Key takeaways
- Savings only hold their value if the interest they earn is higher than inflation. The difference is called the real interest rate, and it can be negative.
- The Central Bank of Iceland raises and lowers its policy rate to keep inflation close to its 2.5% target, and other interest rates in the country follow.
- Indexation ties loans and deposits to the consumer price index. It protects savings from inflation but makes the principal of loans rise.
- Bitcoin pays no interest. Many people see it as a long-term hedge against inflation, but its price swings a lot from day to day.
Contents
Savings only hold their value if the interest they earn is higher than inflation. If interest is 7% and inflation 5%, what your savings can buy grows by almost 2% a year. If inflation is higher than the interest rate, your savings shrink, even though the number of krónur in the account goes up. This article covers interest, inflation, the policy rate and indexation, and what they mean for your money.
Interest is the price of money
InterestInterestThe price a borrower pays to borrow money, and what a saver earns for lending it. Usually given as a percentage per year. is the charge for borrowing money. When you put money in a bank, you are really lending it to the bank, which pays you deposit interest. When you take out a loan, you pay lending interest, which is higher. The difference is one of the banks' main sources of income.
Interest is usually given as a percentage per year. If you have ISK 1,000,000 in an account paying 5%, you earn ISK 50,000 in interest over a year, before tax. How high the rate is depends partly on how long the money is tied up, how much risk is involved and where the Central Bank's policy rate stands.
Inflation eats interest
InflationInflationA general rise in prices over time, which means each króna buys less than before. is a general rise in prices. Statistics Iceland measures it with the consumer price indexConsumer price index (CPI)Statistics Iceland's measure of the prices of goods and services that households buy. It measures inflation and is the basis of indexation., which tracks the prices of goods and services that households buy. In October 2026, twelve-month inflation was 5.9%. The index was set at 100 in May 1988 and then stood at 700.4 points, so prices have risen more than sevenfold in under four decades.
What your money can buy is its purchasing powerPurchasing powerHow many goods and services money can buy. Purchasing power falls when prices rise faster than wages or savings.. When prices rise, each króna buys less. So it isn't enough to ask how much your savings have grown in krónur. The question is whether they buy more than before.
Real interest: what really matters
The rate a bank advertises is the nominal rate. Once inflation has been taken off, what remains is the real interest rateReal interest rateThe interest rate minus inflation. Real interest shows whether savings are really growing in value or shrinking, even as the number of krónur rises.. It tells you whether your savings are really growing in value.
| Nominal interest | Inflation | Real interest (approx.) |
|---|---|---|
| 7% | 5% | 2% |
| 5% | 5% | 0% |
| 4% | 6% | Minus 2% |
Tax makes it worse. The 22% capital income tax is charged on nominal interest, not real interest, on interest income above the tax-free allowance of ISK 300,000 a year. From 7% nominal interest, 5.46% is then left after tax, and with 5% inflation the real rate after tax is only about 0.4%.
Icelanders know negative real interest well. From 1974 to 1983, inflation in Iceland was above 30% every year according to Statistics Iceland, and interest on savings didn't keep up. Savings melted away, and borrowers gained at savers' expense.
The policy rate: the Central Bank's main tool
The Central Bank of IcelandCentral bankThe bank that issues a country's currency, sets interest rates and safeguards financial stability. In Iceland it is the Central Bank of Iceland. aims to keep inflation as close as possible to 2.5% a year on average. Its main tool is the policy ratePolicy rateThe Central Bank's interest rate that other rates in Iceland follow. The bank calls it its key rate and moves it to keep inflation in check., which the bank itself calls its key rate (meginvextir): the interest it pays banks on seven-day term deposits. Other interest rates in the country follow it.
The bank's Monetary Policy Committee sets the rate at least six times a year. In August 2023 it reached 9.25%. From October 2024 it was cut in several steps to 7.25%, but during 2026 the bank raised it again to 8.00%. In October 2026 the policy rate was 8.00% and inflation 5.9%.
Raising the policy rate works like this: loans get more expensive and saving more attractive, people and companies spend and invest less, demand falls, and that slows price rises. Higher rates usually also strengthen the króna, which lowers the price of imported goods. The effects don't come straight away, though, but over several quarters.
