nils bernstein : recent economic and financial developments in denmark speech by mr nils bernstein, governor of the national bank of denmark, at the annual meeting of the association of danish mortgage banks, copenhagen, 27 april 2006. * * * the danish economy is doing well. this is the result of a dedicated effort over many years and probably first and foremost agreement across the political spectrum on the fundamental economic framework. one need not look far beyond denmark to find examples of the opposite. in the short term the major challenge is to make the good times last, while preventing the economy from overheating. in the long term the challenge is to maintain a healthy balance between the labour force and the rest of the population. to a high degree the large government surpluses relate to the strong growth, but also to extraordinarily high revenue from taxation of pension yields and corporate tax, including from the north sea. this type of revenue cannot finance permanently higher expenditure or tax cuts. the sound economy must be maintained, which could prove to be a challenge, knowing that the number of 25 - 60 year - olds, who are the core of today's labour force, will decline by almost 20, 000 per year over the next ten years. let me continue by repeating that denmark pursues a fixed - exchange - rate policy vis - a - vis the euro. this means that we are part of the euro area's efforts to maintain inflation close to, but not above, 2 per cent. the fixed - exchange - rate policy has been one of the means to achieve and maintain the sound danish economy. it has ensured a steady increase in real incomes for wage earners and pensioners alike and facilitated danish business enterprises'long - term planning. as we all know, it is impossible to have your cake and eat it. consequently, under the fixed - exchangerate policy danmarks nationalbank's lending - rate decisions cannot take any account of homeowners'interest expenses, or housing prices for that matter, or the overall economic situation. the spread between the danish lending rate and the benchmark interest rate of the euro area is determined solely by the foreign - exchange conditions. if there is a persistent tendency for foreign - exchange outflows we raise the lending rate without considering the day of the week or the time of day. this is explained clearly in descriptions of danish monetary policy over the years. nevertheless, danmarks nationalbank's raising of the lending rate by 10 basis points in mid - february came

in particular, it is time to build up countercyclical strength. let me put this into perspective. in 2008, banks faced large amounts of stress and increasing losses. this led to a governmentfunded capital injection in 2009 because we feared that we could be facing a credit crunch. if we have a sizeable buffer in place before the next financial storm hits, it can be released. and thereby serve the same function as the capital injections did during the financial crisis. so how big should the countercyclical capital buffer be? the capital injection in 2009 was about 6. 2 billion euro. a buffer of 2. 5 per cent equals approximately 4. 7 billion euro. in my view, in order to have a countercyclical capital buffer that can make a difference, 2. 5 per cent appears reasonable. when it comes to the countercyclical capital buffer, we can make two possible mistakes. we can build up a sizeable buffer and it is not needed for a long time. or, we do not build up the buffer in time and then we need it. i would rather make mistake number one. page 3 of 5 it is the job of the danish systemic risk council to recommend increases and release of the buffer. however, the responsibility of taking timely action lies with the policy - makers. * * * before i tell you about the rest of the day, i would like to say a few words about responsibility and timely action. when conducting macroprudential policy we need to ensure democratic accountability while avoiding inaction bias. democratic accountability is important because measures such as restricting how much individuals can borrow have direct distributional effects. in denmark, the responsibility is with the minister for industry, business and financial affairs. while it is the task of the danish systemic risk council to reduce the risk of political inaction bias. the council can make recommendations and the minister then has to comply or explain. this ensures democratic accountability but it does not completely eliminate the inaction bias. the set - up with comply or explain can lead to a self - imposed inaction bias by the council. if a recommendation by the council is not followed, the council's credibility is challenged. if this is repeated, the council risks becoming irrelevant. therefore, the model's long - term success depends on policy - makers'continued implementation of the council's recommendations. * * * before i leave the stage to our first speaker, let me just say a few words about the