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KKvo_mon_10.inddvo_mon_10.indd 1 008-02-20108-02-2010 114:31:394:31:39 Monetary Review - 4th Quarter 2010

MONETARY REVIEW 4th QUARTER 2010

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This edition closed for contributions on 3 December 2010.

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Rosendahls - Schultz Grafisk A/S ISSN 0011-6149 (Online) ISSN 1398-3865 Monetary Review - 4th Quarter 2010

Contents

Recent Economic and Monetary Trends ...... 1

THE DANISH AND INTERNATIONAL ECONOMY

Economic Developments in Denmark and Sweden in Recent Years . 37 Niels Blomquist, Anders Møller Christensen and Erik Haller Pedersen, Economics Sweden experienced stronger growth than Denmark before the crisis and apparently continues to do so after the crisis. The OECD assesses potential growth as higher in Sweden than in Denmark. Principal reasons are that fiscal policy has been more disciplined in Sweden than in Denmark and that wage inflation has been lower in spite of considerably stronger productivity growth. The different exchange-rate policies pursued have not been decisive to economic developments.

Economic Imbalances in the Euro Area ...... 49 Niels Blomquist and Jakob Ekholdt Christensen, Economics Since 1999, the euro area has generally enjoyed low and stable inflation and increased intra-euro area trade and investment, but this development masks large imbalances between the euro area member states. This article looks into the drivers of the euro area imbalances, and explores what can be done to reduce them. The analysis shows that the capital inflows from surplus member states did not sufficiently boost productivity in the euro area member states with deficits, and that their fiscal policies were too expansionary. Ultimately, the imbalances of the deficit member states became unsustainable. These member states now need to introduce extensive economic austerity measures and structural reforms of e.g. the labour market. In the short term, the surplus member states cannot solve the problems of the deficit member states, as trade with the deficit member states is limited. Structural reform in the surplus member states may in the long term contribute to raising the domestic investment potential and thus to reducing the imbalances. The framework for economic-policy cooperation in the EU must be strengthened to prevent further unsustainable imbalances and risks. Monetary Review - 4th Quarter 2010

Strengthened Economic Governance in the EU ...... 63 Thomas Pihl Gade and Jesper Ulriksen Thuesen, Economics Developments in the government deficits and government debt of the EU member states have had a major impact on the way the economic and financial crisis has evolved in the EU. It has become evident that the current framework for economic governance has not been sufficient. This article describes the contents of the Commission's and the Van Rompuy Task Force's extensive proposals to strengthen economic governance in the EU. The impact will be greatest in the euro area member states, but also non-euro area member states such as Denmark will be affected. Overall, the new initiatives represent an important step in the direction of increased economic stability in the EU.

FINANCIAL CONDITIONS

The Crisis in European Sovereign Debt Markets ...... 81 Søren Lejsgaard Autrup, Jacob Wellendorph Ejsing and Uffe Mikkelsen, Financial markets The repercussions of the financial crisis have triggered a sovereign debt crisis in Europe. For the first time in the history of the euro, a euro area member state has been on the verge of default. This article describes how such a far-reaching crisis could arise in the European sovereign debt markets. Extensive rescue packages have merely bought time for the crisis-stricken member states to implement fiscal tightening and structural reform.

Basel III: Macroprudential Regulation by Means of Countercyclical Capital Buffers ...... 97 Mads Peter Pilkjær Harmsen, Financial markets The future capital-adequacy rules, Basel III, will introduce macroprudential regulation by means of countercyclical capital buffers. If the new rules had been introduced earlier, the banking sector would have been better capitalised, and the buffers to absorb losses would have been higher at the onset of the crisis. This article discusses the implementation and determination of the size of the countercyclical capital buffer.

The Foreign-Exchange Market 2010 ...... 115 Maria Sinding-Olsen, Statistics Turnover in the Danish foreign-exchange market rose by 24 per cent from 2007 to 2010. This is a moderate rate of growth compared with the period from 2004 to 2007, when turnover more than doubled. The global foreign-exchange market showed the same trend as the Danish market, rising by just over 20 per cent. Especially the growing number of players in the market has contributed to increasing turnover. Moreover, foreign exchange is increasingly viewed as an independent asset class for institutional investors, which has boosted activity in the market. Monetary Review - 4th Quarter 2010

DOCUMENTATION

The IMF's Quota and Governance Reform 2010 ...... 125 Helene Kronholm Bohn-Jespersen, Economics This article outlines the main results of the quota and governance reform for the International Monetary Fund, IMF, adopted by the Executive Board of the IMF on 5 November 2010.

Speech by Governor Nils Bernstein at the Annual Meeting of the Danish Bankers Association on 6 December 2010 ...... 131

Press Releases ...... 135

Tables

Vol. XLIX, No. 4 Monetary Review - 4th Quarter 2010

Monetary Review - 4th Quarter 2010

Recent Economic and Monetary Trends

This review covers the period from mid-September to early December 2010

SUMMARY

The upswing in the international economy continued in the 3rd quarter, but growth was lower than in the 2nd quarter. Looking ahead, a sluggish and uneven upswing is expected. It will mainly be driven by strong growth in the Asian emerging economies, while the pace will be much slower in the advanced economies. In all the advanced economies, growth has been buoyed up by public consumption, while private demand has shown a weak trend. Un- employment has stabilised at a high level. The first steps towards fiscal consolidation mean that fiscal policy will gradually shift from supporting demand to focusing on reducing the large government budget deficits. Monetary policy, on the other hand, remains strongly expansionary. This is also the case in Denmark, despite two small interest-rate increases in October. The Danish economy continued to improve in the 3rd quarter, growing by 0.7 per cent on the preceding quarter. Consumption has picked up in the year to date, but at a moderate pace, while the level of investment remains very limited. 3rd quarter growth was to a large extent fuelled by exports and thus by external demand. The current-account surplus is almost kr. 80 billion, while unemployment rose a little in October after having been stable for some months. Next year's government deficit is expected to be just under 5 per cent of the gross domestic product, GDP. It is to some extent cyclically determined, but there is also a considerable underlying deficit. If the upswing is to continue, private demand must take over from public consumption as the driver of growth, also in Denmark. Danmarks Nationalbank's most recent forecast operates with such a change in the growth pattern. After five quarters of sound improvement, GDP growth will be modest in the next few quarters and will then increase towards the forecast horizon in 2012. Private consumption and exports account for the largest contributions to GDP growth, while growth in public consumption is assumed to be zero in 2011, followed by weak growth in 2012. In Monetary Review - 4th Quarter 2010

2 the projection, unemployment rises until the 1st half of 2011 and then falls slightly towards the end of 2012. Consumer price inflation is expected to fall below 2 per cent year-on-year from the turn of the year, when the effect of increases in indirect taxes at the beginning of 2010 drops out of the calculations.