Indexation: the Icelandic way
IndexationIndexationWhen the principal of a loan or deposit follows the consumer price index. Indexation protects savings from inflation but makes debts rise with prices. is Iceland's answer to the inflation problem. With the so-called Ólafslög in April 1979, general indexation of financial obligations was introduced, after a decade in which inflation had eaten up people's savings. The principal of an index-linked loan or deposit follows the consumer price index and so rises with inflation.
For savers, this means inflation doesn't erode the principal. The interest on index-linked accounts is in effect a real rate, because the inflation adjustment comes on top. These accounts are usually tied up for a set period.
For borrowers it works the other way round. An index-linked mortgage has lower interest and lower payments at first than a non-indexed one, but the principal rises with prices. In the early years of a long loan, the debt can grow even though you make every monthly payment. According to the Central Bank, about 59% of outstanding household mortgages were index-linked in October 2024, but most new mortgages in the first half of 2026 were non-indexed.
Compound interest: time works for you, or against you
When interest is added to the principal, it starts earning interest itself. That is called compound interestCompound interestInterest calculated on interest already earned. The amount grows faster and faster over time, whether it is savings or debt.. If ISK 1,000,000 earns 5% a year and nothing is taken out, it grows to ISK 1,628,895 after ten years and ISK 2,653,298 after twenty. Without compounding, the amounts would be ISK 1,500,000 and ISK 2,000,000.
A rough rule of thumb is to divide 72 by the interest rate to find how many years it takes to double an amount. At 6% it takes about 12 years.
The same rule works against you with debt. Overdrafts and credit card balances carry high interest, and if they aren't paid down, the interest is added to the debt, which then grows faster and faster. That is one reason many people pay off expensive debt before they start investing.
Where does crypto fit in?
BitcoinBitcoinThe first and largest cryptocurrency: a digital currency that no single party controls, with a fixed limit of 21 million coins. pays no interest. It pays neither dividends nor inflation adjustments, and the amount doesn't grow by itself. Many people own it because of inflation all the same. Its supply is fixed at a maximum of 21 million, and no central bank can increase it. That is why many see bitcoin as a long-term store of value, and the arguments are set out in Why does Bitcoin have value?
In the short run, though, bitcoin's price hasn't tracked consumer prices. In 2022, when inflation was high around the world, it fell more than 75% from November 2021 to November 2022. The price later recovered and passed its previous high in March 2024.
Some services offer interest or returns on crypto, for example through lending or staking. The risk there is different and often much higher than in a deposit account, and no deposit insurance covers crypto. The lender Celsius offered high returns before it went bankrupt in 2022.
Many people therefore keep savings they might need soon in krónur, and put into crypto only what they can do without for a long time. How much that is depends on each person's risk toleranceRisk toleranceHow much risk and how many price swings you can bear, financially and emotionally, without it upsetting your life or your decisions.. You can also read about the differences between asset classes in Shares, bonds and crypto: what's the difference?
Frequently asked questions
How do I work out the real interest rate?
Roughly, you subtract inflation from the nominal rate. With 7% nominal interest and 5% inflation, the real rate is about 2%. A more precise calculation is to divide 1.07 by 1.05 and subtract 1, which gives 1.9%. Remember the tax too, if your interest income is above the tax-free allowance.
Is an indexed or a non-indexed loan better?
It depends on your circumstances, and there is no single right answer for everyone. A non-indexed loan has higher interest and higher payments at first, but the principal falls steadily. An index-linked loan has lower interest and lower payments at first, but the principal rises with inflation. Talk to an adviser at your bank about your own situation.
Does bitcoin pay interest?
No. Bitcoin pays no interest, and the amount doesn't grow by itself. The price can rise or fall. Services that offer a return on bitcoin do so by lending it out or using it in some other way, and that comes with its own risks.
Closing thoughts
Interest, inflation and real interest decide whether your savings grow or shrink. In Iceland, indexation and a high policy rate come on top, and together they shape the terms on everything from deposit accounts to mortgages. It pays to look at the real interest rate, not just the figure the bank advertises.
Bitcoin offers a different path. It pays no interest but has a fixed supply, and many people hold it as a long-term hedge against inflation. Its price swings a lot, though, so read about the risks before you buy. The story of the króna and inflation is told in What is money?
