption pattern at the time of rebasing of the index in March 2009?

Yes, Statistics Iceland is currently (March 2009) working on the annual rebasing of the CPI, i.e. renewing the composition of the basket of goods and services which constitutes the index base. The rebased CPI compiled on the renewed basis of March 2009 will be released on 28 April 2009. The new basket will be based on the results of the household budget survey of 2005-2007. The car component will be revised with respect to new registration data and new data will be obtained for airfares between Iceland and other countries and for package tours abroad. All items are reviewed on the basis of available data, such as on VAT turnover, as has been done on every occasion of rebasing the index during the last decade. Furthermore, a special attention will be paid to changes in buying pattern.

How is the collapse in car sales following the economic crisis 2008 treated?

Household purchases of private cars have a weight of 7% in the CPI and this is the component in the index which is most easily affected by changes in economic conditions. In October 2008, list prices of new cars rose by 4.1%. As car sales came largely to a stop, this rise in list prices was considered to be unrealistic and was therefore not included in the CPI (effect on the change in the CPI: -0.3%). Statistics Iceland has from November 2008 only included price changes of car sales where transaction has taken place.

What are the effects of the change in the treatment of the car component?

If the method of collecting price data and calculating the car component had been kept unchanged the CPI would have shown a rate of inflation just over 1% higher from November 2008 to February 2009. If the weight for cars had been excluded from the CPI altogether the CPI would have shown a 0.2% higher rate of inflation than it did as the weight of other items would then have increased.

How are package holidays treated in the CPI?

Prices and the weight of package holidays were measured in the CPI in February 2009 using the same method as in the case of cars, i.e. only sold package tours were included.

Has the CPI always been used for indexation of financial obligations?

When indexation of financial assets was permitted by law in 1979 the Central Bank of Iceland calculated a composite index to be used for indexation purposes which was based on the then prevailing cost-of-living index and the building cost index. In 1989 a wage index was added to this composite index. In 1995, a new Act on the Consumer Price Index was enacted replacing the earlier cost-of-living index. At the same time it was decided by law on interest rates and indexation, no. 38/2001 with subsequent changes, that indexation should solely be based on the CPI.

How is the method of indexation determined of savings and credit?

The indexation of savings and credit is based on the Act on Interest Rates and Indexation no. 38/2001 with subsequent changes. The act states that savings and credit may be indexed if the indexation is based on the CPI. The decision to apply the CPI for indexation purposes is thus not made by Statistics Iceland which is mandated to compile the CPI in accordance with the CPI Act, No 12 1995, and international practice.

Is it necessary to use the CPI for indexation purposes of savings and credit?

The use of the CPI for indexation purposes is always a political decision and there are of course other price indices which can be used. The decision to utilize the CPI alone for indexation was based on the arguments that it was an advantage to use a yardstick which is general in nature, comprehensive and recognized both within the country and abroad.

Are there other price indices which are related to the CPI?

There has long been a need for more measures or indicators on price changes than the aggregate CPI. Thus, Statistics Iceland has always compiled the CPI less housing cost where the entire housing component is excluded. Statistics Iceland also calculates monthly several sub-indices and constant tax-rate indices where certain expenditure components are excluded. This is mainly done for analytical purposes.

What is the difference between the compilation of the CPI and the harmonized price index?

The harmonized price index, which is compiled in all the EEA-member states, is similar to the domestic CPI. The scope of the two indices is somewhat different, however, mainly in two respects; foreign tourist expenditures in Iceland are included in the base of the harmonized EEA index but not in the CPI, and owner occupied housing cost, which is included in the CPI, is as yet not included in the base of the harmonized EEA index. The compilation methods and the price quotations used in the compilations are the same in both the indices.

Why is the cost of owner-occupied housing not included in the harmonized EEA index?

From the beginning of the preparation and the compilation of the harmonized index it has been the plan to include owner occupied housing in the harmonized index and use a real estate price index for monthly calculations. This has not been done yet as sufficiently reliable real estate price indices have only been available in few EU member states. The central statistical office of the EU, Eurostat, has during the past few years allocated vast resourses assisting the member states in establishing real estate price indices which can be compiled with sufficient security, regularity and timeliness.


 

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