Lately, grocery prices have been a topic of public debate. Many Danes are experiencing that their daily shopping has become more expensive, which has led to political proposals for differentiated VAT and temporary food checks. A key driver behind these proposals is that the real income of social transfer recipients dropped sharply during the inflation surge in 2022 and has still not recovered. This memo proposes an alternative indexation model which ensures that transfer recipients will not experience prolonged declines in real income the next time inflation spikes.

The analysis shows:

• Sudden increases in inflation can cause an unnecessarily long-lasting decline in the real income of transfer recipients. This is due to the current indexation method. A weakened level of private consumption can contribute to lowering overall economic activity, and the current indexation method therefore affects the economy as a whole.
• We propose a new indexation method based on the price and wage assumptions (the PL index) that the Ministry of Finance already estimates each year when preparing the finance bill.
• By basing indexation on the PL index combined with a correction for previous forecast errors, it is possible to ensure that transfers will, over time, follow the same development as today. The proposed method does not change the size of payments, only the timing.
• Had the proposed indexation method been in place by 2020, transfer recipients would not have experienced such a sharp decline in real income during the inflation spike in 2022, and they would have returned to their previous income level significantly earlier than what actually happened.
• The proposed method can be implemented from 2027 without requiring phasing-in or transitional arrangements, and neither the state budget nor transfer recipients will notice any significant immediate difference. But the next time inflation jumps, the real income of transfer recipients will be better protected.

Read the proposal here