In recent times, grocery prices have been a topic of debate. Many Danes experience that their everyday shopping has become more expensive which has led to political proposals for differentiated VAT and temporary food vouchers. Part of the background for these political proposals is that the real income of transfer‑payment recipients declined in connection with the surge in inflation in 2022 and has still not returned to its previous level. This policy note proposes an alternative indexation model under which the real income of transfer‑payment recipients would not experience prolonged declines the next time inflation jumps.

The analysis shows that:

• In the event of sudden increases in inflation, there may be a prolonged decline in the real income of transfer‑payment recipients. This is due to the current indexation method. This has direct consequences for recipients of transfers, but also affects the overall economy as weaker private consumption can contribute to lower overall economic activity.
• We propose a new indexation method that takes into account the expected development in inflation in the coming year. Current and well‑founded inflation forecasts are crucial to the method’s ability to protect the real income of transfer‑payment recipients against unintended declines.
• Had the proposed indexation method been in effect from 2020, transfer‑payment recipients would not have experienced as large or as prolonged a decline in real income during the inflation surge in 2022 as occurred under the current adjustment mechanism.
• By basing indexation on expected inflation combined with a correction for previous forecast errors, it is possible to ensure that transfers develop over time in the same way as they do today. The proposed method does not change the total level of payments, only their timing.
• Under certain reasonable assumptions, the proposed method can be implemented without requiring phase‑in periods or transitional arrangements.

The proposal can be read here.