Few people have failed to notice that it is now more expensive to fill up your trolley at the supermarket, and that almost everything else costs more than it did. A general increase in prices like this is called inflation.
Inflation is a measure of how much consumer prices have risen. That is, how much more consumers have to pay for goods and services. If the rate of inflation has been 5 per cent over the past year, then you have to pay kr. 105 to buy the same goods and services that would have cost you kr. 100 a year ago.
If inflation is high, your money effectively becomes worth less because you are not able to buy as much for it. In other words, inflation erodes the value of money.
High inflation also leads to more volatile inflation. When future prices become harder to predict, it becomes harder for citizens and businesses to make financial decisions. This is to the detriment of the country’s economy as a whole.
Denmark, like most other countries, aims to keep inflation at a low and stable level.
How high is inflation in Denmark?
In Denmark, Statistics Denmark publishes the Consumer Price Index (CPI) every month, which sheds light on the development in prices for the goods and services bought by private households in Denmark. Here, Statistics Denmark compares the percentage change in prices compared to the prior-year period.
The CPI is calculated on the basis of approx. 25,000 prices collected from approx. 1,800 shops, companies and institutions across the country. The prices of the individual goods and services are included in the CPI with a weighting based on their share of the total average consumption across all Danes. Here, it is important to note two things. First, the CPI is thus a measure of the development in prices of the goods and services that the average Dane buys. However, it also means that your shopping basket may look different to how it usually looks. Second, the index expresses the average price increase. Therefore, the index may well rise even though some prices fall. This happens if other prices increase accordingly.
How can central banks influence inflation?
Central banks play an important role with regard to inflation, as they are responsible for ensuring stable prices in society.
The main tool that central banks have at their disposal to influence inflation is interest rates. The central banks can change the interest rate which ordinary banks have to pay to have money on deposit with the central bank, and this affects other interest rates in society. By raising interest rates and making it more expensive to borrow money for consumption and investment, central banks can suppress demand in the economy and thus inflation. On the other hand, central banks can also cut interest rates to stimulate demand.
In the euro area, the European Central Bank (ECB) works for low and stable inflation. The ECB has an inflation target rate of 2 per cent in the medium term.
Inflation expectations also a factor
When a central bank like the ECB works to achieve a particular inflation target in some years’ time, inflation expectations play an important role. This is because people’s expectations of how prices are likely to develop in future affect the way they spend, borrow and invest money. Therefore, inflation expectations are also important when the ECB assesses what to do to meet its ambition of price stability.
What is Danmarks Nationalbank doing to ensure low and stable inflation?
As Denmark’s central bank, one of Danmarks Nationalbank’s most important tasks is to ensure stable prices.
Denmark has the so-called fixed exchange rate policy, which means that Danmarks Nationalbank constantly ensures that the exchange rate between the Danish krone and the euro is pegged. This is why one euro always costs about kr. 7.50.
By pegging the krone to the euro, Danmarks Nationalbank ensures that the price level – and thus inflation – is always the same in Denmark as in the euro area. In this way, Denmark is able to ‘import’ the price stability which the ECB is working to maintain.
Development in inflation since the introduction of the fixed exchange rate policy
Falling prices can bring the economy to a standstill
The ECB does not have a target inflation rate of 0 per cent as this would entail a considerable risk of inflation turning negative. If prices in society are generally decreasing, it is called deflation. Deflation can cause people to postpone their purchases of goods and services because they expect to be able to buy them cheaper at a later date. And if everyone follows suit, it can bring the economy to a standstill.
Hyperinflation – when inflation runs out of control
The disadvantages of inflation become clearer when we look at more extreme cases. Throughout history, there have been several examples of what extremely high inflation – or hyperinflation – can lead to. This was seen, for example, in Germany in the 1920s.
At its peak, the rate of inflation reached a staggering 300,000 per cent a year. Prices increased so quickly and by so much that money became useless as a means of payment. A newspaper cost 200 trillion marks, you had to transport the money to pay for a loaf of bread from the bakery in a wheelbarrow, and people started using banknotes as wallpaper. When you were paid, it was a question of spending the money as quickly as possible before it lost all its value. In 2018, Venezuela experienced a similar situation, with inflation in excess of 10,000 per cent a year.
From low to high inflation
After many decades of low inflation, inflation increased in the wake of the covid-19 pandemic and Russia’s invasion of Ukraine.
Supply of goods and services limited during the lockdowns
When the pandemic broke out in early 2020, countries around the world shut down completely. The lockdowns and subsequent reopenings resulted in sudden and widespread disruptions to the global economy. Also, the lockdowns meant that it was not possible to buy many of the usual goods and services. During the lockdowns, for example, there were limited opportunities to go away on holiday, go to the cinema or to eat out.
Demand strongly stimulated during and after the lockdowns
Combined with the limited supply of goods and services during the lockdowns, both politicians and central banks sought to avoid an excessive downturn in the economy. They did so by, among other things, trying to support demand.
Political decision-makers issued large relief packages, and in Denmark, for example, frozen holiday pay was disbursed. Central banks also pursued accommodative monetary policies by, for example, keeping interest rates low and intervening with large asset purchase programmes in the financial markets.
Global supply chain challenges spread
Together with the disruptions in supply and demand caused by the lockdowns, there were also significant challenges with global supply chains. Many of the container ships that were due to transport goods manufactured in China to consumers in Europe and the USA, for example, were in the wrong places after much of the shipping traffic ground to a halt during the pandemic. On top of everything, the container ship Ever Given, one of the largest in the world, grounded in and lay across the Suez Canal for almost a week in March 2021, thus blocking one of the world’s most important shipping routes.
The sharp increase in demand and limited supply contributed to the increase in inflation.
War in Ukraine forced up energy and food prices
Inflation was further affected by Russia’s invasion of Ukraine in February 2022. Russia is a major oil and gas exporter, and the invasion and the resulting political tensions contributed to further increases in energy prices. This was particularly true in Europe, which up until the start of the war was a big importer of Russian gas, but which has since experienced significant supply restrictions. This led to dramatic increases in the price of gas in particular. As many countries, for example Germany, also use gas to generate electricity, electricity prices also soared. Today, gas storage facilities around Europa are filled again, and the prices on gas and electricity have come down.
Russia and Ukraine are major exporters of food, and the invasion therefore also had a big impact on food prices, which are still elevated today, though the price increases have leveled off.
If you would like to learn more about how Danmarks Nationalbank expects inflation to develop in future, you can read our latest forecast for the Danish economy.
Want to know more about inflation?