Jens Thomsen: Denmark and the euro - a special relationship
Speech by cc, at the Central Bank of Iceland, Reykjavik, 10 March 2003.
The references can be found on the National Bank of Denmark's website.
* * *
1. Introduction
Until recently the exchange rate arrangements of Denmark and Iceland were similar from a formal
point of view. Both countries pursued a policy classified as fixed, but adjustable exchange rates. There
were some differences as well. From a formal viewpoint the anchors were different. Iceland pegged a
basket of currencies roughly reflecting the composition of the effective exchange rate, while Denmark
in the whole period from the breakdown of the Bretton Woods-system in 1971/73 has participated in
the various European exchange-rate arrangements. It was of greater significance, however, how the
weights to each of the words "fixed" and "adjustable" developed in the two countries.
The main theme of this article is why and how Denmark increasingly gave importance to the word
"fixed" and how the present institutions work. At the same time some considerations will be given to
why Iceland has drawn the opposite conclusion and now pursues a flexible exchange-rate policy
within the framework known as inflation-forecast targeting, cf. Svensson (1997) and several other
contributors.
There is presently little disagreement among economists that the ultimate goal of monetary policy
should be price stability. Indeed, in the statute of the recently established European Central Bank price
stability is clearly stated as the primary objective of the bank, and it is made clear that support of the
general economic policies in the Community is only a secondary objective. In the USA, price stability
enters the objectives for monetary policy, which most other OECD-countries are using inflation
targeting strategies.
2. Exchange-rate developments
Before the creation of the European Monetary Union, most of the EU member states participated in
the European Monetary System - a fixed-exchange-rate system based on a grid of bilateral central
parities and intervention bands. Currently, three EU member states have not adopted the euro: while
the UK and Sweden have inflation-targeting regimes and a floating exchange rate vis-à-vis the euro,
Denmark follows a fixed-exchange-rate policy vis-à-vis the euro. The intermediate target for Danish
monetary policy is thus the krone/euro exchange rate.
The new European fixed-exchange-rate system, ERM II, came into operation on 1 January 1999
replacing ERM I. Denmark became a member immediately, with a narrow fluctuation band of
+/-2.25 per cent around a central parity of 746.038 kroner per 100 euro. In the Vienna communiqué of
September 1998 the Danish narrow band is commented with "the high level of economic convergence
achieved by Denmark in terms of the convergence criteria, including the very high degree of stability of
the krone in the markets and the unchanged parity within ERM I since January 1987. This is the result
of sustained stability-oriented economic policies". The standard fluctuation band in ERM II is +/-15 per
cent.
Membership of ERM II was not a major change of the Danish monetary regime. As a matter of fact,
Denmark has a very long tradition for a fixed-exchange-rate policy. The central parity vis-à-vis the euro
corresponds exactly to the former central rate vis-à-vis the D-mark, which was unchanged from early
1987, cf. Chart 1. Furthermore, by 1982, exchange-rate realignments ceased to be a self-initiated
Danish policy instrument. In 1998, ERM I had 12 members, the 11 countries that now form the
euroarea and Denmark. Presently, with Denmark as the only member of ERM II, there is little risk of
contagion from problems originating elsewhere. However, the hubs and spokes approach in ERM II
compared to the bilateral parity-grid in ERM I, lowers the risk of contagion in case more countries
participate.
Chart 1
The danish krone vis-à-vis the German mark and the euro
DKK / DEM
3.0
3.2
3.4
3.6
3.8
4.0
4.2
1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002
DKK/DEM Central parity, DKK/DEM
Note: From 1 January 1999 a conversion has been made to depict DEM instead of EUR.
The firm commitment to a fixed-exchange-rate policy originates from very poor performance of
macroeconomic policy and, consequently, poor performance of the Danish economy in the 1970s.
Against the background of high inflation, excessive budget deficits, permanent deficits on the current
account of the balance of payments, frequent devaluations of the krone and high nominal interest
rates, the Danish authorities in the early 1980s made a successful U-turn to a stability-oriented
macroeconomic regime. The fixed-exchange-rate policy was, and still is, an important element in the
macroeconomic framework in Denmark. See Christensen and Topp (1997) and Danmarks
Nationalbank (1999) for a more detailed review of the change in Danish economic policy in the
aforementioned period.