THE INTERNATIONAL ECONOMY

The upswing in the global economy continued in the 3rd quarter, although growth declined a little relative to the 2nd quarter, when a number of European countries had posted surprisingly positive economic growth. Looking ahead, the upswing is expected to be sluggish. Uncer- tainty about future economic developments remains considerable, and economic and financial risks are mainly on the downside. The growth pattern predicted by the international economic organisa- tions has not changed much since the 3rd quarter. Growth estimates for 2010 and 2011 have, however, been adjusted downwards for the USA and upwards for the euro area and the UK. The upswing in Denmark's major export markets, Germany and Sweden, is expected to be considerably stronger in both 2010 and 2011 than estimated earlier this year. Euro area growth masks considerable differences, with GDP set to decline in Greece, Ireland and Spain in 2010 and in Greece and Portugal in 2011. Globally, growth is expected to be subdued in 2011, and to pick up a little in 2012, cf. Table 1. Global growth is mainly driven by strong momentum in the Asian emerging economies, while activity is rising at a considerably slower pace in the advanced economies. This diverging growth pattern is expected to continue.

FORECASTS OF GDP GROWTH IN SELECTED AREAS AND COUNTRIES Table 1

2010 2011 2012

Per cent EU OECD IMF EU OECD IMF OECD

USA ...... 2.7 2.7 2.6 2.1 2.2 2.3 3.1 Euro area ...... 1.7 1.7 1.7 1.5 1.7 1.5 2.0 Germany ...... 3.7 3.5 3.3 2.2 2.5 2.0 2.2 UK ...... 1.8 1.8 1.7 2.2 1.7 2.0 2.0 Sweden ...... 4.8 4.4 4.4 3.3 3.3 2.6 3.4 Japan ...... 3.5 3.7 2.8 1.3 1.7 1.5 1.3 China ...... 10.5 10.5 10.5 9.2 9.7 9.6 9.7 India ...... 8.5 9.1 9.7 8.3 8.2 8.4 8.5 World ...... 4.5 4.6 4.8 3.9 4.2 4.2 4.6

Source: IMF, World Economic Outlook, October 2010, European Commission's autumn forecast, November 2010, and OECD, Economic Outlook, No. 88, November 2010. Monetary Review - 4th Quarter 2010

CONTRIBUTIONS TO GROWTH IN THE USA, THE EURO AREA AND CHINA Chart 1

Per cent Per cent 5 15 USA Euro area China 4 12

3 9

2 6

1 3

0 0

-1 -3

-2 -6 1st 2nd 1st 2nd 1st 2nd 1st 2nd 2010 2011 half half half half half half half half 2010 2010 2011 2011 2010 2010 2011 2011 Private consumption Public consumption Fixed capital investments Changes in inventories Net exports GDP (per cent) Note: The bars show the contributions of the individual demand components to GDP growth, stated in percentage points. Figures for China are shown on the right-hand axis. GDP growth rates for the USA and the euro area are annualised half-year growth rates. Source: IMF, World Economic Outlook, October 2010. Data for the 2nd half of 2010 and for 2011 is based on IMF estimates.

In all the advanced economies, private demand has shown a weak trend during the upswing – especially when the considerable setback in 2008 and 2009 is taken into account. It remains uncertain to which extent private demand can take over when public demand is reduced as expected in the coming years. At the same time the contribution to growth from inventory investment, which was significantly positive in the 1st half of 2010, can be expected to fade away. In several countries, private consumption will still be weighed down by high unemployment and high saving ratios, while investment is expected to pick up gradually. Unemployment has stabilised at a high level in several OECD countries. Following substantial drops, employment is rising in some countries, cf. Chart 2, but not sufficiently to reduce unemployment notably. Historic- ally, high unemployment for a prolonged period has often led to higher structural unemployment, which weakens the potential output. The high rate of unemployment and the still large debt burdens also put a damper on private consumption, although household savings ratios in several countries are above the average for the last 20 years. The households' real disposable incomes are expected to rise, which will underpin consumption. Monetary Review - 4th Quarter 2010

EMPLOYMENT AND UNEMPLOYMENT Chart 2

Index, Jan. 2008 = 100 Employment Per cent Unemployment 102 25

100 20

98 15

96 10

94 5

92 0

2008 2009 2010 UK Italy USA Spain Japan France Germany USA UK Japan Euro area area Euro Note: Unemployment shows the most recently published monthly observations for the individual countries/areas. Source: Reuters EcoWin.

In the housing market, upswings are underway in countries such as Canada, Australia and Norway, Sweden and Finland. In other countries – including the USA, the UK, France, Italy, Spain, Greece and the Baltic states – housing markets are still stabilising. The most recent lending surveys point to marginal easing of borrowing conditions in the 3rd quarter in the USA and stabilisation in the euro area. Demand for loans was reported to be slightly weaker in the USA, while it increased a little in the euro area. The marginal easing of borrowing conditions in the USA and the stabilisation in the euro area can help to support an increase in residential investment. Combined with a stronger upswing in business investment in machinery and equipment, this points to a positive growth contribution from gross investment. In Europe the export- heavy economies – e.g. Germany and Sweden – are benefitting from the upswing in world trade.

