What is the effective krone rate?
The effective krone rate is an index calculated by Danmarks Nationalbank to measure the strength of the Danish krone relative to a number of other currencies. Denmark conducts a fixed exchange rate policy against the euro. This means that the value of the Danish krone fluctuates only very slightly against the DKK/EUR central rate of DKK 7.46038. However, the krone is floating against all other currencies. The effective krone rate is a measure of the strength of the Danish krone against the currencies of Denmark’s 27 largest trading partners. In the past decade, the index has remained relatively stable at an index value slightly above 100, referenced to 1980 = 100, see Chart.
A strengthening of the effective krone rate implies that imported foreign goods and services become cheaper in Danish kroner. This helps to moderate inflation in Denmark. A weakening of the effective krone rate has the opposite effect.
What is the real effective krone rate?
The effective krone rate is also used to calculate real effective exchange rates. The real effective exchange rate captures relative price or wage movements (be it in hourly wages, unit labour costs or wage shares) in the same currency. The real effective exchange rate is used, among other things, to measure Denmark's wage competitiveness against other countries. An increasing real effective krone rate reduces the wage competitiveness of Danish companies, making it more difficult for Danish companies to compete with foreign companies. An increase in the real effective krone rate may be caused by an increase in the effective krone rate, or by higher relative wage growth in Denmark compared to other countries. Conversely, declining real effective exchange rates will improve wage competitiveness. Effective exchange rate developments are therefore key to assessing the competitiveness of the Danish economy.
How to calculate the krone rates
The calculation of effective exchange rates is thus based on multiple currencies. Exchange rates are constantly changing, and not all currencies are equally important for the calculation. The effective and real effective krone rates are calculated on the basis of a set of weights, see the table. The weights reflect the extent to which Danish products are exposed to competition from products from other countries. The greatest weight is given to the most important competitors. The set of weights used to calculate the effective exchange rates is traditionally based on industrial trade. Services are thus not included in the calculation of the weights. However, the inclusion of services would not significantly impact the calculations. Agricultural products are not included, among other things due to the many restrictions to trading in these types of products (trade barriers, tariffs, subsidies etc.) which distort prices and trading.
The calculation of the weights factors in competition with foreign products in the Danish market, in the domestic markets of the countries in question and in third markets. The competition in third markets is captured by the double-weighted export weights. Countries that are strong in almost all markets, like China, are assigned a higher export weight than would be indicated by the bilateral trading. The same applies to the USA.
Danish foreign trade is generally becoming increasingly dispersed across countries. Historically important trading partners now play a less important role. This development is reflected in the most recent revision of the weights used to calculate the effective krone rate. The weights assigned especially to China and, to a lesser extent, the USA are increased, while the weights assigned to neighbouring markets such as Sweden, Germany and the UK are falling. The re-weighting trend seen in connection with earlier weight revisions thus continues.