Participation in ERM is voluntary for EU member states. While participation in ERM I and ERM II have
been beneficial to the Danish economy in its own right, these exchange-rate systems and the
successful introduction of the euro should be viewed in a much broader context than from a purely
monetary policy perspective. EU member states co-operate on a large range of political and economic
issues and have set up a common legal and institutional framework, of which the ECB is only one
example. This probably contributed to a smooth transition to a common monetary policy.
3. The Danish fixed-exchange-rate policy
It is important to emphasise that the Danish exchange-rate policy is a fixed-exchange-rate policy, and
not a fixed, but adjustable, exchange rate. Taken literally, this can only be true with euro area
membership. However, in a Danish policy context it means that macroeconomic policies are
conducted with a view to ensuring a fixed exchange rate. There is no contingency plan if things go
wrong. In retrospect, it should be mentioned that this was a process gradually evolving in the mid
1980s and not fully completed until 1987 and not fully understood until the early 1990s, as was the
case with the implications of the full liberalization of financial markets completed in 1988. The 1982
decision did not prevent small adjustments against the D-mark in 1983, 1986 and 1987. These
adjustments took place in connection with adjustments demanded by other countries. France also
stopped adjusting the parity after 1987.
The two key conditions for success are a strong commitment from the authorities to abstain from
creating "home made" shocks (which according to the Danish experience are far more important than
exogenous external shocks) and an unconditional willingness to subordinate monetary policy to the
exchange-rate strategy.
The Icelandic experience has been quite different. According to Andersen and Gudmundsson (1998)
Iceland has been subject to several external shocks, most related to fishing, either catches or prices. It
is remarkable, however, that most shocks have been positive. From this perspective an appreciation of
the Icelandic krone could have been an obvious way to distribute the increasing real income across
the nation. However, this took place via inflation in wages, leading to rising real-wages as well,
because of the high share of imported goods in private consumption. When profitabilty in fishing got
squeezed demands for a depreciation of the currency were normally met after some time, cf. Chart 2.
It is noteworthy, however, that this process has moderated in recent years even before the change in
monetary-policy framework in 2001.
Chart 2
The Icelandic krona
Index 1980 = 100
158,4
100
63,0
39,8
25,1
15,8
10
6,3
4,0
1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
DEM/ISK ISK-NEER Real DEM/ISK
Note: Log scale
Price stability
A first test of the benefits of a monetary regime is to see if it delivers on the final goal. For a central
bank the key issue is price stability, and the Danish monetary regime passes the test. Inflation
measured as the percentage annual increase in the harmonised consumer price index (HICP) has
been stable at around 2 per cent in Denmark since the early 1990s, cf. Chart 3. The persistence of low
inflation has furthermore been conducive to low inflationary expectations. In the period since the
announcement of the fixed-exchange-rate policy low and stable inflation has been achieved without
loss of income relative to our major trading partners, Germany, Sweden and the UK, although it should
be recalled that the transition to a low-inflation economy is not an isolated Danish phenomenon. Most
OECD countries have achieved the same in the last decade, independently of their monetary-policy
regimes. Consequently, Danish inflation performance cannot be taken as a proof of the superiority of a
fixed-exchange-rate regime compared to other regimes.
Increase in harmonised index of consumer prices
in Denmark, Germany and the euro area
Per cent, y-y
7
6
5
4
3
2
1
0
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
Denmark Euro Area Germany
Monetary policy and the business cycle
A fixed-exchange-rate policy implies that the stance of monetary policy is from time to time out of line
with domestic short-term cyclical needs, and is potentially a destabilising factor. When key
monetarypolicy interest rates are closely linked to German interest rates, and since 1999 euro-area interest
rates, there is no room for independent domestic stabilisation by means of monetary policy. This
problem appears to be particularly severe in Denmark, where the business cycle - at least according to
visual inspection - seems to be negatively correlated with the cyclical conditions in Germany and the
euro area, cf. Chart 4. However, it is also possible to draw a completely opposite conclusion from the
deviation in the cyclical patterns: cyclical divergence is immaterial to the success of a
fixed-exchangerate policy.