Price developments Consumer price inflation in the OECD area remains low, although price increases in energy and food in particular have pushed up inflation. Core inflation, i.e. inflation excluding the often very volatile energy and food prices, is fairly low and declining in several countries, cf. Chart 3. The higher core inflation in the UK is mainly attributable to the reversal of the temporary reduction of VAT by 2.5 percentage points, which expired at the end of 2009. Activity has increased, but there is still considerable spare capacity in most advanced economies, cf. Chart 3. For this reason, among others, inflation in these countries is expected to remain low in 2010 and 2011, while capacity limitations have contributed to higher inflationary pressures in several emerging economies. Monetary Review - 4th Quarter 2010

CORE INFLATION AND CAPACITY UTILISATION Chart 3 Per cent, year-on-year Core inflation Per cent Capacity utilisation 3.5 85 83 3.0 81 2.5 79

2.0 77 75 1.5 73 1.0 71 69 0.5 67 0.0 65 2006 2007 2008 2009 2010 2006 2007 2008 2009 2010 USA Euro area UK USA Euro area UK Note: Core inflation is stated as inflation excluding energy, food and alcohol and tobacco for the UK and the euro area, and as inflation excluding energy and food for the USA. Capacity utilisation indicates the degree to which the production potential is utilised in the manufacturing sector. Source: Reuters EcoWin.

Fiscal policy The first steps towards fiscal consolidation entail a gradual shift in fiscal policy from supporting demand to reducing the government budget deficits. All EU member states except Sweden, Luxembourg and Estonia are now subject to the EU's excessive deficit procedure and must therefore reduce their excessive government deficits in the coming years. In some member states – primarily Greece, Ireland, Spain and Portugal – market developments called for more extensive and faster fiscal consolidation than in other member states. In the UK, the government on 20 October presented a large-scale fiscal consolidation programme to reduce the largest budget deficit since World War II. On 26 November, the Portuguese parliament adopted the final budget for 2011, comprising further measures to reduce the government deficit. Likewise, the Irish government on 24 November presented a 4-year consolidation plan, which is expected to be included in the conditions for the forthcoming EU/IMF programme that was approved by the EU finance ministers on 28 November. The European Commission expects the euro area government budget deficit to be 6.3 and 4.6 per cent of GDP in 2010 and 2011, respectively. It has thus revised the estimates for the total budget deficit downwards, reflecting better-than-expected cyclical development in several member states, as well as the fact that some member states have brought forward their consolidation measures. The US fiscal consolidation requirement is also considerable. The IMF expects the US budget deficit to be reduced from 11.1 per cent of GDP this year to 9.7 per cent in 2011, of Monetary Review - 4th Quarter 2010

6 which 0.9 per cent of GDP is attributable to tighter fiscal policy. However, in its Mid-Session Review of the federal budget from July, the US administration envisages prolonging the tax cuts adopted in 2001 and 2003, except as regards the wealthiest part of the population. These cuts were to have expired at the end of 2010.

Monetary policy Due to the considerable spare capacity and the prospect of a sustained weak upswing in private demand in the advanced economies, monetary policy remains accommodative, thereby supporting economic activity. In the euro area, the USA and the UK, key policy interest rates have been kept at a very low level. In other countries, including Sweden and Australia, the central banks raised their official interest rates again in the 4th quarter. As the European Central Bank, ECB, phases out its extraordinary long-term liquidity allotments, there has been a tendency for short-term market interest rates to approach the ECB's key interest rate. In recent months the ECB has to a limited extent continued its Security Market Programme, under which it purchases private-sector and government debt instruments in cases where the bond market is, in the assessment of the ECB, not sufficiently well-functioning. As of 1 December, the ECB had purchased for a total of 67 billion euro since the launch of the programme on 10 May. In Japan, the Bank of Japan on 5 October announced a new programme to purchase various types of financial assets – primarily Japanese government bonds and corporate bonds – for up to 5,000 billion yen. In the USA, the Federal Reserve on 3 November announced further quantitative easing of monetary policy by purchasing Treasury bonds for 600 billion dollars in the period until June 2011. In the UK, the Bank of England has not made any further purchases of government bonds since January 2010, when the current programme limit was reached. The Bank regularly assesses whether this limit should be raised. Quantitative easing typically entails purchase of government securities at the long end of the yield curve with a view to reducing long-term yields, thereby promoting investment and private consumption. Empir- ical studies by the Federal Reserve and the Bank of England indicate that previous purchases of government bonds during the financial crisis actually reduced long-term yields. Hence, in the period during which the Federal Reserve has purchased financial assets or announced a need to do so, real long-term interest rates have been reduced, amid rising equity prices and weakening of the dollar. This point to the quantitative easing having had the desired effect so far, cf. Chart 4. Monetary Review - 4th Quarter 2010

STOCK INDEX, EXCHANGE RATE AND REAL INTEREST RATE IN THE USA AFTER THE FEDERAL RESERVE'S QUANTITATIVE EASING Chart 4

Per cent Federal Reserve announces Index, Nov. 2008 = 100 1st purchase programme 3.5 160 Federal Reserve indicates and decides on 2nd purchase programme 3.0 140 Federal Reserve widens 1st purchase programme 120 2.5

100 2.0 80 1.5 60

1.0 40

0.5 20

0.0 0 Jun 08 Sep 08 Dec 08 Mar 09 Jun 09 Sep 09 Dec 09 Mar 10 Jun 10 Sep 10 Dec 10

S&P 500 Nominal effective dollar exchange rate Real interest rate (left-hand axis) Note: The real interest rate is the effective rate of interest on 10-year Treasury Inflation-Protected Securities, TIPS. Source: Reuters EcoWin.

