Monetary and exchange-rate policy


The fixed-exchange-rate policy means that Denmark's monetary policy is aimed at keeping the krone stable against the euro. Danmarks Nationalbank conducts monetary policy by setting the monetary-policy interest rates. These interest rates are linked to the lending and deposit facilities made available by Danmarks Nationalbank to the banks and mortgage banks. When Danmarks Nationalbank changes its interest rates relative to those of the European Central Bank (ECB), this normally affects the exchange rate of the krone against the euro. Via the money market, the monetary-policy interest rates also affect the lending and deposit rates offered to firms and consumers.

As the central bank of Denmark, Danmarks Nationalbank is responsible for conducting monetary policy in Denmark, which it does by setting the monetary-policy interest rates. Denmark maintains a fixed-exchange-rate policy vis-à-vis the euro area and participates in the European Exchange Rate Mechanism, ERM 2, at a central rate of 746.038 kroner per 100 euro with a fluctuation band of +/- 2.25 per cent. This exchange-rate regime provides a framework for low and stable inflation in Denmark.

Distribution of responsibilities for economic policy

There is a clear distribution of responsibility for economic policy. In a fixed-exchange-rate regime such as Denmark's, monetary-policy interest rates are reserved for managing the exchange rate. The monetary-policy interest rates cannot also be used for managing the business cycle. Danmarks Nationalbank's monetary policy purely aims at keeping the krone stable against the euro. The government conducts its fiscal policy and economic policy in general so as to achieve a stable economic development. Stability-orientated fiscal policy is also of paramount importance to the fixed-exchange-rate policy.

How does Danmarks Nationalbank keep the krone stable?
When Danmarks Nationalbank changes its monetary-policy interest rates relative to those of the ECB, this affects the exchange rate of the krone.

  • All other things being equal, an interest-rate increase strengthens the krone relative to the euro.
  • Conversely, an interest-rate reduction weakens the krone relative to the euro.

In periods when the foreign-exchange market is calm, Danmarks Nationalbank usually changes its interest rates in step with the monetary-policy interest rates of the ECB. In situations with upward or downward pressure on the krone, Danmarks Nationalbank unilaterally changes its interest rates in order to stabilise the krone. In the short term, Danmarks Nationalbank may also influence the exchange rate of the krone by intervening, i.e. buying and selling foreign exchange in the market.

  • When Danmarks Nationalbank sells foreign exchange (and purchases kroner), the krone will have a tendency to strengthen.
  • When Danmarks Nationalbank purchases foreign exchange (and sells kroner), the krone will have a tendency to weaken.

Danmarks Nationalbank's intervention is financed via the foreign-exchange reserve. Read more about the foreign-exchange reserve.

 

Danmarks Nationalbank's lending and deposit facilities
The monetary-policy interest rates are the discount rate, the current-account rate, the lending rate and the rate on certificates of deposit. In practice, Danmarks Nationalbank conducts monetary policy via Danish banks and mortgage banks – the monetary-policy counterparties. The counterparties hold accounts at Danmarks Nationalbank, which undertakes settlement of their interbank payments. The monetary-policy interest rates are linked to the lending and deposits facilities made available to the counterparties by Danmarks Nationalbank.

Danmarks Nationalbank's facilities:

  • Demand deposits: Each counterparty holds a current account at Danmarks Nationalbank, into which it can make overnight deposits which accrue interest at the current-account rate.
  • Weekly open market operations: On the last banking day of each week, Danmarks Nationalbank conducts ordinary open market operations, in which the counterparties may raise monetary-policy loans against collateral and make deposits by purchasing certificates of deposit issued by Danmarks Nationalbank. The loans and certificates of deposit accrue interest at the lending rate and the rate on certificates of deposit, respectively. Normally, loans and certificates of deposit have a maturity of seven days and mature on the last banking day the following week. See latest market operations.
  • Daily open market operations. On all other banking days than the last banking day of the week Danmarks Nationalbank offers purchase and sale of certificates of deposits. The certificates of deposit mature on the last banking day of the week.
  • Liquidity-adjusting deposits and loans: In December 2011, Danmarks Nationalbank introduced liquidity-adjusting deposits and loans in kroner. These operations are conducted as and when required. The rate of interest and maturity reflect market conditions at the given time.

Danmarks Nationalbank uses an "open window" in its ordinary weekly open market operations. This means that Danmarks Nationalbank sets the 7-day interest rates on loans and certificates of deposit, after which the counterparties are free to determine the volume of monetary-policy loans and deposits. The counterparties must pledge collateral for all monetary-policy loans. The collateral basis comprises securities - primarily government and mortgage bonds. Read more about the collateral basis, the monetary-policy instruments and the rules governing counterparties' accounts at Danmarks Nationalbank.

 

Interest-rate pass-through
Danmarks Nationalbank's interest rates determine short-term money-market interest rates, cf. Danmarks Nationalbank's annual money-market survey. The money market is the market for short-term loan agreements and interest-rate contracts, primarily between banks. Monetary-policy interest rates affect money-market interest rates because they are linked to Danmarks Nationalbank's lending and deposit facilities, which are alternatives to borrowing and placement in the money market. Interest-rate formation in the money market is the basis for the deposit and lending rates offered by banks to their customers. In that way, Danmarks Nationalbank's interest rates are channelled via the banks and mortgage banks to the money market and on to the lending and deposits rates applying to firms and households.