The monetary-policy transmission mechanism is of crucial importance in the choice between
businesscycle and exchange-rate stabilisation. The direct effect from changes in short-term interest rates to
domestic demand is comparatively small in Denmark. The terms for mortgage financing, which is the
most important transmission channel to the household sector, are predominantly based on fixed
20-year or 30-year mortgage bond yields. Adjustable mortgage lending at 1-5 year interest rates has,
however, gained in importance in recent years. In early 2003 approximately 30 per cent of
mortgagecredit-lending has adjustable rates, in part reflecting a substitution from bank-lending to
mortgagecredit-lending. In spite of this, it is unlikely to create major problems for handling future speculative
attacks, because the spill-over to 12-months rates is rather limited. The greater concern with respect
to adjustable rate mortgages is the financial health of households in case of a more global rise in
interest rates, of Christensen and Kjeldsen (2002).
The basic textbook model includes only one policy instrument for short-term stabilisation - monetary
policy. This is a standard formulation in the literature and also in line with practice in most
industrialised countries. Discretionary fiscal policy came into disrespect after the abuse of the
instrument in the 1960s and 1970s, which led to stagflation, large budget deficits and high public debt
in many countries. Denmark has also suffered from this experience, but discretionary fiscal policy is
still used to stabilise the economy.
Output gap in Denmark, Germany and the euro area
Per cent
5
4
3
2
1
0
-1
-2
-3
-4
-5
1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002
Denmark Germany Euro area
Note: 2002 and 2003 are projections.
Source: OECD, Economic Outlook.
It is important to underline that the frequency of discretionary fiscal measures is low and far below the
frequency of monetary-policy changes in countries with other monetary regimes. The government
does not meet every two weeks to consider an adjustment to e.g. the VAT rate following the latest
business-cycle information. During the past decade discretionary fiscal stabilisation measures outside
the normal central-government budgetary calendar have been introduced on three occasions:
temporary expansive measures in 1993, and contractive measures in 1997 and 1998, cf. Chart 5.
However, considerations regarding the appropriate macroeconomic impulse from the government
budget to output are made during the annual budget negotiations. In years when fiscal policy has not
been used for stabilisation purposes the fiscal impulse, i.e. the contemporaneous contribution to
GDP-growth from fiscal policy in a given year, has been close to zero. As is the case in most countries
it is also politically easier to increase public expenditure and reduce taxes than the opposite in
Denmark. However, it is our assessment that the reliance on a fixed exchange rate and occasional
discretionary fiscal policy measures has dampened this inherent problem by a greater medium-term
focus in fiscal policy.
Quite the contrary, the fixed-exchange-rate policy has been instrumental in the significant
improvement in Danish economic policy that has taken place in the last 10-15 years. The Danish
government, supported by a large majority in the Danish parliament, is committed to use fiscal policy if
inflationary developments are out of line with the exchange-rate policy. The government has stated
that fiscal policy will be adjusted if inflation deviates more than temporarily from the ECB's definition of
price stability (0-2 pct. increase in the harmonised index of consumer prices - HICP).
Fiscal measures are taken with due regard for developments in government debt as well as in the
current account. Indeed, except for 1998 Denmark has had a surplus on the current account of the
balance of payments since 1990, while there has been a surplus on the government budget since
1997. Furthermore and equally important, the fixed-exchange-rate policy has brought structural
reforms of the tax and benefit systems and the labour market to the policy forefront as the necessary
tools to ensure low unemployment and growth in real income.
First year fiscal impulses in Denmark
Pct. of GDP
1
0.8
0.6
0.4
0.2
0
-0.2
-0.4
-0.6
-0.8
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
Fiscal policy impulse
Note: The fiscal impulse measures the impact on GDP of discretionary fiscal policy.
Source: Ministry of Finance.
The stability and growth pact in EU has been discussed on several occasions over the years. At the
core is that countries should keep their budgets close to balance to have room for letting the automatic
stabilisers work also during periods of weak activity. In this way deficits can be kept below the 3 per
cent maximum set by the Treaty without problems unless the downturn is extraordinary severe. In
such cases sanctions will not be used.
Denmark is also part of the stability and growth pact. The biggest difference between Euro members
and UK, Sweden and Denmark with respect to the pact is that sanctions cannot be given to the
Out-countries. The stability and growth pact has been seen as framework for medium term fiscal
prudence in Denmark, cf. Chart 6.
