SPEECH
SPEECH BY GOVERNOR LARS ROHDE AT THE
SWISS FINANCE POLICY SEMINAR OF THE
FEDERAL ASSEMBLY'S FINANCE COMMITTEES
3 July 2017
DANMARKS NATIONALBANK'S MONETARY POLICY - POSSIBILITIES AND
LIMITATIONS
First let me thank you for inviting me to speak at this seminar. It is a
special pleasure to have this chance to share views and experiences on a
matter close to my heart, namely Danish monetary policy. Especially with
this audience as there are many similarities between monetary policies in
Denmark and Switzerland.
Out of the grey sky on a cold and dull Thursday in January 2015, these
similarities caught the financial markets' attention - fueled by the SNB
announcement that it would abandon the floor on the Swiss franc against
the euro. As you probably know, Denmark experienced a massive inflow
of currency shortly after this announcement. And over the following
weeks, we saw unusual turbulence in the Danish foreign exchange
market.
[AGENDA]
Today I will talk about the Danish fixed-exchange-rate regime with the
cold Thursday in January 2015 as a point of departure. Then I will discuss
some of the potential spill-overs to Danish financial markets from the
unconventional monetary policies conducted by the ECB in recent years.
I will end my speech with some remarks on our experiences with very low
interest rates. We have had negative rates for some years now and so far
their implications have been far less exciting or radical than some might
have thought before entering the negative territory. Basically, negative
interest rates have just been a continuation of low interest rates.
1 Background for the fixed-exchange-rate regime
Let me revert to that episode in 2015.
[CHART 1: Intraday DKKEUR]
The Swiss announcement surprised financial markets resulting in
increased volatility in a wide range of financial asset markets. The Danish
FX market was one of them. In the first few hours after the Swiss
announcement, the Danish exchange rate fluctuated more than usual. Over
the following days and weeks, we experienced a massive currency inflow,
resulting in strong appreciation pressure on the exchange rate.
The Swiss decision seems to have led some foreign investors to look for
comparable candidates to abandoning a peg. There are not many
countries to look for. These investors could make a substantial profit if the
fixed-exchange-rate policy were to be abandoned and the krone
appreciated.
The initial push came from foreign investors. However, nearly two thirds
of the increased demand for kroner in those few weeks in January and
February came from domestic investors, including insurance companies
and pension funds. Some of these companies wished to at least partly
insure themselves against losses in the unlikely event that the krone ap-
preciated like the Swiss franc.
[CHART 2: FX reserve]
But we are not SNB copycats - we are ECB copycats!
So in response, we used our usual measures to defend the peg. We
intervened heavily in the FX market by buying euros and selling Danish kroner
to meet the elevated demand. In addition, monetary-policy rates were
significantly reduced. The sizeable intervention caused a sharp increase in
FX reserves by almost 15 per cent of GDP in less than two months. As the
pressure abated, the level of FX reserves was gradually reversed over the
course of 2015 to reach a level of just above 20 per cent of GDP - close to
the current level.
There is an inherent asymmetry in our use of instruments: Under
depreciation
pressures, there is no limit to how high policy rates can be raised.
And the size of the FX reserves constitutes the upper bar for FX
appreciation
interventions. Under pressures, there is a limit to how low policy
rates can be reduced. The scope for selling kroner and buying euros, in
contrast, is unlimited as we can print as many kroner as we deem
necessary.
As a further and unconventional measure to bring the currency inflow to
a halt, the government decided to suspend issuance of government
bonds temporarily. This move was made after recommendation from
Danmarks Nationalbank. It was an option because the government
already had ample liquidity reserves.
The suspension of issuance is a version of QE - reducing the supply of
bonds available for private investors. It led to a strong decline in the yield
spread to German government bonds for all maturities, in particular in
the short end of the yield curve. The spread became negative even for
long maturity bonds. This made it more costly to speculate against the
krone.
A key point is that despite many similarities, there are significant
differences between the monetary policy regimes in Denmark and Switzerland.
Even when faced with the largest currency flows in the history of our
fixed-exchange-rate regime, we were willing to do whatever it took to
maintain the peg. Abandoning the peg was never an option.
***
Let me jump back to some 200 years ago. Danmarks Nationalbank was
established in 1818 to restore the monetary system after a state
bankruptcy a few years earlier. Danmarks Nationalbank became an
independent institution more than 100 years later in 1936. The National Bank of
Denmark Act of that year is still the legal basis for our activities.
