One of Danmarks Nationalbank’s main tasks is to plan monetary policy so that it ensures a fixed exchange rate against the euro and thus contributes in the best possible way to stable price development. It is therefore important that Danmarks Nationalbank identifies early on whether current economic development and economic policy entail risks in relation to price development, credit development and the stability of the financial system, as these can otherwise make it difficult to conduct a fixed exchange rate policy.
Danmarks Nationalbank therefore prepares assessments of economic trends at regular intervals combined with economic projections in order to closely monitor the situation in the Danish economy. This enables Danmarks Nationalbank to make qualified recommendations for and assessments of the economic policy being pursued in Denmark to avoid, for example, imbalances.
As Denmark pursues a fixed exchange rate policy, Danmarks Nationalbank cannot use what is traditionally the most important tool in a central bank’s monetary policy – the monetary policy interest rate – to influence the level of activity and thus price development in the economy. The interest rate tool is reserved to ensure that the Danish krone remains pegged to the euro. This means that cyclical fluctuations in the economy can only be stabilised by means of fiscal policy. Danmarks Nationalbank therefore provides recommendations regarding the overall impact of fiscal policy on economic activity.
How does Danmarks Nationalbank make projections?
In its projections for the Danish economy and other socio-economic calculations, Danmarks Nationalbank uses a number of models, including MONA. The name ‘MONA’ is a contraction of the words ‘model’ and ‘Nationalbank’.
MONA is a quarterly macroeconomic cyclical model that describes demand components, production, employment, wages and salaries and prices. MONA serves as a tool which Danmarks Nationalbank uses to help forecasting how the Danish economy will develop. The model cannot independently produce projections for the Danish economy, but it can show whether the projection is consistent with all the correlations in the Danish economy which are described in the model, for example between income and consumption. The projection is based on a number of assumptions about factors that lie outside the model, such as the fiscal policy which is currently being pursued, economic growth abroad and the development in interest and exchange rates.
It should be borne in mind that the correlations of the model will always be simplified in relation to reality, as it is impossible to put all relevant aspects of economic reality into a formula. Therefore, the historical development will differ from the model’s estimated correlations – just as it is not certain that the correlations in the model apply to the future. Preparing the projection ultimately depends on a number of expert assessments of whether the forecast development returns back to the estimated correlations – and how quickly.
The assessment of what the final projection is going to look like involves, for example, information that is not included in the model, for example so-called soft indicators of confidence in the corporate sector and among households.
In this context, the model serves three purposes:
First, the model ensures that all identities in the accounting system of the national accounts are respected to ensure that the projection is fully consistent.
Second, the model contains a number of checks and balances that make it possible to verify whether the assumptions of those working on the projection distort the correlations of the model too much.
Third, the model can be used to prepare scenario analyses that, for example, highlight the significance of lower economic growth abroad or higher energy prices for the Danish economy.
Projections in connection with Danmarks Nationalbank’s regular analyses and reports
Assessments and recommendations are published every six months in Danmarks Nationalbank’s two regular outlook analyses for the Danish economy and of monetary and financial trends, respectively.
Danmarks Nationalbank’s projections are also used in its six-monthly stress test of the largest banks in Denmark. The stress tests provide the basis for a general assessment of the resilience of Danish banks in different macroeconomic scenarios.
Economic projections are subject to considerable uncertainty
Danmarks Nationalbank’s projection represents the course that is regarded as the most likely for the Danish economy given the current economic policy. Therefore, Danmarks Nationalbank’s projection will – and should – not include measures which are likely, but which have not yet been finally decided. This creates some uncertainty in the outlook for the economy.
In general, projections of economic development will always be subject to considerable uncertainty. This applies not least in times of violent fluctuations.
Generally speaking, it can be difficult to assess why current developments deviate from the historical trend. And if it is deemed that it is because the economy is heading in an unsustainable direction, it is very difficult to predict when and how a correction will take place.
Furthermore, the Danish economy is highly dependent on economic developments in the world around us. One of the prerequisites for making a projection about the Danish economy is therefore being able to forecast how things are going abroad. There is a high degree of uncertainty associated with this forecast, which will consequently affect the projection for the Danish economy.