Chart 6
Public debt and deficit
Per cent of GDP Per cent of
90 4
80 3
70 2
60 1
50 0
40 -1
30 -2
20 -3
10 -4
0 -5
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
Debt Deficit (right-hand axis)
BIS Review 22/2003
Asymmetric shocks, home-made shocks and exchange-rate policy in Denmark
A floating exchange rate is often considered useful in order to insulate an economy from certain
shocks in a world with nominal wage rigidity and/or limited labour mobility. A fixed-exchange-rate
policy can lead to excessive and protracted unemployment in such a world, and adjustment to
asymmetric shocks is - at least in theory - an important argument against a fixed-exchange-rate policy.
However, the importance of this argument requires answers to the following two questions: 1) What
causes large positive and large negative output gaps? 2) Is a floating exchange rate an efficient shock
absorber?
The Danish economy was in severe slump in 1981, reached a peak in 1986, went back into a period of
slow growth, bottoming out in 1993, and has grown strongly since and exhausted the negative output
gap, cf. Chart 4. The business cycle was also out of line with Germany as well as the entire euro area.
The business cycle in itself and the deviation to the German business cycle cannot be explained by
exogenous external factors. Firstly, the demand for Danish exports did not deviate from the trend to an
extent that can explain the cyclical swings in the period under observation. Secondly, the terms of
trade moved more or less in line with the terms of trade for other EU member states, ruling out
external price shocks as an explanation. Hence, the roots of Danish output fluctuations are to be found
among domestic factors. Accordingly, the analysis does not carry over to an economy subject to large
external shocks.
The trough in 1981 had its origin in the very poor macroeconomic policies of the 1970s that can be
summarised as traditional Keynesian demand stimulus to the oil-price shocks that led to long-term real
interest rates in excess of 10 per cent. The sharp fall in nominal interest rates following the
announcement of the fixed-exchange-rate policy in 1982, in combination with other austerity
measures, was not accompanied by a corresponding immediate reduction in inflation expectations.
This led to a decline in expected ex-ante after-tax real interest rates that triggered a boom in house
prices and private consumption, leading to the peak in 1986. The until then highly preferential tax
treatment of interest-rate expenditures was reduced as from 1987. A decline in actual inflation in
combination with the tax changes led to a sharp increase in ex-post after-tax real interest rates that
triggered the proceeding depression in the housing market and a strong increase in the private
savings ratio. The Danish experience over the last twenty years is thus that "home made" domestic
shocks stemming from economic policy are more important than exogenous external shocks.
The choice of exchange-rate regime is not a choice between a fixed nominal exchange rate and a
floating exchange rate that evolves according to purchasing power parity. A floating exchange rate
often moves relatively far away from any reasonable estimate of purchasing power parity and thus
acts as a shock creator rather than a shock absorber, cf. Buiter (2000). The strength of the dollar in
the mid-1980s and the weakness of the euro until recently are well-known examples. The importance
of such unwarranted disturbances is most severe for small open economies such as Denmark. The
exchange-rate movements depicted in Chart 7 and Chart 8 indicate that Sweden - a small open
economy with a floating exchange rate and low inflation - receives far more noise from exchange-rate
fluctuations than Denmark. The fixed-exchange-rate policy cannot ensure a stable nominal effective
exchange rate or a stable real effective exchange rate. However, the weight to the euro in the effective
Danish exchange rate is slightly below 60 per cent. Thereby, the fixed-exchange-rate policy yields a
nominal hedge in a very important market for the Danish economy. This planning stability is beneficial
to the business climate. A fixed-exchange-rate policy based on the nominal effective exchange rate
would not offer such a hedge against any specific currency.
4. Monetary policy implementation and ERM II
The krone has remained close to the central parity against the euro since ERM II and the third stage of
the European Monetary Union came into operation on 1 January 1999, cf. Chart 9.
In order to achieve exchange-rate stability, the interest rates of Danmarks Nationalbank are adjusted
in step with those of the ECB, with due consideration of conditions in the foreign-exchange market, cf.
Chart 10. A tendency for the krone to weaken will be met by a widening of the interest-rate differential,
and vice versa. Interventions in the foreign-exchange market are used to dampen fluctuations in the
krone rate.
Swedish krona and Danish krone vis-a-vis the euro
SEK, DKK / EUR
7.0
7.5
8.0
8.5
9.0
9.5
10.0
10.5
jan-99 jul-99 jan-00 jul-00 jan-01 jul-01 jan-02 jul-02 jan-03
SEK DKK
Chart 8
Real effective exchange rate in Sweden and Denmark
1980 = 100
110
105
100
95
90
85
80
75
70
65
60
1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002
DKK SEK
Note: The real effective krone rate is based on consumer prices. Most recent observation is June 2002.
