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What sets the trend? The evolution and drivers of Icelandic trend inflation

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  • Bjarni G. Einarsson;Thórarinn G. Pétursson

Abstract

We use Bayesian methods to estimate a model of trend inflation in Iceland, allowing for stochastic volatility in both the trend and cyclical components of inflation and a time-varying persistence of deviation of inflation from its trend. Our results show that although trend inflation has fallen and become more stable since the mid-1980s, most of the improvements in overall inflation performance in Iceland reflects a decline in the volatility and persistence of the cyclical component of inflation. At the same time, our results suggest that the share of overall inflation dynamics accounted for by the trend component has significantly risen in recent years. We also find that the trend continues to be more volatile than in other advanced economies, largely reflecting less firmly anchored inflation expectations and, more recently, the interaction of weakly anchored inflation expectations and large global supply shocks.

Suggested Citation

  • Bjarni G. Einarsson;Thórarinn G. Pétursson, 2026. "What sets the trend? The evolution and drivers of Icelandic trend inflation," Economics wp100, Department of Economics, Central bank of Iceland.
    • Handle: RePEc:ice:wpaper:wp100
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    More about this item

    JEL classification:

    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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