Interest rate hikes by the Central Bank are in fact tax hikes that fall almost exclusively on indebted households, young people and lower‑income groups, writes Stefán Ólafsson, professor emeritus and expert at Efling, in a new article. Stefán points out in the article that those who exert the greatest demand pressure in the economy—higher‑income and wealthier groups—feel little impact from interest‑rate hikes and may even profit from them. In the article, Stefán argues that interest rate hikes are both unfair and ineffective ways to fight inflation. While indebted households have had to take on hundreds of thousands of krona increase in payment obligations, banks and capital owners have profited enormously. He believes that a more effective and fair approach would be to apply temporary tax increases to lower‑income groups instead of “targeting the wrong group”. In reality, a general tax increase would be a much more targeted and swift way to combat inflation, by reducing private consumption. Income from interest rate hikes flows to banks and capital owners, creating excessive profits for the banks, whereas income from tax increases would go to the state treasury. Stefán also criticizes that the current economic policy is based on outdated ideas of neo‑liberalism and calls for a new policy where welfare, justice and targeted economic management are prioritized. Interest rate hike is a tax hike on the wrong group Interest rate increase is equivalent to a tax increase that only affects those who are in debt. Those who owe the most are younger people who struggle to start a family and get their own housing, and some with large student loans as well. Those who have less savings and lower incomes have to take on more debt because of home purchases. These are limited groups in society but not everyone. The higher‑earning and wealthier find less or no impact from these accusations against debtors, both because of lower debts and higher incomes. Those who are in debt and have lower incomes are not the main causes of inflation, but rather the higher‑income and wealthier, who have more influence. This tax increase on debtors therefore does not reduce consumption and investment of the higher‑income and wealthier at will, but primarily harms wage earners in the working‑class and middle‑class. With the interest‑rate increase, the wrong group is being squeezed. The central bank is still raising interest rates/taxes on these people in the hope of counteracting inflation. Why is that the main remedy even though the effect is small? To answer that, it is useful to recall the assumptions of monetary policy. Monetary policy explained Forsend the central bank's premise is generally that inflation is due to excessive demand in the economy (excessive consumption, excessive investment). It is because there is too much money in circulation (public wages are too high, loan money is too abundant and too cheap). Demand pressure, however, is only one of many possible causes of inflation. Other causes call for other measures.[1] But we will wait for that. According to the monetary theory of Milton Friedman and other neo‑libertarians, the way is to reduce the money supply in circulation. Interest rate hikes are the method for that, which has been fashionable in recent years in the West, but it bites “unfairly” most at those who have the least wealth. Those who, across the board, have the most money in circulation are the richer half of the population, capital owners, and well‑performing companies. It could be said that monetary policy tried to slow down the circulation of their money the most. But that has not been fashionable, probably because the richest people who have the most power and their economists want to evade themselves. The aim of interest rate hikes is essentially to reduce purchasing power and investment capacity in the economy. Reduce demand pressure on inflation. What is similar and different about interest rate hikes and tax hikes Interest rate hikes try to achieve the same effects that a general tax increase would achieve. In fact, a general tax increase would be a much more targeted and quicker way to combat inflation. It can reduce the purchasing power of the general public (reduced private consumption) and if it also hits companies and capital owners, it will likely also reduce investment in the economy. Other ways also exist to reduce investment (e.g., precautionary tools of the central bank and regulation of financial markets). An interest rate increase affects demand in the same way as a tax increase, but with a much more limited impact. The advantage of a government tax increase over an interest rate increase is that it is much easier to steer the effects of a tax increase on the groups and industries that are causing the most demand pressure – and these are usually others than the income‑earning half of the population. Tax increases can therefore be much more targeted than interest rate hikes on borrowers. With more targeted action, it is not necessary to sacrifice as much economic growth as follows from the Central Bank's interest rate hikes. Although the effects of interest rate hikes are the same as direct tax increases for those who are affected, there is a natural difference in the implementation. An interest rate increase is a tax increase that the Central Bank and commercial banks control, and the revenues from it flow to banks, capital owners, and pension funds (i.e., to the financial market), rather than to the state treasury as occurs with tax hikes implemented by the government. Therefore, interest rate hikes lead to excessive profits for banks, which have the largest loans. The profit is then paid as a dividend to the bank owners and as bonuses to the managers. It would be more beneficial for the public if this money went entirely to the state treasury and was used to prevent deficits