bodil nyboe andersen : recent economic developments in denmark speech by mrs bodil nyboe andersen, governor of the national bank of denmark, at the annual meeting of the association of danish mortgage banks, copenhagen, 30 april 2003. * * * we live at a time when the global economy is hard to get going. growth is low, stock prices have fallen by 40 - 50 per cent in three years, and interest rates are at a historically low level. in recent months, the “ geopolitical situation ”, a euphemism for the conflict in iraq, has been used to explain the extraordinary uncertainty currently affecting all economic forecasts. now that the military situation has been clarified, focus is returning to the structural problems affecting the large economies of the usa, japan and the euro area. japan ’ s structural problems have been discussed for 10 - 15 years without getting any closer to an actual solution, i. e. economic and political reforms. the expectation is rather that, as time passes, the cyclical downturn will have reached a point where the economy sooner or later recovers by itself. the structural problems faced by the euro area are especially related to the rigidity of the labour market, and to very high and rising unemployment, especially in the two largest euro area member states. these countries also typically have the largest budget deficits. so there is no scope to stimulate demand via fiscal policy. this would be in conflict with the requirements of the stability and growth pact, and would entail even larger structural budget deficits. when the economy was stronger, these euro member states failed to improve the underlying fiscal position, and in several countries it was even weakened. therefore we now face a situation with large structural budget deficits, and have forfeited the flexibility which the stability and growth pact is intended to give. for a number of years the usa has been the locomotive driving global growth, and the end of the 1990s saw an exceptionally strong boom in the usa. during those years, the usa built up a large current - account deficit. many other countries would have faced considerable problems with financing a current - account deficit that expanded from around 1½ per cent to 4 per cent of gdp in three years. but at the same time the rest of the world wanted to increase investments in the usa, especially equity investments. therefore the large deficits were easy to finance, and the dollar in fact rose in those years. now that the economy is growing less strongly,

part covers the structural macroeconomic facts of importance for the fixed - exchange - rate policy. the second part deals with the technical and tactical aspects of monetary - policy implementation in erm ii. the paper concludes that a fixed nominal exchange rate vis - a - vis the euro is beneficial for a small open economy such as denmark. 2. 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 all macroeconomic policies are conducted with a view to ensuring a fixed exchange rate. there is no contingency plan if things go wrong. 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. 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 2. 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 general proof of the superiority of a fixed - exchange - rate regime. increase in harmonised index of consumer prices in denmark, germany and the euro area chart 2 per cent, y - y denmark euro area germany monetary policy and the business cycle output gap in denmark, germany and the euro area chart 3 per cent - 1 - 2 - 3 - 4 - 5 denmark germany note : 2002 and 2003 are projections. source : oecd economic outlook. euro area