This implies that the decision-making body should be ready to take interest-rate decisions at more or
less any time, and therefore the structure of the decision-making process is quite different from that of
a central bank pursuing an inflation target. Moreover, the possibility of more or less real-time
evaluation of the success of Danmarks Nationalbank's monetary policy, i.e. whether the exchange rate
stays within the band, implies that there is no ambiguity with regard to fulfilment of the target.
Accordingly the word transparency implies something different under a fixed-exchange-rate system
and an inflation-targeting regime, cf. Storgaard (2002).
ERM II band and the Danish krone vis-à-vis the euro
DKK/EUR
725
730
735
740
745
750
755
760
765
1999 2000 2001 2002 2003
DKK/EUR Central rate Fluctuation band
Chart 10
Key monetary policy interest rates in Denmark and the euro area
Per cent
6.0
5.5
5.0
4.5
4.0
3.5
3.0
2.5
2.0
jan-99 jul-99 jan-00 jul-00 jan-01 jul-01 jan-02 jul-02 jan-03
DK lending rate Euro main refinancing/minimum bid rate
Euro marginal rate in main refinancing operation
It is evident from Chart 8 that the exchange rate against the euro is far more stable than allowed by
the fluctuation band of +/-2.25 per cent against the euro. In the years preceding the breakdown of
ERM I in 1992-93 many exchange rates, including the krone, fluctuated widely within the narrow band,
while primarily the Dutch guilder, the Belgian franc and the Austrian schilling generally fluctuated little
within the bands. Obligatory intervention at the margin was not a rare event, and realignments
occurred frequently in some periods. Part of the explanation for these differences in exchange-rate
dynamics under the two arrangements may be a higher risk of contagion effects from other countries
under ERM I due to the parity grid in place. If, for example, macroeconomic developments in one
member state seemed to justify a realignment of its central parity in the ERM I, this tended to affect
financial market prices in other member states as well, reflecting expectations of further realignments.
In some cases this happened even though macroeconomic fundamentals did not seem to justify
realignments in other countries, see for example Favero and Giavazzi for an analysis of contagion
under ERM I. From a formal viewpoint there was no centre in ERM I, while ERM II consists of bilateral
agreements between the ECB and each participating central bank. Problems in one country are there
fore less likely to lead to problems for other countries. Of course, at the moment any contagion within
ERM II can be ruled out as Denmark is currently the only member! From May 2004 onwards it can be
envisaged that some of the applicant countries will start to participate in ERM II, but the risks of
contagion are considered to be small due to the hubs and spokes arrangement.
The widening of the band to +/-15 per cent in 1993 was not considered meaningful as a basis for the
fixed-exchange-rate policy of Denmark. Consequently, Danmarks Nationalbank embarked on a
unilateral policy to stabilise the krone with the central parity as a point of reference - albeit from time to
time a distant point of reference. This policy brought the krone to a stable position close to the central
parity in early 1997. Since then, Danmarks Nationalbank's key interest rates have shadowed the
interest rates of the Bundesbank, and as of January 1999 the interest rates of ECB. In addition,
Danish interest rates have been changed unilaterally in periods with upward or downward pressure on
the krone and in periods of unrest in foreign-exchange markets. The most notable incidents in recent
years were in the autumn of 1998 in connection with the global financial turmoil and in the autumn of
2000 immediately after the referendum that rejected euro area membership.
It is crucial for the exchange-rate policy that Danmarks Nationalbank follows ECB rates without
hesitation, irrespective of domestic considerations. Furthermore, the short-term interest rate differential
has to be increased promptly if the krone has a pronounced tendency to weaken beyond the
day-today fluctuations. Intervention in the foreign-exchange market cannot stand alone, but must be
accompanied by appropriate increases in interest rates. In this respect the present Danish exchange
rate arrangement is close to a currency board. It is also an integral element of the foreign-exchange
defence that the interest-rate differential is increased quickly and substantially, but only reduced
gradually as a delayed response to currency inflows. This policy ensures that speculation against the
krone is costly and unprofitable.
