SPEECH
Governor Lars Rohde's speech at Danmarks
Nationalbank conference marking the 40th
anniversary of the Danish fixed exchange rate
31 October 2022
regime
CHECK AGAINST DELIVERY
*** Welcome ***
Ladies and gentlemen. It's a great pleasure for me to be here today. I am
grateful for seeing so many familiar faces.
Today we mark the 40-year anniversary of the current Danish monetary
policy regime. A regime where we keep the Danish krone stable to the
euro. And before that, to the German Mark.
In 1982, I entered Danmarks Nationalbank for the first time as a young
economist. The year that the new regime was introduced. And yes, I had
curly dark hair back then.
In those days, many countries pursued a fixed exchange rate policy. That
has changed. Today, the Danish monetary policy regime is one of the
longest running fixed exchange rate regimes in the world. And it is
somewhat unique.
Over the years, the regime has become a cornerstone of economic policy
in Denmark. And it has contributed to a remarkable transformation of the
Danish economy. A transformation from a fragile economy characterised
by high inflation and substantial imbalances to the strong economy that
we know today.
As is the case for most central banks, the primary objective of Danish
monetary policy is to ensure low and stable inflation.
The key question is therefore: Has the fixed exchange rate policy
delivered low inflation? Based on the long period of price stability we
enjoyed until the recent global surge in inflation, the answer is clearly
'yes'.
Following the introduction of the current monetary regime, inflation
gradually declined to German levels. Yields on government bonds
underwent a similar trend.
The policy regime has also benefitted the economy more widely. It has
contributed to macroeconomic stability, and it has facilitated trade
integration with the euro area.
*** Denmark's long tradition of fixed exchange rate policy ***
40 years with a fixed exchange rate policy is a long time. But our history
with fixed exchange rate regimes goes back much further.
Back in the 19th century - more than 200 years ago - we first followed
the silver and later the gold standard. As a result, the Danish krone was
fixed to other countries' currencies with similar silver and gold-based
monetary systems.
When we left the gold standard in the 1930s, we pegged our currency to
the British pound.
After World War II, we were part of the international dollar-based Bretton
Woods system. And later, we participated in the arrangements around
the European currencies.
*** In the 1970s and early 1980s, monetary stability was lost ***
The first three decades after World War II constituted a period of
monetary stability.
But in the 1970s and early 1980s stability was lost. Policy mistakes
following the first oil crisis - including tax reductions - and a setup for
taxation not geared for high inflation contributed to a sharp increase in
inflation.
In search of quick fixes to more structural economic problems,
consecutive Danish governments resorted to devaluating the krone.
The devaluations weakened the economy. It culminated in the early 1980s
where unemployment had increased to around 10 per cent. Inflation was
above 10 per cent. Government budget deficit close to 10 per cent of
GDP. And long-lasting current account deficits had increased foreign debt
outstanding to more than 40 per cent of GDP.
Expressions such as "Denmark on the edge of the abyss" and "state
bankruptcy" were part of the public debate.
*** The introduction of the current fixed exchange rate regime ***
In 1982, there was a change in government. This provided an opportunity
to chart a new economic course.
On Thursday 9 September, the leaders of the largest political parties in
the incoming government - Poul Schlüter and Henning Christophersen -
issued a short statement. Only five lines. But it turned out to be defining
for macroeconomic policymaking in the decades to come.
The statement concluded that "...a devaluation is not included, nor will it
be included, in the formulation of the economic policy that will be
presented by the new government".
At the outset, the significance of the statement was probably
underestimated - even within Danmarks Nationalbank. In our annual
report for that year, the fixed exchange rate policy is mentioned only
briefly.
The new government soon got an opportunity to show its commitment.
About a month after the government had been formed, the Swedish
Krone was devaluated by 16 per cent. The fact that we did not follow suit
with a devaluation provided credibility to the commitment.
*** Ground rules for a fixed exchange rate policy ***
The introduction of the current fixed exchange rate policy regime also
marked the introduction of a stability-oriented economic policy more
broadly. Wage indexation was suspended and later abolished. Fiscal
policy was tightened substantially. And a few years later, legislation was
amended to discourage excessive borrowing.
Over the last 40 years, a stability-oriented economic policy with a focus
on medium-term objectives together with structural reforms - not least in
the labour market - have transformed the Danish economy.
Today, unemployment is among the lowest in Europe. We have sound
fiscal balances and low public debt. Large current account deficits have
been replaced by large surpluses. This has transformed Denmark from a
debtor nation to a creditor nation with net foreign assets of about 70 per
cent of GDP.
In turn, we have created a highly robust economy. I think it is fair to say
that the fixed exchange rate policy has had an educational effect on
several generations of politicians. They all remember or have heard of
the economic woes of the 70s and 80s. And no one wants to end up there
again.
*** The system has withstood several tests over time - adding credibility
to the system ***
Keeping the exchange rate fixed is not always an easy task. It takes
determination. Vigilance. A forward-looking and responsive mindset. A
willingness to learn and adapt.
