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Development in activity and the balance of payments

In 1997 real GDP grew by almost 3½ per cent overall, while domestic demand rose by more than 4.25 per cent and thus by far more than among Denmark's trading partners. Several indicators of domestic demand, e.g. consumer confidence, car sales and retail turnover, also point to continuing high consumption in the first half of 1998.

Private consumption has increased somewhat more than households' disposable incomes. The increasing propensity to consume must be attributed in particular to consumers' generally positive expectations among other things as a consequence of continued growth in prices for owner-occupied homes. From comparison of the 1st quarter of 1998 with the same period of the preceding year the Association of Danish Mortgage Banks has compiled the growth in cash prices for owner-occupied homes at just below 12 per cent. The strong decline in the level of interest rates has undoubtedly also affected the propensity to consume in view of the conversions of mortgage-credit loans to loans at lower interest rates. Although bond owners have suffered equivalent losses, where non-residents or institutional investors are involved there is no equivalent negative effect on consumption. The losses of institutional investors will not entail significantly lower pensions as the real-interest tax rate, and tax revenues to the Treasury, will decline.

Capacity utilization in industry has increased significantly as a consequence of the rise in activity, cf. Chart 5. At the close of 1997 the indicator of the capacity shortfall as compiled in Statistics Denmark's business survey was higher than in the mid-1980s when the previous economic upturn peaked.

Employment increased strongly in 1997 and the first months of 1998. In international terms the unemployment level is now very low. Applying the EU-harmonized definition unemployment is currently just below 6 per cent. Within the EU only Austria, Luxembourg and the Netherlands have lower unemployment rates.

The stronger development of the Danish economy compared to Denmark's trading partners was reflected in a marked deterioration of the current account. The surplus in 1997 was just over kr. 7 billion, compared to approximately kr. 18 billion in 1996, i.e. a deterioration of kr. 11 billion in one year. At the beginning of 1998 the current account deteriorated further.

This deterioration in the balance of payments also reflects that the public savings surplus has not increased sufficiently to compensate for the decline in the private sector's savings surplus.

The private sector's savings balance is often reflected in the development in demand for loans, cf. Chart 6. A decline in the private sector's savings surplus will thus typically entail a higher financing requirement in the private sector, and thereby an increase in borrowing. This trend has also been apparent during the present upswing. In the mid-1980s the savings balance deteriorated significantly over a very short period. During this upswing the savings balance has likewise deteriorated considerably, but from a significantly more favourable starting point. Growth in lending to non-residents by the banks and mortgage-credit institutes has increased during the last three years and has now reached an annual growth rate of approximately 8 per cent. However, the growth in lending has not reached the extremely high level which prevailed during the upswing in the mid-1980s when the taxation rules entailed a generally negative real interest rate after tax.

The indications of a further increase in consumption, the high level of capacity utilization, the recent strong deterioration of the current account, and not least the more relaxed financial conditions which are a consequence of the fixed-exchange-rate policy require that the announced tight public budget policy in 1998 be maintained, and that a real tightening take place in 1999. Since 1993 public consumption has risen every year by approximately 1½ per cent more than expected when the Finance Act was

adopted, cf. Chart 7. In the present cyclical situation a tight fiscal policy is necessary to keep total domestic demand down. The unexpectedly large decrease in the current-account surplus can be attributed among other things to the more relaxed fiscal policy than planned in recent years.

Development in wages and prices

Inflation has been relatively moderate. In the 1st quarter of 1998 the year-on-year rate of increase in consumer prices (CPI) was 2 per cent, which is lower than in 1997, cf. Table 1. The decline in the rate of increase in consumer prices (CPI) is to a high degree attributable to falling energy prices. The dampening should also be viewed against the very strong food-

price increases in 1997, whereas increases in the 1st quarter of 1998 have been more moderate. Finally, most recently charges for public services have shown weak development. Import prices rose throughout 1997, but appear to have flattened out at the beginning of 1998 when particularly prices for a number of raw materials declined, among other things as a reaction to the downturn in Asia.

The relatively moderate level of inflation is higher than among our trading partners, however. Considering the harmonized index of consumer prices (HICP), calculated since 1995, it will be seen that since mid-1996 Denmark's harmonized consumer-price inflation has been on average 0.3 per cent above the consumer-price inflation in the future euro area, cf. Chart 8. The harmonized index of consumer prices for the euro area is a new index which covers inflation in the countries participating in the third stage of EMU as from January 1, 1999. The index is calculated as a weighted average of the harmonized index of consumer prices from each country. The joint index is expected to be a significant indicator for monetary policy in the euro area.

The rate of increase in wages in Denmark is still high and on a year-on-year basis has been around 4 per cent since 1994. With an increase of around 4 per cent the wage increases in Denmark are approximately 1½ per cent higher than in the other core countries, and approximately 2½ per cent higher after adjustment for exchange-rate fluctuations. It is to be hoped that this difference will disappear once the differing cyclical positions are eliminated. The tighter labour market and wage increases beyond those in other countries clearly reflect the complications which arose during this year's collective bargaining. The bottleneck problems do not yet appear to be as great as during the upswing of the 1980s, even though employment is rising quickly from a high level.

The collective negotiations took an unexpected turn when the conciliation proposal put forward by the official conciliator (Forligsmanden) was rejected by a ballot of union members, resulting in a strike as from April 27. The strike ended on May 7 when the government took steps to intervene since the parties to the labour market had not yet come to any agreement and there was prospect of a prolonged strike. These measures entailed that the cost structure for employers remained by and large as set out in the rejected conciliation proposal. For example, the agreed average annual rates of increase in respectively the minimum wage and the normal wage of approximately 2.6 per cent and 3 per cent were retained. On the other hand, the increase in the pension contribution was reduced in favour of extra days of leave. In order to avoid an increase in employers' costs as compared to the rejected conciliation proposal viewed over a two-year period with effect from January 1, 1999 the employee sickness tax was reduced by almost kr. ½ billion.