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In terms of monetary policy, 1998 has been an eventful year. As in the previous year, the Danish krone was very close to the central rate. In 1997, however, capital inflows were considerable and Danmarks Nationalbank purchased foreign exchange, whereas 1998 saw periods of foreign-exchange sales to support the krone, as well as periods during which Danmarks Nationalbank purchased foreign exchange.
In the beginning of May the Nationalbank raised the discount rate and the repo rate by 1/2 per cent because the unclarified situation up to the referendum on the Amsterdam Treaty as well as the labour-market dispute had led to an outflow of capital and a slight weakening of the krone rate. The uncertainty concerning the situation in Denmark diminished significantly after the referendum, and the interest rates were lowered by 1/4 per cent.
In August a wave of speculation arose against the Norwegian krone, and after repeatedly raising interest rates Norges Bank finally discontinued its intervention and allowed the Norwegian krone to "float". The Danish krone was subject to shortlived pressure and the Nationalbank stabilized the krone rate, resulting in a brief period of intervention.
The general unrest on international financial markets and investors' increasing aversion to risk led to a flight to D-mark and the other future euro currencies. At the same time, the financial markets began to focus on the growing balance problems of the Danish economy, especially the balance of payments. Another contributing factor was that both the Norwegian krone and the Swedish krona had dropped significantly during the summer. The pressure against the krone built up gradually, but accelerated in mid-September. In the first instance the Nationalbank chose to intervene, but after a few days it was clear that the unrest was continuing. We therefore decided to raise the discount rate by 1/2 per cent and the repo rate by 1 per cent in order to place a premium on speculation against the krone. Against this background the market development reversed.
During the last two months the krone has been strong and the Nationalbank has repurchased a significant proportion of the currency we used to support the krone in August-September. We have therefore gradually been able to re-lower interest rates.
As a consequence of the fixed-exchange-rate policy unrest on the foreign-exchange market is counteracted by raising interest rates. This nat-urally means that the unrest so to speak is "transferred" to the interest-rate markets, so the money-market interest rates will normally be rising if there are signs of pressure building up against the krone. In Denmark we thus see some volatility of the money-market rates during periods of financial unrest. Sweden and the UK have chosen to manage the short-term interest rates on the basis of domestic considerations. Their money-market interest rates are a little more stable than Denmark's during periods of unrest, but on the other hand their exchange rates show considerable volatility, which Denmark's strategy avoids.
The fixed-exchange-rate policy plays a central role in Danish economic policy. So it was an important signal when at the informal ECOFIN meeting in September Denmark concluded an agreement with the ECB and the future euro-area countries on participation in ERM II with a fluctuation band of +/-2 1/4 per cent around the krone's central rate against the euro.
ERM II is the new exchange-rate mechanism which will replace the present system on the introduction of the euro in January 1999.
The framework of ERM II was already decided in a resolution from the Amsterdam summit in June 1997. In the summer of 1998 the ECB on this basis adopted an agreement on ERM II. Both texts describe the possibility that a country which has shown a high degree of convergence can agree a narrower fluctuation band than the normal 15 per cent.
On this basis Denmark negotiated a maximum fluctuation band of 2 1/4 per cent for the Danish krone vis-à-vis the euro central rate.
It is important to emphasize that this agreement does not indicate that we now expect the Danish krone to fluctuate throughout this band. It has always been the plan to continue the policy pursued in recent years of maintaining a very stable krone rate against the D-mark. The Danish ERM II arrangement can therefore be described as a safety net which should preferably never be used, but whose existence does have a certain psychological effect.
The Nationalbank will continue to use monetary policy to stabilize the krone rate. By entering into this agreement the government at the same time acknowledges that it will pursue a fiscal policy which lives up to the requirements set by a fixed-exchange-rate policy. We ourselves, via economic policy, must protect the exchange rate. We do not expect the ERM II arrangement to do this for us.
The Nationalbank does not find that politicians in Denmark seek to interfere in interest-rate policy. Our colleagues in certain other countries have good reason to be envious.
On the other hand, in both the market and the media many analyses and forecasts and much good advice are put forward to tell us how we should act in a given situation. Sometimes the explanations are far more fantastic than we can even imagine.
We naturally read these analyses and good advice with great interest. However, just as it is important to the Nationalbank's independence that we are not subject to political pressure, it is also vital that we consider carefully the motives behind the financial markets' comments on the situation. It is an inspiration to receive comments and good advice and we can always learn from them, but when it comes to fixing interest rates and designing the monetary-policy instruments we alone must take the appropriate decisions.
