The Danish Economy

Growth picked up outside the euro area during 2003. In the USA the economic upturn was to a large extent driven by expansionary monetary and fiscal policy. Growth in Japan was surprisingly positive with rising business investments and exports. In the euro area GDP growth was still weak since domestic demand remained low and exports declined in the 1st half of the year. The government deficit increased in the USA and to a lesser extent in the euro area.

In the USA growth was low at the beginning of 2003, particularly as a result of uncertainty relating to the Iraq crisis. The war in Iraq in March-April brought clarification, and from the spring onwards the economy strengthened. The development in stock prices reversed, and consumer and business confidence gradually increased.

Growth in GDP was 3.1 per cent in 2003, cf. Chart 1, after a significant upturn in the 2nd half of the year. Growth was mainly driven by domestic demand. Tax cuts and conversion of housing loans stimulated private consumption, while government consumption increased primarily as a result of military expenditure. Business enterprises' propensity to invest was also stimulated after two years of falling investments. Particularly technology investments rose. In spite of the higher growth, employment only increased slightly. This is attributable to e.g. continued streamlining of production, leading to exceptionally high increases in productivity.

In the 1st half of 2003, low and falling inflation combined with sluggish activity led to concerns about a sustained period of deflation, i.e. generally falling prices. On the grounds of the risk of an undesirable fall in inflation, the Federal Reserve lowered the federal funds target rate by 0.25 per cent to 1.0 per cent in June. Inflation continued to decline in the 2nd half of the year, and in January 2004 inflation excluding energy and food was 1.1 per cent. However, the deflation concerns subsided in step with the increase in growth and improved growth prospects.

The government budget balance deteriorated further in 2003 due to fiscal-policy relaxations, and the deficit was 4.9 per cent of GDP, against 3.4 per cent in 2002. The government deficit almost corresponded to the balance-of-payments deficit of 5.0 per cent of GDP.^[1] Private-sector savings and investments thus balanced after a number of years with savings deficits. The reversal of the trend in the private savings balance is attributable to consolidation in the business sector. Household savings remained low, and their indebtedness increased.

The real effective dollar rate fell by approximately 10 per cent in 2003 and was thus in line with the average since 1980, cf. p. 40. The price of oil in dollars rose up to the outbreak of the war in Iraq and then dropped back. From May the price of oil gradually rose again, which is attributable to growing economic activity, as well as the weakening of the dollar. In euro, the increase in the oil price was more modest.

At the beginning of 2004 there are prospects of continued growth in the US economy. However, since the upswing is to a large extent driven by expansionary fiscal policy, which has exacerbated the imbalances, the sustainability of the upswing in the long term is somewhat uncertain.

In Japan growth accelerated surprisingly in 2003. GDP growth of 2.7 per cent was mainly driven by exports and business investments, while private consumption was weak. The government deficit remained more or less unchanged at just over 7 per cent of GDP, and debt amounted to more than 150 per cent of GDP at end-2003.^[2] Employment stabilised after having declined for five years, and wages stopped falling. At the same time deflation subsided, and in the last months of the year the consumer price index was unchanged compared with the previous year, partly as a result of changes in indirect taxes and subsidies. The percentage of bad loans at the large banks fell, but structural problems in the financial sector were still considerable. The monetary-policy interest rate remained close to zero throughout 2003. Monetary policy was, however, eased by increasing the target for overall liquidity in the banking sector. In addition, the Bank of Japan repeatedly purchased dollars for large amounts to counteract the strengthening of the yen.

Contrary to expectations, the economic slowdown in the euro area continued in 2003. GDP growth was 0.4 per cent in 2003, against 0.9 per cent in 2002. The 1st half of 2003 saw negative growth due to lower exports and investments. From the summer onwards exports rose, and a moderate upturn was observed in domestic demand. Employment remained more or less unchanged, and unemployment increased only slightly in spite of the weak growth. This may be attributed to labour-market rigidities in some countries.

In recent years productivity growth in the euro area has been nowhere near the productivity growth in the USA. This highlights the need for labour-market reforms. Several large member states have initiated structural reforms, but further measures are required in order to reduce unemployment and ensure sustainable public finances in the long term. In 2003 Germany implemented tightening measures in relation to e.g. social security benefits, as well as a minor health reform, and France tightened up the pensions area. Both countries also adopted tax cuts.

The sluggish economy and falling import prices, resulting e.g. from the strengthening of the euro, contributed to bringing inflation down to 2.1 per cent in 2003. The European Central Bank, ECB, operates with a medium-term inflation target below, but close to, 2 per cent. Core inflation^[3] was 1.7 per cent in the 2nd half of the year.

The ECB lowered its interest rate by 0.25 per cent and 0.5 per cent, respectively, in March and June 2003 to 2 per cent, with reference to reduced future inflationary pressure and weaker economic growth, cf. p. 30ff. Viewed in isolation, these reductions stimulated economic activity, although the simultaneous appreciation of the euro had the opposite effect.

In 2003 the public finances deteriorated for the third consecutive year, and debt as a percentage of GDP increased after having fallen for six years. The government deficit for the euro area is estimated to have risen to 2.7 per cent of GDP in 2003.^[4] This was due to the low level of economic activity, while the cyclically adjusted budget balance improved slightly. Both Germany and France exceeded the 3-per-cent limit stipulated in the EU Treaty for the second year running, with deficits of just over 4 per cent of GDP, cf. p. 80ff.

At the start of 2004 it is uncertain whether an upswing is imminent in the euro area. The global economy is picking up, but the strengthening of the euro exerts pressure on the earnings of exporters, and the continued need for structural reforms makes it uncertain whether domestic demand will increase significantly.

The UK did not experience the same economic slowdown as most other EU member states. Growth was 2.1 per cent in 2003, driven by public and private consumption. Fiscal policy was eased, and the low level of interest rates stimulated an already strong housing market. In November 2003 and February 2004 the Bank of England raised its interest rate by 0.25 per cent to 4 per cent. In December the government changed the Bank of England's inflation target to an annual increase in the EU Harmonised Index of Consumer Prices, HICP, of 2 per cent. The Bank of England thus now applies the same price index as the ECB in monetary-policy planning.

In Sweden GDP growth was relatively robust at 1.5 per cent in 2003.^[4] The increase in exports was substantial considering the sluggish international growth, and private consumption was relatively strong. However, unemployment rose significantly, and inflation fell throughout the year. In view of a possible dampening of inflationary pressures Sveriges Riksbank lowered its monetary-policy interest rate on three occasions in the 1st half of 2003 by a total of 1 per cent, and by a further 0.25 per cent to 2.5 per cent in February 2004.

Growth was weak in Norway with an increase in mainland GDP of 0.6 per cent in 2003.^[5] Unemployment rose from 3.9 per cent in 2002 to 4.5 per cent in 2003. In the light of the economic slowdown and the repercussions of the appreciation of the Norwegian krone in 2002 core inflation dropped below the central bank's inflation target during 2003. Norges Bank reduced its interest rate on seven occasions from 6.5 per cent at the beginning of the year to 2.25 per cent at end-2003. In January 2004 Norges Bank lowered its interest rate by a further 0.25 per cent.

The danish economy

The Danish economy was not unaffected by the slowdown in Europe. After modest GDP growth of 1.0 per cent in 2002, growth was zero in 2003, cf. Chart 2. The development in GDP was thus slightly weaker than in the euro area. Throughout 2003 unemployment rose and employment fell, particularly at the beginning of the year. There was a large current-account surplus, and government surplus.