SPEECH
SPEECH BY GOVERNOR LARS ROHDE
AT DANSKE BANK MARKETS EVENT,
NEW YORK CITY
CHECK AGAINST DELIVERY
20 April 2017
Thank you for inviting me to speak.
Today, I will focus on a long-term view of the Danish economy. My key messages are:
1. As a result of a long history of reform-oriented policies, the Danish economy today stands
strong with no major imbalances.
2. The fixed exchange rate regime has been a cornerstone in the Danish economy for more
than 30 years - and this has not changed with negative interest rates.
3. The strategy for issuance of Danish government bonds is focused on supporting liquidity.
Issuance is concentrated in 2- and 10-year nominal bonds.
35 years ago the Danish economy was in a miserable state. There were huge imbalances
illustrated by a deficit of the public finances of almost 10 per cent of GDP and a long term interest
rate of more than 20 per cent. This was partly a consequence of the shocks to the global
economy in the 1970s but also a result of an inappropriate economic policy. The path to a turna-
round began with the introduction of the fixed-exchange-rate policy in 1982.
It was followed by a long period of major reforms of the economy - of the labour market, the
tax system, and the pension system. The result has been that Denmark today stands as one of
the few economies in the world with an AAA rating with stable outlook.
Of the reforms implemented over the period, I will highlight one: The reform of the pension
system in 2006. Here the public pension age was indexed to life expectancy. Together with the
longstanding tradition of funded labour market pensions, this is the main reason behind the
assessment that public finances are sustainable in the long run. We do not have huge unfinanced
pension obligations waiting to be unleashed in the future as is the case in many other countries.
The reforms of the labour market have reduced the level of structural unemployment to close to
4 per cent of the labour force.
The Danish labour market is flexible with few restrictions on hiring and firing but with an
extended social safety net. In my mind there is no doubt that this is a major reason for the relative
positive attitude vis-á-vis globalisation among the majority of the Danish population.
The turnaround of the Danish economy can also be illustrated by the development in the current
account and the Danish net foreign asset position.
At present, the current account surplus is almost 8 per cent of GDP - the highest level in the
post-war era. Denmark has consistently run a balance of payments surplus since 1990.
The balance of payments surpluses have turned a net foreign debt of close to 40 per cent of
GDP in the beginning of the 1990s into an even larger net claim.
In recent years there has been a substantial return on net foreign assets of 3-4 per cent of GDP.
This explains a part of the large surplus on the current account. Another part is due to the
buildup of pension funds. The ageing of the population will eventually reduce the surplus on the
current account and perhaps turn it into a deficit.
Let me stress that the surplus on the current account is the aggregated result of households'
and firms' individual decisions. It is not a public priority to have as high a surplus as possible.
Although the Danish economy today is sound there have been bumps on the road...
The Danish economy boomed in the mid-2000s and ended up over-heated with big imbalances
in terms of a housing bubble, loss of competitiveness, and high household indebtedness. The
economy was particularly hard hit by the financial crisis almost ten years ago, and it has taken a
long time to recover.
Since 2012 the economy has been in an upswing with growth in employment and a closing out-
put gap. We expect this to continue in the coming years with growth in real GDP of around 1.6
per cent per year.
There are currently no major imbalances in the economy that call for immediate political action.
Danish firms today are very competitive. Public finances are healthy and sustainable in the long
run. Inflation has been low for a period due to the fall in oil prices in late 2015 but is now
forecasted to just below 2 per cent in 2018. The only major "imbalance" is a surplus on the current
account of 8 per cent of GDP, and it is not really an imbalance but reflects to a certain extent
demographic induced structural savings surplus, as previously mentioned.
There are challenges, however...
One is to ensure sufficient labour supply to cover the increasing demand for labour.
Employment is close to its structural level and in the coming years it will be a bit above as seen in the
chart. Unemployment is also close to its cyclically neutral level. Thus, there are very few available
resources on the labour market.
In our central forecast scenario, the increased demand for labour will be covered by increased
labour supply.
Major reforms of the labour market have been implemented over the past two decades. This has
raised the structural level of employment.
The pension reforms have increased markedly the participation rates among senior groups on
the labour market and will continue to do so in the coming years as the reforms are phased-in.
