Analyses focus on current issues of particular relevance to Danmarks Nationalbank’s objectives. The analyses may also contain Danmarks Nationalbank’s recommendations. They include our projections for the Danish economy and our assessment of financial stability. Analyses are targeted at people with a broad interest in economic and financial matters.
Effective liquidity distribution is key for well-functioning money markets
Well-functioning money markets are important for the effective transmission of monetary policy rates as well as the stability of broader markets in Danish kroner. Monetary policy counterparties, MPCs, with exclusive access to Danmarks Nationalbank’s monetary policy facilities, have a responsibility to support money market functioning through their distribution of central bank liquidity. As the supply of central bank liquidity can vary over time it is important that krone money markets remain well-functioning, even when available central bank liquidity falls. MPCs should therefore consider Danmarks Nationalbank’s weekly lending facility as an integral part of their day-to-day liquidity management to the extent needed to ensure their continued support of money market functioning.
Key messages
Why is this important?
Danmarks Nationalbank uses monetary policy to achieve its objective of low and stable inflation. Denmark has a fixed exchange rate policy. This means that the Danish krone exchange rate is kept stable against the euro. The exchange rate is structurally influenced by the differential between money market interest rates in Denmark and the euro area. Danmarks Nationalbank has the tools to maintain the fixed exchange rate policy in any environment, via interventions in the foreign exchange market and policy rate adjustments. However, the regular use of monetary policy instruments by MPCs and active redistribution of central bank liquidity to other market participants is important for the effective functioning of money markets in Danish kroner.
"All monetary policy counterparties should consider Danmarks Nationalbank’s weekly lending facility an integral part of their liquidity management. There should be no stigma attached to using it."
Martin Wagner Toftdahl,
Director and Head of Banking & Markets
Main chart
Using the lending facility is the only way for MPCs to increase the supply of central bank liquidity
Note:
The bars represent a simplified version of Danmarks Nationalbank’s balance sheet, with assets on the left-hand side and liabilities on the right. The middle set of bars show the effect of an intervention (selling euros and buying kroner to a value of kr. 65 billion) resulting in a fall in the foreign exchange reserve on the asset side and a fall in the net position on the liabilities side. The bars on the right show the effect of MPCs drawing kr. 65 billion from the lending facility, creating both an asset and a liability and increasing central bank liquidity in the banking system by kr. 65 billion.
Source:
Danmarks Nationalbank.