This is particularly true in periods with pressure on the krone. And we
have seen our fair share of such periods. But we have shown that we are
ready to do whatever it takes to keep the krone stable.
As the economy has transformed over the years, so has the type of
exchange market pressure that we encounter. And each time we have
drawn new experiences.
In the early 1990s, European foreign exchange markets came under
strong pressure from speculators. Our currencies were pegged to each
other within the Exchange Rate Mechanism, ERM. But one after another,
they came under attack. The Danish krone was no exception.
Amid the turmoil, the United Kingdom abandoned its fixed exchange rate
policy. Later Sweden and Norway followed suit. The situation developed
into an attack on the entire ERM system.
Responding to the crisis, it was decided to widen the bands within which
the currencies were allowed to fluctuate to plus/minus 15 per cent.
Although Denmark had argued in favour of retaining the ERM as far as
possible in its existing form, the Danish krone depreciated significantly
against the D-Mark.
The Danish government under the leadership of Prime Minister Poul
Nyrup Rasmussen - who is here today - and Danmarks Nationalbank
agreed to stand ground.
It was emphasised that Denmark had sound economic fundamentals and
that the fixed exchange rate policy would be maintained despite the
widening of the fluctuation band. We also tried to obtain support from
the Bundesbank to get back to a narrow band between the Danish krone
and the D-Mark.
Markets eventually calmed down and the krone exchange rate against
the D-Mark was brought back to its level from before the turmoil. The
ERM crisis is the last time that a crisis has caused a noticeable deviation
of the exchange rate from its central parity.
During the global financial crisis in 2008, new lessons were learned. First
of all, we were reminded of the need for large buffers. This applies to our
foreign exchange reserve. But also, in the financial sector. We also saw
how excessively accommodative economic policies in the years leading
up to the crisis contributed to the economic setback in Denmark.
Heightened global uncertainty prompted investors to seek safe havens.
Several small currencies came under pressure - including the Danish
krone.
To stabilise the krone, we intervened heavily. To quote my predecessor,
former Governor Nils Bernstein on the matter; "We could literally see our
reserves pouring out of our coffers. I felt like driving a car without
brakes."
As a result, we increased interest rates on several occasions, thereby
widening the spread between our policy rate and that of the ECB. A clear
example that defending a fixed exchange rate regime is costly at times.
But we never doubted that it was worth it. And as a result of our efforts,
the exchange rate remained stable throughout the crisis.
In the aftermath, we decided to increase our foreign exchange reserves
significantly. As Governor Bernstein put it; "We had to recognise the truth
in the simple saying; money is hardest to come by when you need it
most."
In the first 30 years of the fixed exchange rate policy, currency crises were
typically associated with downward pressure on the krone. That changed
with the sovereign debt crisis in 2011-12.
Assets in Danish kroner were suddenly considered a safe haven by
investors who worried about the risk of a potential break-up of the euro
area. As a result, we intervened heavily by purchasing currency. We also
became acquainted with negative interest rates. It was the first time in
our 200-year history that we had negative rates - in fact, it was the first
time for any central bank to reduce its key policy rate into negative
territory.
The introduction of negative rates brought us some spotlight in the
central banking community. A spotlight that intensified in 2015 when -
out of the blue - The Swiss national bank abandoned the floor of the
Swiss franc against the euro.
The Swiss decision led investors to look for comparable candidates to
abandon their peg. With only few countries to look for, Denmark
immediately experienced a massive inflow of currency. Consequently, the
krone came under strong pressure to appreciate against the euro.
Those hectic weeks in beginning of 2015 stand clear in my memory. The
whole bank was buzzing with activity. We were all on alert.
We sold kroner of a historical amount of 275 billion - corresponding to
37 billion euros. And in just three weeks, we cut the deposit rate four
times to -0.75 per cent. An unprecedented low.
Also, on our recommendation, the government suspended the issuance
of bonds. Like a QE programme, this reduced the supply of bonds
available to investors, thereby pushing yields lower.
Throughout the crisis, I repeated one message time and again: "We will
not abandon the peg". And in the end, the speculators got the message.
Leaving them with significant financial losses. While we had additional
earnings of just over 2 billion kroner.
During the first decades of our policy regime, we developed experience
in dealing with large currency outflows. The fact that episodes of pressure
in foreign exchange markets can now result in substantial currency
inflows is testament to our strong economic fundamentals.
More recently, the exchange rate peg weathered the pandemic crisis.
While we resorted to applying our monetary policy tools, there was not
much drama. That is eye-catching considering the severity of the crisis. It
reflects the robustness and the confidence that has been built up in the
Danish economy over the past 40 years.
*** Closing of the speech ***
So let me conclude: Throughout the last 40 years we have shown both
the determination and the ability to pursue a fixed exchange rate policy.
We have the necessary tools, and we are backed by support from the
government. Together, we stand shoulder to shoulder in our
commitment to the peg.
The policy also enjoys support from across the political spectrum as well
as from economic experts, the financial community, the business
community as well as from the labour unions. This is testament to the
strong results that the policy has delivered for the Danish economy over
the last 40 years.
Thank you for your attention!