This counteracts a structural decline of the number of persons in the working ages due to aging
of the population.
Part of the increase in the supply of labour will probably come from abroad, e.g. Eastern Eu-
rope. This will help to avoid a shortage of labour in the years to come.
So far, the tight labour market has not resulted in accelerating wages. Over the last couple of
years, the rate of increase has, however, been higher than abroad. And we expect this to
continue in the years to come.
In a fixed-exchange-rate regime as the Danish one, wages function as a buffer capturing shocks
to the economy instead of the exchange rate. A flexible labour market and flexible wage
formation are therefore essential. There is still room for higher wage growth and employment in
the Danish economy - but it should happen in an orderly way avoiding excesses.
Another part of the economy which warrants vigilance is the housing market.
Prices on single-family houses have been rising the past four years in large parts of the country.
That is a good thing. This has fuelled demand and thereby underpinned the growth in the
economy.
Real house prices are still well below the level during the over-heating of the housing market in
the mid-2000, and we forecast a soft landing for the housing market.
The rate of growth in house prices for the market on average has levelled off over the past half
year and is now below 4 per cent on a yearly basis in nominal terms. For the market for owner-
occupied flats in the Copenhagen area, the story is different...
Here, prices have been rising by around 10 per cent per year for several years. In the most
recent quarters, the price increase has levelled off somewhat - but the rate of increase is still 8 per
cent per year in nominal terms.
The price level for owner-occupied flats in Copenhagen is high relative to incomes and interest
rates. At the same time, interest-rate sensitivity is higher in Copenhagen than the average for
Denmark overall. This makes the Copenhagen housing market vulnerable to interest-rate hikes.
Thus, there is a considerable risk that if the real price increases seen in recent years continue,
they will be followed by corresponding falls.
Let me underline, we are not yet in a housing bubble, but the situation warrants attention.
Part of the problem is that the present regime of housing taxation is destabilising. To counter
this, a number of macro-prudential measures have been taken. Among these is a requirement of
a higher down payment if one wants to buy a house or apartment in Copenhagen and a number
of other cities, just as the requirements of the financial robustness of the buyer has been tight-
ened.
The monetary policy rate is directed solely at the fixed-exchange-rate policy and thus is not
available to counter pressures on the housing market.
The situation in the mid-2000s is in fresh memory but we do not see a similar situation develop
in near future. It is a risk factor, however.
Let me now turn to monetary policy and our experiences with negative interest rates.
For a long time, Danish monetary policy has been focused on maintaining a fixed exchange rate
against the euro. In fact, Danmarks Nationalbank has conducted a fixed-exchange-rate policy for
more than three decades - first against the D-Mark and from 1999 against the euro. We recently
celebrated the 30 years anniversary of the central rate.
The legal framework is the European Exchange Rate Mechanism. Officially, the krone may
fluctuate by up to 2.25 per cent on either side of the central rate, but in practice Danmarks National-
bank ensures that the fluctuations are far smaller. This reflects that Danmarks Nationalbank
takes consistent action as the krone exchange rate starts drifting away from the central rate.
The exchange rate peg is a cornerstone of Danish economic policy. It is a political decision. This
means that there is a clear mandate, and the policy enjoys support from across the political
spectrum. It is a fundamental part of the overall framework for economic policy.
The policy framework implies that interest rates are reserved for keeping the krone stable.
Monetary policy does not take factors such as growth, employment and house prices into account.
These considerations are - or should be - addressed by other economic policies. In particular,
fiscal policy potentially plays an important role in ironing out economic fluctuations.
As a result of the policy regime, Danish monetary policy interest rates tend to track euro area
interest rates set by the European Central Bank, the ECB, very closely. This means that to the
extent that the Danish business cycle is synchronised with that of the euro area, our monetary
policy will tend to limit economic fluctuations.
Overall, the policy framework has delivered strong results. Compared to most other countries,
we have enjoyed a stable macroeconomic environment.
The long history of the exchange rate peg means that all agents in the economy make decisions
based on its existence:
 Firms and households set wages knowing that a loss in competitiveness will not be offset by
a depreciation of the exchange rate. This has ensured price and wage stability - and firmly
anchored inflation expectations.