By tradition the Nationalbank's view of the economic situation is discussed at the annual meeting of the Danish Bankers Association. We have just issued our Monetary Review with an evaluation of recent monetary trends, so I will just add a few comments. It has become apparent that Denmark's excellent performance in reducing unemployment in recent years has been at a cost. We are now close to the capacity limit, with the problems this entails.
Our wage levels are rising more than those of our trading partners, particularly the future euro-area countries. So far, this has not triggered any increase in inflation, still affected by falling energy and food prices. If inflation is measured in terms of the EU-harmonized price index (HICP) Denmark lies only slightly above the euro-area countries' average. However, the level of underlying inflation has increased and we are losing market shares on export markets. Since private real incomes and thereby private consumption are still rising strongly, we are now in a situation where pressure on the Danish economy is causing the balance of payments to deteriorate strongly. We no longer have any scope for manoeuvre. Denmark's growth in the next few years must be clearly below growth in our trading-partner countries. It will also be necessary to reduce the wage-increase rate. We cannot just wait for wage increases in Europe to reach the Danish level at some time in the future.
This situation therefore makes high demands of the public sector's wage negotiations in the spring of 1999, just as a tight fiscal policy in the coming years will also be necessary, in order to take into account the effects of strong growth in local-government expenditure. These demands are further amplified by the fact that growth in Europe appears to be slightly below the forecasts of summer 1998.
Danmarks Nationalbank takes such a great interest in the balance of payments because a deficit can be viewed as an indicator of disequilibrium in the national economy. A current-account deficit implies that domestic savings are too low, requiring capital imports from abroad. There may very well be good real-economic grounds for a deficit, for example very high investments. This does not change the fact that a deficit increases our already substantial foreign debt, making us vulnerable at times of international unrest, as experienced during 1998.
If we had been a member of a large currency area, like the coming EMU, a current-account deficit in Denmark would not have had any impact on the currency situation. The structure itself entails that the overall external balance of payments of the euro area is of significance to the foreign-exchange position. In this situation the development in one country's balance of payments has to be evaluated solely on the basis of the real-economic consequences and not in a financial-market context.
In one month's time 11 EU member states will make the transition to the single currency, the euro. Major adjustments of the financial markets will take place during the long weekend from December 31 to January 3, the "conversion weekend". However, the economic consequences have already been noted during 1998. One is the convergence of the interest rates of the future euro-area countries, another is the stability which has characterized their currencies during periods of financial unrest. Denmark was obliged to raise interest rates significantly in September, whereas Finland was by and large unaffected by the financial unrest in Scandinavia.
However, the more fundamental economic consequences of EMU will not appear for a number of years. It has been said that the single currency should be regarded as the fulfilment of the single market, as the last element in the creation of a large domestic European market for companies within the euro area. A market of this scale entails greater transparency and ef-fectiveness and will also provide for stronger growth, to the benefit of companies and consumers alike.
The introduction of the euro is of significance to the Nationalbank's relations with the members of the Danish Bankers Association, particularly in the areas of statistics and Target. The new automatic reporting system for external payments has required substantial development resources from both the banks and the Nationalbank. Once the system is run in, however, both parties will reap the benefit of the rationalization measures, and the payments statistics will be more accurate.
Several statistics projects will take place during the next few years as a consequence of the expansion of the European financial statistics. This applies particularly to the new balance sheet statistics and new interest-rate statistics. The Danish Bankers Association and the banks have taken a very positive view of these projects. It is in our common interest that the Danish statistics be gradually approximated to the statistical requirements of the euro-area countries. This will facilitate international comparison, and we will not have to do things twice, should Denmark at some time in the future wish to join EMU.
Two years ago, on the same occasion, I stated that the intra-European payment system, Target, was under preparation. At that point it was uncertain what conditions would be set for the out countries to join. We therefore had to be prepared for in the worst case quite restrictive terms. The conditions were not actually clarified until very late, namely during the last few months. However, even though the conditions are not as favourable as for the euro-area countries we must say that they are acceptable. Via a special deposit scheme the Nationalbank will be able to make intra-day credit available within a framework of EUR 1 billion. The cooperation between the Nationalbank and the banks on this major project has been extremely constructive and we shared an interest in finalizing the arrangements while under a great deal of pressure of time.
I would like to conclude by thanking the Danish Bankers Association for our succesful cooperation in many different committees and working groups and at management and board level. We look forward to continuing this good relationship. There is no doubt that the coming years will present many new challenges as a consequence of the changes in the financial structure of Europe.
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