Central-bank independence is enshrined in this act. Among other things,
it states that the Board of Governors is solely responsible for determining
monetary-policy interest rates. However, the act does not explicitly say
anything about exchange-rate policy. The current fixed-exchange-rate
policy was decided and introduced by the Danish government in 1982.
Since then the policy has been sustained by consecutive governments
with broad parliamentary support.
3: exchange rate since
[CHART 1982]
The formal framework for the fixed-exchange-rate regime is the European
Exchange Rate Mechanism, ERM2. Officially, the krone may fluctuate by
up to 2.25 per cent on either side of the central rate. In practice, Dan-
marks Nationalbank ensures that fluctuations are far smaller as you can
see from this chart.
The decade-long experience with the exchange-rate peg means that the
regime is deeply rooted in the Danish economy and economic policy. It is
strongly supported by the general public. And the regime enjoys strong
credibility among market participants. Market forces normally ensure that
the exchange rate is close to the parity without any need for central-bank
interventions.
[CHART 4: Inflation rates]
The current Danish fixed-exchange-rate policy was introduced on the
basis of an unsustainable macroeconomic situation in the 1970s and early
1980s with high levels of unemployment. There were recurrent deficits on
the government budget balance as well as on the balance of payments.
Furthermore, repeated devaluations in order to restore competitiveness
only resulted in high and volatile inflation and high interest rates.
In contrast, the German Bundesbank had good experience of maintaining
a rather stable inflation by the standards of that time. Since Germany was
Denmark's largest export market, it was decided to link the Krone to the
D-mark.
As time passed and the peg gained credibility, it gradually became a
disciplining mechanism for wage and price setters and policy makers.
Progressively the Danish inflation level approached that of Germany.
Over the past 30 years, the macroeconomic situation has improved a lot
due to the stabilisation-oriented economic policy. After substantial
improvements in competitiveness, we have had significant surpluses on the
balance of payments for the past many years - much like Switzerland.
Denmark is now a creditor nation with net foreign assets around 50 per
cent of GDP.
The fixed-exchange-rate regime is still a cornerstone of Danish economic
policy. The policy framework implies a clear division of responsibilities in
the economic policy. Monetary-policy interest rates are reserved for
keeping the krone stable and do not take factors such as growth,
employment and house prices into account. These considerations are
addressed by other economic policies. In particular, fiscal policy plays an
important role in ironing out economic fluctuations.
2 Spill-overs from monetary policy in the euro zone
An exchange-rate peg can only be maintained if one is willing to
implement the same monetary policy stance as the anchor country. This is a
precondition in a world with international capital mobility. A strong
spillover from the ECB's monetary policy to Danish financial conditions is
therefore to be expected.
[CHART 5: Monetary policy rates in DK and ECB]
Indeed, as we can see from this chart, the key monetary-policy rate of
Danmarks Nationalbank tends to track that of the ECB very closely. Usual-
ly we announce interest-rate changes within a few hours of the ECB's
announcements.
The exceptions are in situations with volatility in foreign-exchange
markets and large capital flows. In those situations, unilateral interest-rate
changes might be necessary. I have already talked about one such
occasion - the surge in capital inflows in early 2015.
In normal times, the euro-area monetary-policy stance is summarized by
the short-term interest rate set by the ECB. When the ECB wants to
loosen policy, it reduces its key interest rate. And when it wants to tighten, it
increases it again.
Since the great financial crisis of 2007-08, many things have been far from
normal. In response to persistently weak demand and low inflation,
central banks across the globe have reduced their monetary-policy rates to
levels close to their effective lower bound. In that respect, Switzerland
and Denmark are actually on the forefront. In the beginning of 2015, we
both reduced our monetary-policy rates to -0.75 per cent.
With interest rates close to their effective lower bound, central banks
have deployed a host of unconventional measures to achieve the desired
amount of monetary accommodation. Of these measures, the most
prominent one has been to engage in purchases of financial asset on a massive
scale - often referred to as QE. For more than two years, the ECB has
been purchasing assets worth between 60 and 80 billion euros per
month.
And this takes me back to the point that to support an exchange-rate
peg, monetary policy must mirror that of the anchor country - in our case
the monetary policy of the ECB.
In normal times, matching the monetary policy moves of the ECB is
simple. To offset the impact that an interest-rate change by the ECB has on
the krone-euro exchange rate, we simply adjust our interest rate by the
same magnitude.