Financial markets Since August, most financial markets have been characterised by growing confidence in economic developments. On 1 December, 10-year yields in Germany were 70 basis points higher than the trough at end-August, while 10-year yields in the UK and the USA had risen by approximately 50 basis points, cf. Chart 5. The increase has been very uneven across euro area member states, with the 10-year yield spread to Germany widening considerably for Greece, Ireland, Italy, Portugal and Spain. The high government yield spreads of these member states indicate that the markets operate with a risk that these member states will not

10-YEAR YIELDS AND YIELD SPREADS TO GERMANY IN 2010 Chart 5

Per cent Yields Percentage points Yield spreads 4.5 10

4.0 8

3.5 6

3.0 4

2.5 2

2.0 0 Jan Apr Jul Oct Jan Apr Jul Oct USA Germany UK Greece Ireland Portugal Spain Italy Source: Reuters EcoWin. Monetary Review - 4th Quarter 2010

8 be able to service their government debt. The markets became extra jittery when the European Council of heads of state or government at its meeting on 28 October decided to establish a permanent mechanism for resolving sovereign debt crises in the euro area, and that this mechanism is to include the option of orderly restructuring of sovereign debt with the involvement of the private sector. Investors took the latter wording to mean that private-sector bond owners may suffer losses in connection with restructuring of sovereign debt. Among the euro area member states, Germany in particular has urged that a permanent crisis resolution mechanism be established in order to strengthen the incentive for fiscal discipline driven by the markets. Introducing discipline via the markets assumes that bond owners are not fully secured against losses if it becomes necessary to restructure sovereign debt. In the weeks after the European Council meeting on 28 October, uncertainty about the consequences of the Council's decision on a permanent mechanism led to widening of the 10-year government yield spreads in some member states. As a result, the finance ministers of France, Germany, the UK, Italy and Spain in connection with the G20 summit on 12 November issued a joint declaration in an attempt to soothe the markets. The declaration states that any new provisions on restructuring of sovereign debt will not apply to existing debt, but only to debt issued after the commencement of the new permanent crisis resolution mechanism in mid-2013. Until then, issues relating to sovereign debt will be managed within the framework of the existing Euro- pean Financial Stability Facility, EFSF, which does not presume involvement of the private sector. The establishment of the EFSF and the above declaration from the G20 meeting could not, however, prevent the Irish government bond market from coming under so severe pressure that the EU finance ministers had to announce an imminent EU/IMF financial assistance programme for Ireland on 21 November. This programme is to contribute to stabilising the ailing Irish banking sector, and also to financing the large Irish government budget deficit until fiscal consolidation has been achieved. The EU/IMF financial assistance programme was approved by the EU finance ministers on 28 November. At the same time, the Eurogroup issued a statement on key features of the framework for the forthcoming permanent crisis resolution mechanism, the European Stability Mechanism, ESM. At its meeting on 16 December 2010, the European Council is to decide on the detailed structure of the ESM.1

1 The European sovereign debt crisis is elaborated on and discussed in the article "The Crisis in European Sovereign Debt Markets" on p. 81 of this Monetary Review. The current efforts of the EU to strengthen fiscal surveillance and to establish a permanent crisis resolution mechanism are described in the article "Strengthened Economic Governance in the EU" on p. 63. Monetary Review - 4th Quarter 2010

EXCHANGE-RATE FLUCTUATIONS VIS-À-VIS THE DOLLAR Chart 6

Index, 1 Jan 2005 = 100 130

120

110

100

70 2005 2006 2007 2008 2009 2010 Euro Pound sterling Swedish krona Japanese yen Chinese yuan Note: An increase means that the currency has strengthened against the US dollar. Source: Reuters EcoWin.

Turning to the foreign-exchange markets, the recent strengthening of the US dollar has to some extent reversed the weakening observed since the summer. Recent exchange-rate fluctuations have, however, been moderate compared with the pronounced strengthening of the dollar relative to especially the euro, the pound sterling and the Swedish krona that took place during the financial crisis in late 2008, cf. Chart 6. An exception is the Japanese yen that has appreciated strongly vis-à-vis the dollar. Consequently, the Bank of Japan on 15 September intervened in the foreign-exchange market for the first time since 1994, but this only led to a brief weakening of the yen. The most recent development in the prices of a number of commod- ities and equities reflects slightly greater confidence in the sustainability of the upswing in the global economy. The prices of oil, metals and food have risen since the summer of 2010. Likewise, equity markets in the USA, the euro area and the UK have shown an upward trend over the last few months. In the UK, this also applies to financial equities, while the prices of financial equities in the USA and the euro area have been more stable throughout most of 2010.

G20 and global imbalances The large global external imbalances have once again come to the forefront of international economic policy discussions. Large global im- Monetary Review - 4th Quarter 2010

10 balances entail risks to economic and financial stability. The discussions have focused mainly on the need to establish a better balance between savings and investment, particularly in the USA and China. Until the crisis in 2008-09, large imbalances accumulated in the current accounts of many countries. Following a temporary cyclical reduction, imbalances are now set to grow once again1, cf. Chart 7. To achieve a better balance, some countries – notably the USA – should become less dependent on domestic demand and more dependent on external demand, while other countries – especially China – should move in the opposite direction. Economic policies may contribute to reducing global imbalances in several ways. The role of exchange-rate regimes and the introduction of numerical limits on the current account of the balance of payments have been given particular attention in the discussions, including under the auspices of the G20. As regards the issue of exchange rates, the Federal Reserve's quantitative easing has been criticised by several countries that have seen this policy as a deliberate attempt to weaken the dollar with a view to strengthening US competitiveness at the expense of other countries.2 At the same time China, which has one of the world's largest current- account surpluses, has been criticised for a foreign-exchange regime that does not permit the Chinese renminbi to appreciate sufficiently. A deliberate policy to promote or maintain exchange rates that are out of step with the economic fundamentals could lead to distortion of competition in international trade. Attempts at "competitive devaluation" have previously led to extensive protectionist measures with a severe adverse impact on the world economy. Against this background, it is positive that the G20 summit in Seoul on 11-12 November agreed to move in the direction of more market-based exchange rates that reflect economic developments, and to refrain from competitive devaluations. Prior to the preparatory G20 meeting of finance ministers and central bank governors on 22-23 October, the US Treasury secretary, Timothy Geithner, had also proposed a numerical target for a current-account surplus or deficit relative to GDP. At the G20 summit it was, however, agreed not to introduce an actual numerical target. Instead, indicators yet to be determined will be introduced for economic imbalances, so that sustained large imbalances will lead to further investigation of why

