The Danish Economy

The high global growth since mid-2003 has augmented the demand for oil. Combined with a number of disruptions on the supply side, caused by e.g. political unrest in the Middle East and in other oil producing countries and concerns about oil producers' high capacity utilisation, this led to a substantial rise in the oil price throughout most of 2004. The oil price fell back towards the end of the year, but was more than 30 per cent higher at the close of the year than at the beginning, measured in dollars. In euro terms the increase was just over 20 per cent. 

In the USA, GDP rose by 4.4 per cent in 2004. Fiscal policy continued to support growth, but not nearly to the same extent as in 2003, and monetary policy was still expansionary. Growth was domestically driven via sound increases in private consumption and private investments. Private consumption was among other things stimulated by tax cuts in 2003 that also affected 2004, low interest rates and a buoyant housing market, as well as positive trends in the labour market. The high oil prices only briefly dampened consumption. The growth in private consumption exceeded the increase in disposable incomes, and the households' savings ratio thus reached a new low.

Improved corporate earnings, inter alia as a result of high productivity growth, and sound financing opportunities contributed to a substantial increase in business investments. Residential investments also increased considerably.

 The upswing spread to the labour market, where employment rose by more than two million during the year. This was, however, lower than expected. Unemployment fell from 5.7 to 5.4 per cent of the labour force. Wage increases remained moderate. Core inflation (measured by the Consumer Price Index, CPI, excluding energy and food) rose slightly, partly as a consequence of increased economic activity. For the full year, it was just under 2 per cent. CPI inflation was approximately 1 per cent higher, mainly reflecting rising oil prices.

In June 2004, the Federal Reserve commenced a gradual normalisation of monetary policy. The fed funds target rate was raised from 1.0 per cent in June to 2.25 per cent at year-end and then to 2.5 per cent in February 2005. Nonetheless, monetary policy was still expansionary at the beginning of 2005. Judging from the forward interest rates, the market expects the Federal Reserve to continue to raise its target rate at a measured pace.

The upturn in the US economy since 2003 has been underpinned by expansionary fiscal policy that has led to a significant deterioration in government finances. In spite of the favourable economic development, the budget deficit of 4.4 per cent of GDP was at the same level as in 2003. Government finances are not sustainable in the longer term, since demographic trends will exert pressure on expenditure for pensions and health services.

The strong growth in consumption and investments pushed up imports. The current account of the balance of payments deteriorated further, and preliminary statements point to a current-account deficit in the range of 6 per cent of GDP in 2004. The record deficit is attributable to low savings ratios in both the public and private sectors. The deficit has to a large extent been financed by Asian central banks.

Prospects for 2005 indicate robust growth, although at a slightly lower level than in 2004. Uncertainty is related primarily to the imbalances in the US economy, which contributed to a significantly weaker dollar in the 2nd half of 2004, cf. p. 39. The weaker dollar will improve US business competitiveness, but history shows that this is not likely to have a decisive positive impact on the balance of payments. One reason is that exports only account for around 10 per cent of the economy. Substantial improvement of the balance of payments would require higher domestic savings. 

In Japan, GDP rose by 2.6 per cent in 2004. The high growth rate seen in 2003 continued at the beginning of 2004, but from the 2nd quarter growth came to a halt. This was especially attributable to falling government investments and a dampening of private consumption. In the 2nd half-year the high export growth diminished, especially to markets in East Asia, including China. The government deficit was reduced to 6.5 per cent of GDP, compared to 7.7 per cent in 2003. The gross government debt was 164 per cent of GDP at end-2004.

The economic slowdown also affected employment. After rising at the beginning of 2004, it fell in the last months of the year.

Consumer prices were stable throughout the year. Since there were no indications of a general rise in prices, the Bank of Japan maintained its zero-interest-rate policy. Up to March 2004 the Bank of Japan bought US dollars for large amounts to counteract a strengthening of the yen.