The predominant role of long-term fixed-rate mortgages in Denmark and the limited spill-over from
fluctuations in short-term rates to maturities of 12 month or more reduces the tensions associated with
raising interest rates in order to defend the exchange rate. Furthermore, the monetary policy
instruments used by Danmarks Nationalbank allow for a differentiation of monetary-policy signals that
can ease the burden on "the man in the street" even further - at least in the short run. Commercial
banks have unlimited access to borrowing at Danmarks Nationalbank in the weekly operations for as
long as they have sufficient collateral. Danmarks Nationalbank's lending rate is thus the decisive
signal for money-market interest rates.For short periods it may be raised more aggressively than the
discount rate, which is the decisive rate for the general borrowing and deposit conditions at
commercial banks. See Danmarks Nationalbank (1999, 2003) for a detailed account of the Danish
monetary-policy instruments and various liquidity measures that can be implemented in the event of
serious foreign-exchange unrest. Presently issues regarding speculative attacks seem to be of a
theoretical nature with interest rate spreads against Germany at 15-20 basis points all along the yield
curve. However, we continue to be prepared for even remote eventualities.
The fixed-exchange-rate policy and Danmarks Nationalbank's unconditional willingness to support the
exchange rate are firmly embedded among participants in the foreign-exchange market as well as
among Danish exporters and importers. The large commercial banks' speculative behaviour in the
foreign-exchange market acts as a stabiliser. If the krone lies on the weak side of the parity, the
commercial banks will position themselves in support of the krone, and they will furthermore advise
their customers to purchase krone e.g. sell export proceeds in foreign currency. The reverse is the
case if the krone is on the strong side of the central parity. All this takes place within a narrow range
around the central parity.
From an economic point of view, the ERM II works smoothly and Denmarks has almost the samme
exchange-rate stability as we would have had in case of membership of the European Monetary
Union.
From a political point of view the situation is completely different. During the second stage of EMU, the
Nationalbank participated fully in the preparatory work for the third stage. This came to an abrupt halt
in the summer of 1998 when the ECB started. When the party to celebrate the new institution in
Frankfurts Alte Oper on 30 June 1998 was over, the Nationalbank found itself marginalised. From one
day to the next we went from a position in the core with our share of influence to a position without
influence and with difficulties in finding out what is on the active agenda. The Governing Council of the
ECB has the understandable attitude that those who participate are those who decide, irrespectively of
Danish participation in ERM II. This position is only fair and the Nationalbank of course accepts it. That
being said, it is problematic because of the importance for the Nationalbank of the work of the ECB,
not least because Denmarks position as an out-country is not given by a lack of fulfilment of the
convergence criteria. The mandate of the General Council, where the Nationalbank participates, is
quite limited. The Council only meets four times a year.
At the September 2000-referendum the majority of Danish voters rejected EMU-participation. In early
2003 polls suggest that the overwhelming majority of voters now favour participation, and even more
voters feel sure that Denmark eventually will participate. It makes it more problematic to be without
influence when full participation is a relevant alternative.
At the same time this implies a clear exit strategy, namely EMU-participation. Most other countries
trying to conduct a fixed-exchange-rate policy, including Iceland, have not had the same lighthouse
ahead, making it difficult to generalise the Danish experiences to countries with other institutional
arrangements.
5. Conclusion
From an operational point of view the main importance of ERM II is to provide the central parity of the
krone against the Euro.
Danmarks Nationalbank seeks to stabilise the krone within a much narrower range than the
+/-2.25 per cent fluctuation band. The ERM II band serves as a safety net. It provides international
support in a worst-case scenario. It is probably more important that by entering the ERM II agreement
in 1998 the Danish government strengthened its commitment to pursue an economic policy in
accordance with the requirements set by the fixed-exchange-rate policy.
A stability oriented macroeconomic framework conducive to growth and employment can undoubtedly
be achieved in many different ways. In the case of Denmark the fixed-exchange-rate policy and ERM
(I and II) membership have been instrumental to the establishment of such a framework. There are
many country-specific circumstances that make life either easy or difficult under a fixed-exchange-rate
regime. However, there are two fairly general lessons to be learnt. Firstly, monetary policy must be
unconditionally subordinated to the exchange rate. Secondly, a fixed-exchange-rate policy is neither
an approach by which lower interest rates can be achieved the easy way, nor a way to postpone
structural domestic adjustments with the support of the anchor country. The primary responsibility for
the establishment of a stability oriented macroeconomic framework remains with the individual country
itself.