1 See Niels Blomquist and Susanne Hougaard Thamsborg, Global Imbalances – a Threat to the Upswing? Danmarks Nationalbank, Monetary Review, 3rd Quarter 2010. 2 It should be remarked, however, that traditional easing of monetary policy, by reducing short-term interest rates, would also have a tendency to weaken exchange rates in countries with floating rates. Normally, this effect of monetary policy does not lead to protests from the outside world, provided that the easing of monetary policy is a response to weak economic activity and low and falling inflation. Indeed, the European Central Bank has indicated that it does not see the quantitative easing in the USA as an unfriendly gesture vis-à-vis the rest of the world. Monetary Review - 4th Quarter 2010

GLOBAL IMBALANCES BROKEN DOWN BY COUNTRIES AND AREAS Chart 7

Current account, percentage of global GDP IMF estimates 2.0

1.5

1.0

0.5

0.0

-0.5

-1.0

-1.5

-2.0 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15

China Euro area Japan USA OPEC Asia, excl. Japan and China Others Note: OPEC: the Organization of Petroleum Exporting Countries. Source: IMF, World Economic Outlook Database, October 2010. they are not corrected. The IMF will assist in the development and assessment of such indicators. Furthermore, the G20 countries have concluded an agreement on individual economic policy commitments to support strong, sustainable and balanced global growth.

MONETARY AND EXCHANGE-RATE CONDITIONS

In recent months, the krone has been stable vis-à-vis the euro at a level close to its central rate in ERM II. In the autumn, Danmarks Nationalbank raised the current-account rate and the rate of interest on certificates of deposit twice, with effect from 15 and 29 October 2010, respectively. On both occasions, the increase was by 0.1 percentage point, bringing the current-account rate to 0.6 per cent and the rate of interest on certificates of deposit to 0.7 per cent. The lending and discount rates were kept unchanged at 1.05 and 0.75 per cent, respectively. In September, Danmarks Nationalbank purchased foreign exchange for kr. 3.4 billion net in connection with intervention in the foreign-exchange market, while foreign exchange totalling kr. 9.5 billion net was sold in October and November. At end-November, the foreign-exchange reserve was kr. 419.2 billion. The background to the interest-rate increases and Danmarks National- bank's intervention in the foreign-exchange market was that the short- Monetary Review - 4th Quarter 2010

12 term European market interest rates had risen more than the corresponding Danish market interest rates. Prior to the interest-rate increases, this led to a slight weakening of the krone. The rising European market interest rates reflect a substantial fall in excess liquidity in the euro area over the last few months, cf. Chart 8. As a number of the ECB's previous liquidity allocations with long maturities have expired, euro area banks' demand for liquidity has declined. In this context it should be noted that the ECB will continue with full allocation of liquidity at a fixed rate of interest in its weekly main refinancing operations, at least until 12 April 2011. It is thus the banks themselves that, under the given conditions, find it optimal to demand less liquidity than previously. The liquidity currently offered by the ECB is at shorter maturities than previously, however. This could be one of the reasons for the decreasing demand from banks. The shorter maturities are attributable to the ECB's effort to normalise the monetary-policy situation in the euro area. This is done by not renewing a number of the extraordinary long-term liquidity allocations as they expire. In December the ECB announced that in each of the months of Janu- ary, February and March 2011 it will conduct a 3-month operation with full liquidity allotment. In line with the 3-month tenders conducted in

EXCESS LIQUIDITY AND THE OVERNIGHT INTEREST RATE IN THE EURO AREA Chart 8

Per cent Billion euro 3.5 400

3.0 300

2.5 200

2.0 100

1.5 0

1.0 -100

0.5 -200

0.0 -300 Jan 09 Apr 09 Jul 09 Oct 09 Jan 10 Apr 10 Jul 10 Oct 10

ECB's interest rate on main refinancing operations ECB's interest rate on deposit facility Overnight interest rate in the euro area Excess liquidity (right-hand axis) Note: Excess liquidity is given by the banks' deposits under the deposit facility, current-account deposits with the Eurosystem and the ECB's fine-tuning market operations less the ECB's reserve requirements and the banks' use of the marginal lending facility. Since mid-October 2008, the ECB's main refinancing operations have been at a fixed allotment rate. 5-day moving averages for the overnight interest rate in the euro area (Eonia). The most recent observations are from 1 December 2010. Source: Reuters EcoWin and ECB. Monetary Review - 4th Quarter 2010

13 the autumn, but unlike the practice introduced during the financial crisis, these allocations will not be made at a fixed rate of interest, but at the average rate of the weekly main refinancing operations over the life of the respective operations. From early 2009 until recently, the ample liquidity in the euro area has caused the overnight interest rate to remain at a level close to the ECB's interest rate on its deposit facility, which is currently 0.25 per cent. As the excess liquidity has diminished, short-term money-market interest rates in the euro area have approached the ECB's lending rate in its main refinancing operations, which is currently 1 per cent, cf. Chart 8. The rising money-market interest rates in the euro area have had an impact on the spreads between money-market interest rates in Denmark and the euro area, which has affected the exchange rate of the krone. The implied yield spread for FX swaps between kroner and euro has been negative in recent months, cf. Chart 9. This means that there has been a forward discount on purchase of euro for kroner forward, whereas this usually entails a forward premium. The interest-rate spread between collateralised lending (interest-rate swaps) in Denmark and the euro area has been close to the monetary