But how do we match the monetary-policy stance of the ECB when it pro-
vides monetary stimulus by engaging in large scale asset purchases? As
the ECB purchases bonds issued by euro area sovereigns, the supply of
such bonds available to private investors is reduced. In such a situation
Danish sovereign bonds stand out as an obvious alternative to for
example German bonds.
The strong commitment to the peg implies that there is no exchange-rate
risk for euro area investors associated with investing in
kronedenominated assets. Moreover, the strong focus on fiscal sustainability
that has been exercised by successive Danish governments implies that
the risk of default is very low. And furthermore, Danish sovereign bonds
are in general highly liquid.
[CHART 6: Danish and German 10-year government bond rates]
So it should come as no surprise that changes in Danish sovereign bond
yields tend to track changes in German yields very closely. This was also
the case in late 2014. Mounting expectations of an ECB QE programme
led to substantial declines in sovereign bond yields across euro area
countries. And it continued to be the case after the launch of the ECB's
Public Sector Purchase Program (PSPP), although the suspension of
government bond issuances caused some fluctuations in Danish yields.
In a forthcoming paper we will provide more details on the way market
participants' expectations of the ECB's asset purchases have affected
Danish financial markets. In particular, we assess the impact on Danish
sovereign bond yields.
We find that the reaction of Danish sovereign bonds has been very much
in line with how German bonds have reacted. And clearly more so than
the bonds issued by a number of countries which are in the euro area.
7: Decline in 10-year yields due to ECB communication]
[CHART
This chart shows how long-term sovereign yields in a number of
countries have reacted to selected pieces of ECB communication in the six
months leading up to start of QE.
In the study, we look at the reaction of sovereign bond yields in the two
days following each piece of communication. Summing over the 17 pieces
of communication included in the study, we arrive at the effects that you
can see here.1
The chart shows that in all of the 2-day windows combined, Danish 10-
year sovereign bond yields declined by a total of 30 basis points. This is
very close to the corresponding decline in German yields of 28 basis
points. Yields in other northern European countries declined slightly
more.
However, countries in the south of Europe experienced substantially
larger declines in yields. To sum up, Danish and German bond yields are
close substitutes. The impact of QE on bond yields in the euro area also
has a spillover effect on Danish bond yields.
3 Monetary policy when rates go negative
Let me share with you some of our experiences with very low and
negative interest rates. Danmarks Nationalbank pioneered by setting a key
monetary-policy rate well below zero already in 2012 to stave off large
capital inflows.
Since then, many other central banks, including the ECB and the SNB,
have now gained experience with policy rates significantly below zero.
With monetary policy rates as low as currently -0.75 per cent in
Switzerland and -0.65 per cent in Denmark, we have been in unchartered
territory for some years now. What have we learnt from this period?
A key message is that the situation with negative policy rates in Denmark
largely mimics that of low, but slightly positive rates. And side effects
have generally been negligible. In the following I will go a bit more into
detail on some of the aspects.
8: Different deposit rates for different
[CHART segments]
There has been more or less full pass-through to lending rates in the
economy since the key policy rate was lowered to -0.75 per cent in 2015.
However, the degree of pass-through to banks' deposit rates has differed
across customer segments.
Many large non-financial corporations face negative interest rates on
their bank deposits. The same applies to the majority of insurance and
pension companies. This is appreciated due to the importance for the
transmission to the exchange rate.
Banks have, on the contrary, been reluctant to introduce negative
interest rates to households. Their actions have generally little impact on the
exchange rate.
With negative policy rates one potential concern could be a significant
hoarding of cash. So far, there have been no signs that this should be the
case in Denmark. One explanation for this is that firms and institutional
investors would face significant costs of handling, storing and insuring
cash. And as just mentioned, households have not been meet with
negative deposit rates so far.
[CHART 9: Declining share of cash payments]
Another explanation is that Danes to an increasing extent seem to prefer
to use electronic payments instead of cash - either by using credit cards
or smart phones. This suggests that the inconvenience cost of cash is
rather high in Denmark. The decreasing use of cash suggests that the
effective lower bound of policy rates is well below the current level in the
Danish case.
Another frequently mentioned concern in relation to negative rates is the
potential impact on banking sector profitability. Do we see a substantial
decline in earnings in the banking sector because of low interest-rate
margins and flatter yield curves? The short answer is no.