With strong growth in 2004, the rest of Asia made a substantial contribution to the global upswing. In China, GDP grew by 9.5 per cent. Growth was probably dampened a little by a series of credit- and monetary-policy tightenings to prevent overheating of the economy. 

The global upswing did not really materialise in the euro area in 2004. GDP growth at 2 per cent was good in isolated terms, but clearly declining over the year. This reflected weak development in domestic demand, with both consumption and investments increasing less than GDP growth. In the 1st half-year, the economy was driven primarily by exports, but as the euro strengthened and with the first signs of lower global growth, the increase in exports declined. The dampened economic growth in the euro area compared to the USA was especially attributable to its largest economy, Germany.

Unemployment in the euro area was stable at around 9 per cent, which was considerably higher than in e.g. the USA and Denmark.

Inflation, measured by the Harmonised Index of Consumer Prices, HICP, was above 2 per cent for most of 2004, partly as a result of rising oil prices, while core inflation (HICP excluding energy, food, alcohol and tobacco) was stable throughout the year, at just under 2 per cent. Wage increases remained moderate. The European Central Bank, ECB, assessed that inflation in the medium term would be in accordance with the ECB's objective of price stability. On this basis, the ECB maintained its interest rate at 2 per cent in 2004. The interest rate was last adjusted in June 2003.

The government budget deficits of the euro area member states grew and totalled 2.9 per cent of GDP for the full year 2004^[2], which was marginally lower than the 3-per-cent limit stipulated by the EU Treaty. Germany and France, both of which exceeded the limit in 2002 and 2003, had budget deficits exceeding 3 per cent of GDP again in 2004, cf. p. 81. Viewed as one, the budget deficits of the euro area member states were, however, still considerably below the deficits of the USA and Japan.

Unless domestic demand, including private consumption, picks up, the situation at the beginning of 2005 does not point to the upswing gaining momentum in the euro area in 2005. The strengthening of the euro may dampen exports. The labour market is expected to remain weak, but without any significant impact on wage formation. If the EU target of a significant increase in employment by 2010 is to be met, structural reforms are required. This would also make a major contribution to ensuring the sustainability of government finances in the long term.

In the 10 new EU member states, GDP rose by around 5 per cent in 2004, which is the highest increase for a number of years. Growth was driven primarily by investments, while both imports and exports rose substantially as a result of EU membership and removal of the last barriers to trade. Unemployment fell in 2004, while inflation rose in most new EU member states as a result of rising oil prices, the phasing-out of subsidies and increasing economic activity.

In the UK the economic upswing that began in 2003 continued. GDP rose by 3.1 per cent after sound progress in the 1st half-year in particular. Growth was driven by the domestic economy, a contributing factor being the buoyant rise in housing prices of recent years. Housing prices flattened out in the 2nd half-year, however, which may be attributed to the monetary-policy tightening. The Bank of England raised its base rate by a total of 1 per cent to 4.75 per cent in the period up to August 2004. Inflation remained low despite the high level of activity and tight labour market.

Both Sweden and Norway saw a cyclical upturn with high growth. The improvement was broadly based on both consumption and investments. In Sweden exports rose significantly in the 1st half-year, but declined in the 2nd half-year. In Norway, however, export growth was negative. The high GDP growth did not pass through to the labour markets on any significant scale. In Sweden employment remained unchanged. In Norway employment rose a little, and unemployment diminished slightly. Due to the modest impact of GDP growth on the labour markets, wage increases were moderate and inflation low, close to 1 per cent in both countries. In Sweden and particularly in Norway, lower prices for imported goods contributed strongly to the low rate of increase in consumer prices. The subdued inflationary pressure meant that both Sveriges Riksbank and Norges Bank lowered their official interest rates in the spring of 2004, to 2 per cent and 1.75 per cent, respectively.

THE BALANCE OF PAYMENTS	Chart 3
Note: 4-quarter moving average.
Source: Statistics Denmark.