SELECTED INTEREST-RATE SPREADS BETWEEN DENMARK AND THE EURO AREA Chart 9

Percentage points 2.5

2.0

1.5

1.0

0.5

0.0

-0.5 2007 2008 2009 2010

Monetary-policy spread Uncollateralised lending Interest-rate swaps FX swaps Note: 5-day moving averages, except for the monetary-policy spread, The monetary-policy spread is the difference between Danmarks Nationalbank's lending rate and the ECB's marginal rate in its main refinancing operations. The interest-rate spread for uncollateralised lending is the spread between 3-month Cibor and Euribor. The interest-rate spread for FX swaps is determined on the basis of the premium on 3-month forward FX transactions between kroner and euro. The interest-rate spread for interest-rate swaps is based on a 3-month interest-rate swap at the overnight interest rate. The most recent observations are from 1 December 2010. Source: Reuters EcoWin and Danmarks Nationalbank. Monetary Review - 4th Quarter 2010

14 policy spread since the summer of 2010. This reflects how the European market interest rates have approached the ECB's key lending rate. The spread between uncollateralised loans in Denmark and the euro area has narrowed a little since October, but remains wider than the spread for collateralised lending.

Developments in the credit and capital markets Bank Rescue Package I expired on 30 September 2010, marking the end of the unlimited government guarantee to all depositors and other unsecured creditors against losses on claims on banks that are members of the Private Contingency Association. Since its establishment in connection with the unlimited government guarantee, the Financial Stability Com- pany has acquired nine banks1. Following the expiry of the unlimited government guarantee, ordinary deposits are covered up to an amount corresponding to 100,000 euro, approximately kr. 745,000, while certain special deposits are fully covered2. People with deposits exceeding 100,000 euro will have to consider whether they have confidence in their bank's ability to meet its obligations. The expiry of Bank Rescue Package I did not cause problems in the financial sector. This should be viewed in light of the sector's general strengthening of its capital base and liquidity reserves. This is partly attributable to Bank Rescue Package II, which gave banks the opportunity to receive government injections of hybrid core capital and to issue bonds under individual government guarantees, as well as the fact that they have not been allowed to distribute dividends until the expiry of Bank Rescue Package I. Up to the turn of the quarter and the expiry of Bank Rescue Package I, use of Danmarks Nationalbank's facilities by banks and mortgage banks was limited, so there were no signs of unrest in the money market. On 30 September, Danmarks Nationalbank was open for the sale and purchase of certificates of deposit, which had been announced beforehand. On the last Friday in September, Danmarks Nationalbank's monetary- policy lending to its counterparties increased to almost kr. 10 billion from a level close to zero in the preceding months. In early October it fell back to nearly zero. The same pattern, albeit at a higher level, was seen in June up to the end of the 1st half of the year, cf. Chart 10. The

1 Eik Banki, Eik Bank Danmark, EBH Bank, Fionia Bank, Gudme Raaschou Bank, Løkken Sparekasse, Capinordic Bank, Straumur Burdaras Investment Bank hf and Roskilde Bank. The latter was transferred from Danmarks Nationalbank and the Private Contingency Association, which had

2 acquired Roskilde Bank before the commencement of Bank Rescue Package I. Such as children's savings accounts and establishment accounts, as well as pension, education and home savings accounts. Monetary Review - 4th Quarter 2010

THE BANKS' AND MORTGAGE BANKS' USE OF DANMARKS NATIONALBANK'S FACILITIES Chart 10

Kr. billion 250

200

150

100

-50

-100

-150

-200

-250 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Monetary-policy loans Current-account deposits Certificates of deposit Net position Note: The most recent observations are from 1 December 2010. Source: Danmarks Nationalbank.

monetary-policy counterparties still have a positive net position vis-à-vis Danmarks Nationalbank. This means that the rate of interest on certificates of deposit is currently the key interest rate for the Danish money- market rates. In September, auctions were held over non-callable fixed-rate bullet bonds for financing adjustable-rate loans ("fixed bullets"). Spreading out the auctions over the year helps to reduce the refinancing bulge around the turn of the year, so that a more even distribution of these auctions is achieved. The total sales volume was around kr. 50 billion. Adjustable-rate loans as a share of the mortgage banks' gross new lending has declined in recent months. Adjustable-rate loans now constitute 51 per cent of total new lending, down from more than 85 per cent at the turn of the year. Nevertheless, adjustable-rate loans remain the dominant type of mortgage credit. At end-October, 69 per cent of the total outstanding volume of mortgage loans thus fell into this category. The yield on short-term and long-term mortgage bonds rose in the autumn, to levels of around 1.4 per cent and 4.4 per cent, respectively, cf. Chart 11. During the autumn, the yield on a 10-year Danish government bond rose by approximately 0.5 percentage points, to around 3 per cent at present. Nevertheless, the current level remains very low compared with previously. Monetary Review - 4th Quarter 2010

YIELDS ON DANISH GOVERNMENT AND MORTGAGE BONDS Chart 11

Per cent 8

0 Jan 07 Jul 07 Jan 08 Jul 08 Jan 09 Jul 09 Jan 10 Jul 10 1-year fixed bullet Long-term mortgage bond 30-year 4-per-cent mortgage bond 10-year government bond Note: The 1-year yield on fixed bullets is a weekly average, with 1 December 2010 as the most recent observation. The long-term mortgage bond yield is an average effective yield on 30-year callable mortgage bonds, stated on a weekly basis with week 48 as the most recent observation. The 30-year 4-per-cent mortgage bond is shown from 1 February 2010 as this is the long-term mortgage bond currently traded. The most recent observation is from 1 December 2010. The yield on a 10-year government bond is the 10-year par yield. Source: Nordea Analytics, Association of Danish Mortgage Banks and Danmarks Nationalbank.