Banking sector profitability in Denmark has been robust and increasing in
recent years because other factors have countered those negative effects
on interest earnings. Low interest rates also stimulate economic activity
and ease debt-servicing costs for businesses and households. The result
is lower impairment charges for the banks. Furthermore, banks have also
been able to raise their fees.
Periods of low interest rates are sometimes associated with risks of
long very
bubbles in asset prices. Given the current period of low interest
rates, we continue to monitor the development in asset prices closely,
especially in property markets. Thus far, the development in real-estate
prices has been broadly in line with fundamentals such as income,
interest rates and other user costs.
There are, however, some important regional challenges in the capital
area, where strong vigilance is needed. In case of any concerns about in-
flated asset prices, other economic policies may need to be activated,
including micro and macroprudential policies.
The recent years' unconventional policy measures by many central banks
have resulted in higher prices of long-dated bonds. This could be
regarded as a transfer of wealth from debtors to creditors. It has led to
some discussions about the distributional aspects of monetary policy.
However, one should bear in mind that the central bank's ability to
influence longer-term interest rates is often a crucial feature of monetary
policy because longer-term interest rates are important for economic activity.
Hence, distributional effects may be knock-on consequences of the
conduct of monetary policies.
The extremely low policy interest rates around the world have to be
understood in the context of very low inflation and high private demand for
financial assets - the counterpart to high savings and low investments in
the private sector.
The low interest rates set by central banks across various currency
regimes - fixed, floating or monetary unions - are responses from central
banks pursuing their mandates. It might not be a preferred state, but the
global economy would have been worse off had interest rates been high-
er. In the Danish case, the negative interest rates have been nothing but
a necessary consequence of our exchange-rate policy.
Thank you for your attention!
DANMARKS
NATIONALBANK
MONETARY POLICY IN DENMARK
- POSSIBILITIES AND CONSTRAINTS
​Lars Rohde, Chairman of the Board of Governors, 3 July 2017
Agenda
1. Background for fixed
exchange rate regime
2. Spill-overs from monetary
policy in the euro zone
3. Monetary policy with
negative interest rates
4. Questions?
Swiss contagion to Danish FX market
15 January 2015
Swiss
Kroner per euro
Bid-ask spread, pips
announcement
7.430 25
Widened bid-ask spread
(right-hand axis)
7.432 20
7.434 15
7.436 10
7.438 5
Increased exchange-rate volatility
7.440 0
09:00 10:00 11:00 12:00 13:00 14:00 15:00 16:00
Sharp increase in foreign exchange
reserve in 2015
Per cent of GDP
40
35
30
25
20
15
10
5
0
99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17
​Note: In per cent of nominal GDP at yearly frequency. GDP for 2017 is from Danmarks Nationalbank's most recent projection from March 2017.
​Source: Danmarks Nationalbank and Statistics Denmark.
The ERM2 agreement and the fixed
exchange rate
Kroner per euro
6.0
6.5
7.0
7.5
8.0
8.5
9.0
82
84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16
Market rate Central rate Fluctuation limits (+/- 2.25 per cent)
Fixed-exchange-rate policy introduced
after a period of high and volatile inflation
Per cent, year-on-year
18
16
1982: Exchange-rate peg
14
12
10
Danish inflation
8
German inflation
6
Euro-area inflation
4
2
0
-2
Danish monetary-policy rates tightly
linked to ECB rates
Per cent
6
5
Danmarks Nationalbank
4
3
ECB
2
1
0
-1
-2
Danish government bond yields
comoves strongly with German yields
Per cent
2.50
Suspension of
government
bond sales
2.00
1.50
1.00
Denmark
0.50
0.00
Germany
-0.50
Decline in long-term Danish yields in line
with core euro area countries
Basis points decline in 9-year government bond yields
120
Periphery
Core
Floater
100
80
60
40
20
0
Denmark Finland France Germany Netherlands Italy Portugal Spain Sweden UK
Households are largely exempt from
negative interest rates on deposits
Rate of interest on bank deposits
Percentage share
100
Other types of
deposits
75
50
Demand
deposits excl.
lending-related
deposits
25
0
Non-financial corporations Insurance and pension companies Wage earners, pensioners, etc.
Negative Zero Positive
Share of cash payments in Denmark is
declining steadily
Per cent
100
2016: 20 per cent
90
80
Cash payments
70
60
50
40
Cheque payments
30
Card payments
20
10
0
THANK YOU!