 Banks implicitly support the peg by engaging in what you could call "stabilising speculation":
They take positions, if the exchange rate starts to fluctuate. This illustrates the credibility of
the peg in financial markets.
 The government also knows that monetary policy will not "correct the mistakes" made by
fiscal policy. Also, as an overly expansionary fiscal policy may reduce the credibility of the
fixed exchange rate. This - to some extent - disciplines fiscal policy. The tendency to fiscal
pro-cyclicality during the strong economic expansion in the mid-2000s might well have been
worse under a different monetary regime.
To summarize, the peg to the D-mark/euro has served Denmark well for more than three
decades.
From time to time the framework is, however, put to a test by strong capital in- or outflows. One
such test occurred in January and February 2015 when Denmark experienced a very large inflow
of capital. The inflow started as the Swiss National Bank announced on 15 January that they
would no longer prevent the Swiss Franc from appreciating against the euro.
To prevent the krone from appreciating, Danmarks Nationalbank responded by intervening in
the FX market followed by interest rate reductions.
With effect from 6 February, the rate on certificates of deposits was reduced to -0.75 per cent.
This was a level that had not been seen previously. As the inflow of capital started, its width and
depth was not known. This induced us to reduce rates gradually.
Danmarks Nationalbank's monetary policy interest rates were transmitted to money-market
interest rates. Control of the difference between money-market rates in the euro area and
Denmark - the interest-rate spread - is crucial for controlling the exchange rate. And the experience
clearly showed that the interest rate spread is also effective during episodes of negative interest
rates and appreciation pressure on the krone.
These conventional measures were supplemented by extraordinary measures such as the tem-
porary suspension of the issuance of government bonds.
Compared with previous episodes of pressure against the krone, our interventions in the FX
market were larger in 2015. This reflects the size of the capital flows. But it also makes an
important difference whether there is upward or downward pressure on the krone.
In periods with upward pressure, Danmarks Nationalbank sells kroner. As we can always issue
kroner, this implies that there is no limit to how much we can intervene in the FX market. On the
other hand, there is a limit to how much interest rates can be reduced - although there are no
indications that we have been close to that limit.
Later in 2015 - when the pressure had abated - we again intervened in the FX market. But this
time by purchasing kroner thereby bringing FX reserves back down.
As I will return to in a minute, the substantially negative official interest rates have implied that
large bank deposits by firms and institutional investors also receive negative interest rates.
Households, on the other hand, have not been exposed to negative interest rates.
In principle, negative interest rates can be circumvented by holding cash, which always offers a
nominal return of zero. But we have not experienced an unusual increase in the demand for
cash. This reflects the substantial costs of secure storage and transport of large amounts of
cash. Furthermore, it is cumbersome and expensive to use cash for transactions involving large
amounts or large geographical distances. And almost 3⁄4 of all cash outside the MFI sector is
held by households - a sector that has not been exposed to negative interest rates.
Increased household demand for cash would primarily be a problem of social efficiency relating
to the trouble of settling transactions in cash. The impact on our policy target - the exchange
rate - is likely to be modest. More importantly, the transmission to the exchange rate would
weaken if banks were to choose to settle accounts in cash, thereby deactivating money market
rates. Or if institutional investors were to hold cash rather than earning negative deposit rates.
Assessing how far into negative territory interest rates can go before the various actors switch
from deposits to cash on a major scale is difficult. Currently, there are no indications that
negative interest rates lead to a surge in the demand for cash. This indicates that the lower bound on
monetary policy rates in Denmark well is below the current level of the rate of interest on
certificates of deposit of -0.65 per cent.
It is also relevant to point out that Denmark is not a very cash-based economy and that the
share of cash transactions has been declining.
As mentioned before, households have so far been shielded from negative rates. Negative
interest rates on deposit are, however, in wide-spread use for corporates and investment and
pension funds. The increased spread between household deposit rates and other sectors might
be due to sectoral differences in alternatives to deposits.
For households, the alternative to deposits might be cash with a zero interest rate, but incurring
the inconveniences of cash. On the other hand, for large corporates, investment and pension
funds the alternative might be placement on money market-like terms.
Banks are continuously adjusting their business models. Declining margins have - on average -
lowered banks net interest income. Interest income now constitutes less than half of their total
income.