The banks' deposit and lending rates have ceased to fall, thereby ending a trend seen since the culmination of the financial crisis in October 2008. The interest-rate falls have gone hand in hand with Danmarks Nationalbank's reductions of its monetary-policy interest rates. The banks' interest-rate margin for retail customers is now back at the level from the summer of 2007, while the margin for the corporate sector is at a higher level than before the crisis, cf. Chart 12. The interest- rate margin remains substantially higher for sole proprietorships than for other business enterprises, reflecting that sole proprietorships typically raise smaller loans than other business enterprises. Moreover, larger enterprises, typically structured as limited liability companies, have easier access to alternative funding in the capital markets and are often able to provide more extensive collateral. This improves their bargaining power vis-à-vis the banks. In recent months the banks and mortgage banks have, on aggregate, had a stable volume of lending to households, while lending to the corporate sector has decreased slightly, cf. Chart 13. In Danmarks Natio- nalbank's lending survey, the banks' credit managers state that overall their credit policies to both the corporate sector and retail customers remained unchanged in the 3rd quarter relative to the previous quarter. Monetary Review - 4th Quarter 2010

THE BANKS' INTEREST-RATE MARGINS BROKEN DOWN BY GROUPS Chart 12

Percentage points 7

0 2003 2004 2005 2006 2007 2008 2009 2010 Households, etc. Other business enterprises Sole proprietorships Note: The most recent observations are from October 2010. Source: Danmarks Nationalbank.

LENDING BY BANKS AND MORTGAGE BANKS TO HOUSEHOLDS AND THE CORPORATE SECTOR Chart 13

Kr. billion Kr. billion 800 1,750

700 1,650

600 1,550

500 1,450

400 1,350

300 1,250 2006 2007 2008 2009 2010 Lending by banks to households Lending by banks to the corporate sector Lending by mortgage banks to the corporate sector Lending by mortgage banks to households (right-hand axis) Note Seasonally adjusted data. Outstanding lending to Danish households and business enterprises by banks and mortgage banks located in Denmark. "Households" also includes sole proprietorships, including farms. The corporate sector consists of non-financial corporations. The most recent observations are from October 2010. Source: Danmarks Nationalbank. Monetary Review - 4th Quarter 2010

They do not expect credit policies to change in the 4th quarter. For the corporate sector, the demand for loans rose a little in the 3rd quarter, and overall the banks expect a slight increase in the demand for loans from both retail and corporate customers in the 4th quarter.

THE DANISH ECONOMY

Economic activity The Danish economy continued to recover in the 3rd quarter, but at a slower pace than in the strong 2nd quarter, when the entire GDP growth was matched by inventory developments, cf. Box 1. In the 3rd quarter, seasonally adjusted real GDP grew by 0.7 per cent relative to the 2nd quarter and by 3.0 per cent relative to the 3rd quarter of the preceding year. For the first nine months of 2010, the annual growth rate was 1.7 per cent. Private consumption recovered nicely, following a strong decline in the 2nd quarter. All in all, private consumption is picking up. Investment fell in the 3rd quarter after a substantial increase in the 2nd quarter. No underlying signs of growth in investment have emerged yet. In contrast, exports of goods and services continued to grow steadily, rising by 1.9 per cent in the 3rd quarter. Public consumption also fell a little, but the figure for the first nine months of 2010 remains 2.1 per cent higher than in the same period of 2009. Economic growth is curbed by ongoing strong consolidation in the private sector. Many business enterprises are posting sound earnings, but invest only to a limited extent. There is a wish to reduce leveraging. At the same time, private consumption remains restrained. Household consumption relative to disposable incomes – the consumption ratio – is slightly below its long-term average. The number of enforced sales has shown a downward trend since the turn of the year, and overdue payments by households to mortgage banks fell in the 1st half of the year after a prolonged increase. This reflects the household sector's improved ability to meet payments. Following a minor fall in the 1st half of 2010, retail sales have moved sideways in recent months. Dankort payments point to a slight increase in retail sales from October to November. The consumer confidence indicator has been marginally positive during the autumn, but consumers have taken a slightly more pessimistic view of the Danish economy. Car sales have, however, risen and are now almost back at the pre-crisis level. Indicators point to only a modest increase in private consumption over the rest of the year. Monetary Review - 4th Quarter 2010

INVENTORY DYNAMICS IN THE DANISH ECONOMY Box 1

Although inventory investment is numerically small compared with e.g. consumption and fixed capital formation, it can have a considerable impact on short-term GDP growth. If demand for a company's products suddenly declines, this will typically lead to an unplanned surge in inventories at first, as it takes time for the company to adjust output to the new level of demand. The subsequent adjustment process means that the company will reduce its output so much that inventories are brought down to the desired level, and then output can be raised again to match the lower demand. During this process, output temporarily drops more sharply than demand, illustrating how short-term inventory movements can increase fluctuations in output. In addition, the import content in inventory investment is considerable and adjustment of inventories and output to lower demand will therefore also lead to an extraordinary fall in imports for a while. The contribution from inventory fluctuations to GDP growth depends on the change in inventory investment. Rising inventory investment, i.e. an increase in the build-up of inventories or a lower rate of inventory depletion, makes a positive contribution to GDP growth, and vice versa. But the large import content means that the registered contribution from inventories to growth overestimates the real effect on GDP growth of changes in inventory investment. Inventory investment fell strongly from 2008 to 2009 and, viewed in isolation, therefore made a negative contribution to GDP growth of around 2 percentage points, cf. Chart 14. In recent quarters, the change in inventory investment has been positive, thereby making a positive contribution to GDP growth, especially in the 2nd quarter of 2010. Hence, inventory investment is important to understanding short- term developments in output, but cannot be expected to make more permanent contributions to GDP growth.

INVENTORY DYNAMICS Chart 14

Per cent, year-on-year 6

-2

-4

-6

-8 2005 2006 2007 2008 2009 2010

Growth in real GDP Growth in real GDP excl. contribution from inventories Note: Seasonally adjusted data. The most recent observations are from the 3rd quarter of 2010. Source: Statistics Denmark and own calculations. Monetary Review - 4th Quarter 2010

CONFIDENCE INDICATORS Chart 15

Percentage balances Percentage balances 30 15

20 10

10 5

0 0

-10 -5

-20 -10

-30 -15

-40 -20

-50 -25 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Consumer confidence (right-hand axis) Industry Building and construction Services Note: Indicators of expectations for industry, services and building and construction. The most recent observations are from November 2010. Source: Statistics Denmark.

