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Speech by Bodil Nyboe Andersen at the Annual Meeting of the Danish Bankers Association on 5 December 2001In 2001, Danish monetary and foreign‑exchange policy have been very undramatic, but elsewhere in the world, monetary policy has held centre stage. This applies especially to the USA, where the Federal Reserve has been extremely active, lowering interest rates on ten separate occasions in 2001 in order to stimulate economic activity. During the year, the short‑term US interest rate has been lowered from 6½ per cent to 2 per cent, which is a very significant reduction. In Europe too, monetary policy has drawn great interest and been an issue for much discussion, especially in the euro area, where the European Central Bank's policy has been the subject of vigorous comment by politicians, the media and economists. It is sometimes overlooked in the monetary-policy debate that there are substantial differences across countries between the goals and design of monetary policy. The USA has a rather broad monetary‑policy objective. Monetary policy is expected to promote maximum employment, stable prices, and moderate long‑term interest rates. In the present cyclical situation, this has been interpreted to mean that the reduction of demand over the past year should be countered with expansionary monetary policy. The many reductions of interest rates have not prevented a cyclical downturn. The issue is now whether the lowering of interest rates can reverse this development into a new upswing in the months to come. It remains to be seen whether it is possible to ease monetary policy so much and so quickly without this leading to higher inflation, thereby threatening price stability. An indicator will be the direction of long‑term yields in the near future. In Europe, especially the euro area, there is a clearer division of work between monetary policy and fiscal policy than is the case in the USA. Monetary policy has been made responsible for price stability. Considering the historical background, we see that in the 1970s and 1980s most European countries had both high inflation and high interest rates. This led to a number of distortions of economic development because decisions were also influenced by the expected development in prices. During this period, only Germany showed remarkable price stability, attributed by many to the Bundesbank's independence and firm hand on monetary policy. The most noteworthy aspect was that Germany also enjoyed strong economic progress and favourable development in employment. The German model thus played a decisive role in the design of the Maastricht Treaty. Price stability was made the explicit objective of the European Central Bank, and the ECB was ensured political independence in its conduct of monetary policy. This clear objective of price stability entails that the ECB can only lower interest rates in order to promote economic activity if this presents no risk to price stability. This is part of the explanation for the fact that, although the ECB has lowered interest rates in 2001, its approach has been far more cautious than in the USA. Another – often neglected – fact is that at the turn of the year the level of interest rates was significantly lower in Europe than in the USA. However, not only the European Central Bank has a clear objective to maintain price stability. During the 1990s, a number of other central banks adopted an equivalent objective and applied inflation targeting to their conduct of monetary policy. In Europe, this applies to e.g. the UK and Sweden, where such systems have been in place for almost 10 years, and Norway, which last spring restructured its monetary policy according to this system. Although the institutional arrangements vary from country to country, the main theme is that in determining interest rates the central bank seeks to keep medium‑term inflation within a specific range. With regard to the ECB, the objective is inflation of below 2 per cent, while for the UK it is close to 2½ per cent. The strong emphasis on using monetary policy to maintain price stability has been successful, and generally inflation in Europe is low in current years. Today, we tend to regard low inflation as a normal situation. This may be the explanation for the periodic pressure on the central banks to use monetary policy to achieve other goals such as increased employment, or to influence the exchange rate in one direction or the other. However, if the official interest rate is to safeguard a particular future development in prices, its level is determined by this very factor. It is not possible also to pursue other objectives requiring a higher or lower interest rate, since the monetary‑policy authorities have only one instrument, the short‑term interest rate. In Europe it must be used to maintain price stability. As will be known, Danish monetary policy has a different design: as for the other European central banks, the overall objective is price stability. However, this is achieved more indirectly by keeping the krone firmly stable against the euro. For this to be successful, fiscal policy must be designed to ensure medium‑term development in prices that does not deviate substantially from the euro area's objective. The fixed‑exchange‑rate policy is only credible if our competitiveness is high. Monetary policy is responsible for the more short‑term stabilisation of the exchange rate. In calm times it must "shadow" monetary policy in the euro area. This is achieved by holding Danmarks Nationalbank's lending rate close to that of the European Central Bank, and moreover by matching any changes, apart from very small fluctuations of a few basis points. At times of foreign‑exchange unrest or fear of unrest, Danmarks Nationalbank widens this spread in order to make holding kroner more attractive. This monetary‑policy reaction pattern is well‑known to players in the foreign‑exchange and money markets. Adhering for many years to the rules of the game set by the fixed‑exchange‑rate policy has lent this policy a high degree of credibility. Market participants closely monitor the fluctuations in the exchange rate, and when it tends to weaken, money‑market interest rates will rise quickly, making krone holdings more attractive. The banks' advice to their customers on when to buy and sell future foreign‑exchange positions helps to stabilise the market in the same way. So in Denmark, the current situation is that the krone is not only stabilised by Danmarks Nationalbank's interventions in the foreign‑exchange market and its adjustments of interest rates, but first and foremost by the market participants' behaviour. In other words, the foreign‑exchange market participants speculate