in the budget and to maintain infrastructure and welfare. If targeted, moderate and temporary tax increases had been applied instead of interest rate hikes when inflation surged in 2022 and 2023, the fiscal deficit could have been eliminated much earlier, a deficit that arose during the COVID period and was mostly due to support for companies in tourism‑related industries. That would have changed everything for the inflation rate as a result. Then we would not be in any trouble now and could focus on strengthening economic growth, the domestic economy and welfare. The distribution of burdens from interest rate hikes and tax hikes is different Interest rate hikes work just like tax hikes but fall mostly on the wrong groups, if the intention is to use them to reduce demand pressure due to excessive private consumption and investment. When such actions against a common problem (inflation) are directed only at a limited group in society, they need to be harsher than if they were broader and more targeted. One interest rate increase can raise the payment burden of debt‑burdened families by tens of thousands of krona per month. A rapid interest rate increase over a short period (e.g., from 2% to 9.25% as occurred in 2022 and 2023) becomes a massive tax increase for debt‑burdened families. For many, repayments on non‑indexed loans during this time rose to between 100 and 200 thousand krona per month. Smaller companies that are indebted in the domestic market dilute the effects of these interest rate hikes, which affect them directly in the price level. There is an example that an interest rate increase leads directly to higher inflation. Obviously, there is a huge flaw in the interest rate hikes! Large export companies take loans abroad and do not feel the interest rate increases here at home. Foreign parties that build hotels here do not either. These parties are tax‑free, although they can cause a great demand pressure! Interest rate hikes do not, however, reduce the investments of pension funds which are generally the largest driver of the economy. Another flaw is that interest rate hikes do not reduce private consumption of roughly two million tourists who come to the country each year. Those who owe less (often older people and those with higher incomes), as well as affluent capital owners who have recently increased their savings, feel little to no impact from tax increases that are embedded in interest rate hikes. In fact, participants in these groups can benefit from the interest rate increase, e.g., through higher returns on savings – which then amounts to a tax reduction for them. And these are precisely the societal groups that primarily drive inflationary demand pressure, with high consumption and investment. This is, so to speak, all wrong! An interest rate increase is thus in fact a very unfair and ineffective measure, a poorly designed tax increase, which has proven to deliver limited results in reducing inflation. Why is it possible to accept a large tax increase on the younger, lower‑income and less‑wealthy, in the form of interest‑rate hikes, while those better off are protected and even favored? Why? Why not raise taxes on the most affluent? When it is assumed that interest rate hikes are nothing but tax hikes that nevertheless target only a limited part of the population (usually the wrong groups), injustice and unfairness are shouted. Why not tax those who are behind the greatest demand pressure, the richer and higher‑earning? Then perhaps this method could begin to deliver real results in lowering inflation. Adam Smith, the father of economics, recommended that the poorer ones bear the greatest tax burden. If taxes need to be raised temporarily to combat demand inflation, then the tax increase should primarily be directed at the wealthy - if people wanted to follow Adam Smith's prescription. In fact, it would be most sensible not to raise taxes on those with lower income and fewer assets, but only on those who are wealthier, who truly have a seat at the table and also bear the greatest blame for inflation. That would be a path of welfare capitalism in the spirit of John Maynard Keynes and the authors of the welfare state concept, such as Jeremy Bentham, John Stuart Mill and William Beveridge. We should aim for that, not towards the American wealth of the few. But in order to go that way, politicians and economists need the courage to change the functioning of society, with a more just and efficient economic management. We must not sacrifice growth on the altar of interest rate hikes, which are based on outdated and unjust ideas of neoliberal economics (see my article in the source "Efnahagslífið: Stöðnun til 2028? "). Hopefully the government of Kristrún Frostadóttir has been able to take real steps in this direction, as well as intervene in the housing market and the financial market with regulation, as I have previously pointed out (see e.g. the article "Inflation: A Better Way Is Available "). The time for real changes in economic policy has long been running out. Stefán Ólafsson is a professor emeritus at HÍ and works as an expert at Efling. The article first appears in the source on 26 May 2026. [1] Demand pressure is obviously not the only possible cause of inflation and therefore the perspective of monetary policy is inadequate from the beginning. Other causes are e.g. imported inflation (price increases on the world market for oil, food prices etc.), profit‑driven inflation (e.g. unchecked rent increases and housing price that can be traced to imbalances in the housing market etc.) and simply profit‑seeking companies in greater profit. Finally, there is countless demand expansion that follows a rapid increase in foreign tourists, and many other could be mentioned. Other causes than demand pressure call for other measures but are hidden in the use of interest rate hikes.