Banks are compensating for the falling net interest income by expanding new business areas
such as wealth management and adjusting their fees.
Thus, to the worried banker, I can say that the fear of falling income in a world with negative
interest rates have not materialized in Denmark. But he needs to keep his eyes on the road and
continuously make the needed adjustments.
As described in the previous slides, the Danish economy is in good condition and holds the
highest possible credit rating with all major rating agencies.
One reason is the low level of debt. Central-government debt is currently 23 per cent of GDP, and
the EMU debt is among the lowest in Europe.
As you may know, issuance of central government debt is conducted by Danmarks Nationalbank
on behalf of the Danish government. The agreed framework includes two very central funding
rules that support the separation of fiscal and monetary policy: The domestic and the foreign
funding rule.
Under the domestic funding rule, the central government borrows in kroner to cover its current
budget deficit and redemptions on the domestic debt.
The krone-denominated bonds and bills are held by a broad investor base - including both
Danish and non-resident investors. The Danish insurance and pension sector is the biggest investor
segment with holdings of around 50 per cent of the bonds, while non-resident investors hold
approximately 40 per cent. Some of them are US dollar-based investors like you.
Foreign funding, on the other hand, is only used to maintain an adequate foreign-exchange
reserve.
This means that, as a general rule, the central government raises loans in foreign currency if it is
deemed appropriate to support the foreign-exchange reserve. This has not been the case in
recent years, and the loans have been gradually repaid.
Therefore, since the repayment of a dollar-loan in March 2017 the Danish central government
currently has no foreign currency loans.
In 2017, the target for domestic bond issuance is 65 billion kroner - or around 9 billion euro.
This is unchanged from 2016. Issuance will mainly be focussed in the 2- and 10-year segments to
build up of the volume of two new on-the-run issues and to support market liquidity.
In addition to focussing issuance, several other recent measures support liquidity in the
government bond market. This includes the introduction of regular switch operations - allowing
primary dealers and investors to switch off-the-run issues to more liquid on-the run issues
without major transaction costs. Switch operations are conducted bi-weekly, supporting the primary
dealers' opportunities to supply liquidity in the secondary market.
In addition, the central government also supports the market via tap sales and buy-backs
directly in secondary markets. This gives the primary dealers an extra opportunity to buy and sell se-
curities in smaller volumes outside the auctions, further reducing the risk of trading in Danish
government bonds.
Most recently, as of 1 April, a new primary-dealer model was introduced. In the new model,
requirements have been tightened so that each primary dealer to a larger extent is measured
relative to the best price quoters. At the same time, the best price quoters are rewarded, which
provides a stronger incentive to quote the sharpest possible prices - hopefully to the benefit of
you and the rest of the market.
The very preliminary experience has been increased secondary market turnover and tighter
price quotations.
A new 10-year bond was opened successfully in January and a new bond maturing in 2020 is
expected to be issued later this year. Despite focussing on those segments in 2017, the central
government maintains a broad list of on-the-run bonds. This includes 5- and 20-year bonds and
an inflation-linked bond.
So, for those of you looking for high quality bonds with good liquidity, there should be plenty of
options available in Danish government bonds.
Thank you for your attention.
DANMARKS
NATIONALBANK
THE DANISH ECONOMY
​By Governor Lars Rohde, 20 April 2017
Key messages
1. The Danish economy today stands strong with no
major imbalances
2. The fixed exchange rate regime has been a cornerstone
in the Danish economy - and this has not changed with
negative interest rates
3. The strategy for issuance of Danish government bonds
is focused on supporting liquidity
From the brink of the abyss to AAA-country
1982 2016
Current account balance Per cent of GDP -3.0 8.1
International investment position -31.8 56.0
Per cent of GDP
Unemployment rate Per cent 9.5 3.8
Budget balance Per cent of GDP -9.5 -0.9
Central government debt Per cent of GDP 44.4 22.8
Inflation Per cent 10.1 0.0
Long-term government bond yields 20.8 0.3
Per cent
Decline in structural unemployment
Turn-around in the Danish net foreign asset
position
Net assets, per cent of GDP
Current account balance, per cent of GDP
10 100
8 80
6 60
4 40
2 20
0 0
-2 -20
-4 -40
-6 -60
82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16
Net assets (right-hand axis) Current account balance
Looking ahead: The Danish economy moves
towards a moderate boom
Per cent
6
Boom
Boom
Boom Boom
5
4
3
2
1
0
-1
-2
Output gap
-3
-4
-5
83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19
...with mounting pressure on the labour
market
1,000 persons
2,900
2,850
2,800
Employment
Forecast
Structural
2,750
employment
2,700
2,650
2,600
...but Danish firms have a strong
competitive position
Subdued wage development
helped Danish industrial firms
improve their competitiveness
Vigilance required on the housing market
Note: Real house prices.
