A bountiful quarter-century for Icelandic households

Disposable income per capita in Iceland has risen by 90% in real terms in the past quarter-century. It is expected to shrink this year, however, owing to increased unemployment, relatively high inflation, difficult operating conditions for many small companies, and declining investment income. In all likelihood, though, the blow to disposable income will be both smaller and much more unequally distributed than it was a decade ago.

In 2019, disposable income per capita rose by 3.8% and real disposable income per capita by 0.7%, according to new figures from Statistics Iceland (SI). Disposable income totalled nearly ISK 4.3m per person in 2019 and has increased by a third in real terms in the past decade. Actually, in real terms, it was ISK 100,000 higher per person than at the peak of the upswing in the mid-2000s.

But it is just as interesting to look further back in time. SI’s figures extend back to 1994, thereby covering 25 years. Over that period, disposable income per capita has risen by 90% after adjusting for inflation. In other words, Icelanders have managed to boost their disposable income by an average of 2.6% per year over this period, in spite of the various shocks to the economy. This is a trend that is more often seen in emerging countries, and probably not one that has many parallels among advanced economies.

Purchasing power moves in line with the business cycle

Developments in real disposable income have tracked the business cycle quite well in recent years. As can be seen in the chart, after a steep drop at the beginning of the 2010s, purchasing power grew perhaps the fastest around the middle of the decade, owing to strong income growth coupled with low inflation. Since then, disposable income growth has eased and inflation has gained momentum. By this measure, disposable income growth in 2019 was the weakest seen since 2013.

The chart also shows the year-on-year change in the number of tourists visiting the country each year since 2003. Although the economic history of the past decade is considerably more complex than can be illustrated in a simple comparison of the two variables in the chart, it can be said that this comparison shows both one of the main drivers of the cycle and one of its key implications.  The rise of the tourism sector has boosted activity throughout the domestic economy by bringing in rapidly rising export revenues at a time when a stronger ISK (largely the result of those revenues) kept inflation in check. 

Marked changes in investment income and expense

Developments in investment income and expense in the past quarter-century tell the story of marked change in the Icelandic economy. In 2019, for example, households’ interest income per capita was only a fourth of what it was in 2008. This should come as no surprise, since interest rates today are a fraction of those seen in the 2000s. This refers, of course, to nominal interest rates, and it is probably better to use 2007 as the comparison year since real interest rates were considerably higher then, while inflation surged in 2008. The chart shows that in 2019, per capita dividends on shareholdings (in ISK terms) came close to the level seen in 2007. The difference, though – and it is a favourable difference – is that last year’s returns were based on a much more solid foundation than those just over a decade ago.

It is also interesting to examine developments in households’ interest expense. Last year, interest expense totalled ISK 79bn, as opposed to just under ISK 20bn at the turn of the century and ISK 61bn a decade ago. On the other hand, Icelanders’ total residential property holdings totalled ISK 4,557bn in 2019, as compared with ISK 851bn at the turn of the century and ISK 2,255bn a decade ago. In other words, Icelanders’ gross property holdings have doubled in the past decade and grown fivefold since the turn of the century, while mortgage interest expense has risen by 29% since 2010 and 286% since 2000. This reflects both that households’ asset position is stronger and that their mortgage interest expense is falling.

Decline in disposable income unequally distributed in the COVID crisis

Presumably, 2020 will be the first year since 2013 to see a contraction in disposable income per capita. Real wages will grow by about 3%, based on developments year-to-date in the wage index and consumer prices, together with the outlook for the final months of the year. On the other hand, rising unemployment will cleave a hefty slice out of disposable income for the affected households. Investment income will probably be weaker as well, and business owners’ profits will probably shrink significantly, as there are a large number of sole proprietors and small firms in the tourist industry. This is offset in part by a small – or even non-existent – year-on-year increase in interest expense, and net transfers will presumably be much more strongly positive than in recent years, owing to the surge in benefits payments during a period of moderately rising taxes.

The COVID-induced decline in disposable income will probably be much smaller, on average, than the drop in 2009-2010, when real disposable income shrank by an average of nearly one-fourth. But this will be cold comfort to the large group of people who are out of work. In our macroeconomic forecast, we project that unemployment will average 7.8% of the labour force this year and 7.6% next year. In addition to the direct economic effects, we hardly need mention the deep-seated mental and social problems caused by persistent unemployment. It is therefore vital to work on all fronts to fuel a resurgence in job creation – and sooner rather than later, so that the maximum number of eager hands can participate as soon as possible in creating value of all kinds, for the benefit of society as a whole.


Jón Bjarki Bentsson

Chief economist