in a stable krone/euro rate, so that market speculation has a stabilising effect. Speculation is a very emotional word. Currency speculation usually makes one think of a situation where the market speculates in the probability that the authorities will not be able to hold the fixed exchange rate firm. However, the market can, as stated, also speculate that the authorities will actually maintain the exchange rate, in the face of fluctuating supply of and demand for currency. The market participants thus take positions with this expectation in mind, and themselves actually contribute to the stabilisation. This behaviour is also "speculative", although we do not usually call it that. When the market is in agreement with the official policy, the authorities instead usually describe this as "sound behaviour". This may sound like splitting hairs. The point is that in most situations currency trading has a very beneficial function in society. The market's contribution to stabilising the Danish krone entails a continuous very large number of currency trades to ensure that supply and demand are constantly set off in the foreign‑exchange market. Moreover, the foreign-exchange market actually has a very important economic role to play by financing foreign trade and other international transactions. If a Danish exporter to Mexico receives Mexican pesos in payment, these funds must be exchanged to Danish kroner. This takes place via a chain of transactions in the foreign‑exchange market that may for example entail Mexican pesos being exchanged for dollars, which are then exchanged for euro, which are finally exchanged for Danish kroner. This entire series of transactions helps to make international trade more flexible, and thereby cheaper. A tax on all currency trading, called the Tobin tax, will undermine the economic usefulness of currency trading to stabilise the exchange rate and reduce the costs of international trade. Such transactions actually account for the predominant share of the foreign-exchange trading volume. Especially a small country with an independent currency is very dependent on a well‑functioning foreign‑exchange market. The proponents of a Tobin tax only argue on the basis of detrimental speculative transactions, which in spite of everything are actually quite rare. However, when they do occur, they are very dramatic and provoke major news headlines. They can also have serious consequences for the currency that is affected. However, seeking to fight them by taxing all foreign-exchange transactions is out of proportion. Moreover, dramatic speculation is often, but not always, founded on fundamental imbalances in the country concerned. Such speculation is therefore motivated by profit expectations that are so high that a tax of 1 per mille is no deterrent. However, a tax at that level will destroy a well‑functioning foreign‑exchange market. Therefore Danmarks Nationalbank finds that the discussion of a Tobin tax should cease. This tax will not prevent detrimental speculation and it will have a negative effect on ordinary foreign‑exchange transactions. When we one day write the history of 2001, the main heading is hardly likely to be the more or less aggressive monetary policies of different countries, or the discussion of the Tobin tax. The main topic will be the meaningless, tragic terrorist attacks on New York and Washington. Despite the extensive damage, we can state that the events on 11September did not in themselves present a threat to financial stability. Central banks all over the world immediately made extra liquidity available in order to counter the effects of the delays arising in the financial markets. This is a natural task for a central bank. A very positive aspect was that, in these difficult times, financial institutions all over the world showed quite extraordinary solidarity and willingness to assist each other. Institutions, which usually engage in cut‑throat competition, were instead helping each other and taking care not to profit from others' difficulties. The markets have now returned to normal conditions, and it is business as usual on the competition front. The slowdown in the economy seen all over the world will not only affect securities price trends, but also the financial institutions, after many good years of economic growth. In Denmark, the Danish Financial Supervisory Authority, and not Danmarks Nationalbank, is responsible for overseeing the individual financial institutions. The Authority has rules and procedures to which the institutions must adhere, and we must expect them to do this, for better or for worse. The rules are there amongst other things to ensure that any detrimental development in a financial institution does not get out of hand before measures are taken to intervene. It would be wrong to expect the Authority to simply lower its requirements when developments are less favourable. In many countries, the supervision of credit institutions is the responsibility of the central bank, and the future supervisory structure is subject to lively debate at the European level. In Denmark, there is no wish to change the present structure. Danmarks Nationalbank cooperates very positively with the Danish Financial Supervisory Authority and the division of work between us is very clear. Among other things, this entails that Danmarks Nationalbank takes an interest in "financial stability". In recent years this has become a specific central‑bank task, regardless of whether the central bank in question is responsible for supervision or not. Financial stability concerns the conditions for the overall sector, and not the more detailed matters related to individual institutions, which is the province of the Authority. For a couple of years, Danmarks Nationalbank has published articles on financial stability. As from 2002, we will issue a separate annual publication on this subject. In the course of this work, we draw great benefit from our cooperation with the financial sector. In 2001, there is also reason to cite another major project undertaken in cooperation with the financial sector. This is the KRONOS payment system that was launched on 19 November. It is a very sophisticated system with a host of facilities. Its structure enables the banks to select among different solutions according to their requirements. In these and other areas of cooperation, such as trading activities, cash handling, statistics, committee work, and much more, Danmarks Nationalbank has cooperated on a very positive basis with the Danish Bankers Association and its member banks. On behalf of Danmarks Nationalbank, I would like to extend a warm vote of thanks.
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Version 1.0 April 2002 Nationalbanken. |