Source: Statistics Denmark and own seasonal correction.
Strong growth in prices on owner-occupied
flats in Copenhagen
Index, 2010 = 1
1.6
... relative to income and level of interest rate
1.4
1.2
1.0
0.8
Price of owner-occupied flats
(Copenhagen and Frederiksberg)
0.6
0.4
Estimated price
(modelled price based on income, interest rates, etc.)
0.2
0.0
Monetary Policy and Negative Interest
Rates
Danish exchange rate peg since 1982
Kroner per euro
6.0
6.5
7.0
7.5
8.0
8.5
9.0
83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15 17
Market rate Central rate Fluctuation limits (+/- 2.25 per cent)
Other economic agents take peg as given
Consumer price inflation
Pct., year-year
18
16
14
12
10
8
6
4
2
0
-2
70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14
Denmark Germany
Substantial policy action since 2015
Interest rate spread, percentage points
1.0
Sale of FX
0.8
0.6
0.4
0.2
0.0
-0.2
-0.4
-0.6
-0.8
Purchase of FX
-1.0
Jan 14 Apr 14 Jul 14 Oct 14 Jan 15 Apr 15 Jul 15 Oct 15 Jan 16 Apr 16 Jul 16 Oct 16 Jan 17
Monetary Policy spread Money market spread
​Note: Shaded quarters illustrate quarters where Danmarks Nationalbank intervened for more than DKK 20 bn. (net). Money market spread is the spread between 1
month OIS rates (i.e. EONIA- and CITA-swaps). Monetary policy spread is the spread between Danmark Nationalbank's CD rate and the ECB's deposit rate.
​Source: Rio, Thomson Reuters Datastream, Danmarks Nationalbank and own calculations.
19. april 2017
Normalization of FX reserves
No surge in the demand for cash
Kr. billion
54
52
50
48
46
44
42
Jan 12 Jan 13 Jan 14 Jan 15 Jan 16 Jan 17
Value of large notes in circulation Linear trend
So far, households have been shielded
from negative deposit rates
Per cent p.a.
2,0
1,5
Households
1,0
Investment and
pension funds
Corporates
0,5
0,0
-0,5
-1,0
Banks are adjusting business models
towards more fee-based income
Kr. Kr. billion billion
35
30
Interest income now
Net interest income
makes up less than
25
half of total income
20
15
Net fee income
10
5
Administrative margins
on mortgages
0
Central Government Debt
The currency split - Danish funding rules
T-bills and bullet loans
Domestic funding rule
• Issuance in DKK to cover the
deficit and redemptions of
Method: Auctions
domestic debt
supplemented with tap
Dollar and euro loans
Foreign funding rule
• Issuance in foreign currency
to maintain an adequate
Method: Syndication
foreign-exchange reserve
Issuance strategy for 2017
Target for bond Focus on 2- and Policy is still focused
issuance: kr. 65 10year bonds on supporting
billion liquidity
The central government
The target for sales of
The government debt
maintains a broad list of
government bonds and
policy is still focused on
on-the-run bonds but
Tbills in 2017 is kr. 65 billion
supporting liquidity by
issuance in 2017 will
and kr. 30 billion,
being active in the
predominantly be in 2-year
respectively, which is
secondary market.
and 10-year nominal
unchanged from 2016.
bonds.
Broad range of on-the-runs: Focus on 2- and 10-year
Kr. billion
140
Opening:
1st Auction:
During 2017
25 January 2017
120
100
80
60
40
20
0
17 18 19 20 21 22 23 24 25 26 27 ... 39
Nominal bonds Index-linked bond