Business confidence indicators support the picture of a relatively weak upswing, cf. Chart 15. While service sector expectations have risen a little, the indicators for building and construction and for industry have fallen in recent months. Seasonally adjusted industrial production was slightly higher in the 3rd than in the 2nd quarter. Although the corporate sector overall posts rising profits, many business enterprises, especially the small ones, are still marked by the crisis. This is reflected in the failure rate, which has risen from an already very high level, albeit with a small decline in September and October. It is mainly small enterprises with few employees that fail, which means that the impact on unemployment is small.

Housing market Over the past year, prices for owner-occupied housing have displayed a very different pattern in the capital region than the rest of Denmark. At the national level, the prices of single-family and terraced houses rose by just over 3 per cent in the 3rd quarter of 2010 relative the 3rd quarter of 2009. However, this masks an increase of almost 12 per cent in the capital region and virtually unchanged prices outside the Copenhagen area, where prices also rose less in the boom years. Prices for owner- occupied flats have moved in tandem with house prices. Monetary Review - 4th Quarter 2010

At the national level, the number of house trades has grown by 12 per cent relative to last year, but remains below the pre-crisis level. In the capital region, the number has been almost flat. The limited turnover means that the supply of homes for sale continues to rise. According to the Association of Danish Mortgage Banks, a total of just over 50,000 single-family and terraced houses and owner- occupied flats were for sale in October, up by a good 7 per cent compared with October 2009. The statistics include homes advertised on the Internet.

Foreign trade and balance of payments Exports have grown in recent months. This has particularly been visible for sea freight, where both prices and volumes have risen. Manufactured exports have also picked up. Thus, the improvement in world trade seen over the past year is now being reflected in Denmark, although exports remain well below the pre-crisis level. The recovery in industrial production and manufactured exports has come with a certain lag compared with many other countries. Explana- tory factors could be that the last year's fall in the effective exchange rate of the krone and stronger growth in productivity have been unable to balance the sustained deterioration in wage competitiveness seen in the preceding years. The rise in domestic activity has also led to growth in imports in recent months. The increase has been evenly distributed across categories of goods, except fuel etc. The level of imports is below the level of exports so that the trade balance still shows a surplus. The seasonally adjusted surplus, excluding ships etc., has been around kr. 5 billion a month for the last 18 months, but with considerable fluctuations from month to month. In September, the current-account surplus reached almost kr. 80 billion, measured as a 12-month sum. This is equivalent to 4.4 per cent of GDP, which is very high in a historical context.

Labour market After having moved sideways for some months, seasonally adjusted gross unemployment rose by a total of 3,800 in September and October, to 170,300 people or 6.2 per cent of the labour force. Gross unemployment is the sum of net unemployment, previously referred to as registered unemployment, and people on activation schemes. The rise in gross unemployment was attributable to higher net unemployment, while the number in activation fell a little. Measured by the internationally comparable random-sample labour-force survey (arbejdskraftsunder- Monetary Review - 4th Quarter 2010

22 søgelse, AKU), unemployment in Denmark was 7.3 per cent in the 3rd quarter. Large fluctuations have been seen in the labour market during the most recent recession, cf. Box 2. Private sector employment, as reflected in the national accounts, fell by 22,000 in the 3rd quarter, while public sector employment rose slightly.

Wages and prices According to the Confederation of Danish Employers, wage inflation in the private labour market has been around 2.5 per cent over the last year, a significant fall compared with a few years ago. Public sector wage increases are also declining after a period of very strong growth. The lower wage inflation in the private sector reflects a still relatively weak labour market and ample capacity in the corporate sector. Danish wage increases are now almost in line with those abroad. However, Danish wages rose more strongly than those of Denmark's competitors over a long period, so the wage level is very high in an international context, cf. Chart 16. While output has been rising for the last year or so, employment has been falling, resulting in a substantial increase in productivity following a sharp drop in the preceding years. Rising productivity is a typical pattern early in an upswing, when business enterprises initially seek to

LABOUR COSTS IN INDUSTRY Chart 16

USA = 100 180

160

140

120

100

0 Norway Denmark Germany Sweden UK USA East Asia, Eastern excl. Japan Europe 2008 1998 Note: East Asia comprises Korea, the Philippines, Singapore and Taiwan. Eastern Europe comprises the Czech Republic, Hungary, Poland and Slovakia. Labour costs are stated on an hourly basis and include paid wages and employer contributions, etc. Not adjusted for purchasing power. Source: US Bureau of Labor. Monetary Review - 4th Quarter 2010

LABOUR MARKET TRENDS DURING THE RECESSION Box 2

Since the end of 2008, the fall in private sector employment has exceeded the combined increase in public sector employment and registered unemployment by 110,000, cf. Table 2. Analyses performed by comparing a number of sources show that the pattern in the labour market during the most recent recession has differed from those seen in previous business cycles. For example, young people have been more inclined to opt for education or training rather than to enter the labour market. At the same time, some of those already in education seem to have postponed their final exams.

DEVELOPMENTS IN THE LABOUR MARKET Q4 2008-Q3 2010 Table 2

Thousands

Fall in private sector employment ...... 190 Rise in public sector employment ...... 20 Rise in registered unemployment ...... 60

Remainder ...... 110 Of which: Activation ...... 30 Job seekers not receiving public benefits ...... 30 Foreign labour ...... 10 Education and training ...... 30 Permanent public benefits, excl. early retirement . 5 Early retirement ...... -10 Others ...... 15

Total ...... 110

Note: Activation comprises people on activation schemes who are unemployed, but ready to take jobs (source: Statistics Denmark). Job seekers not receiving public benefits comprises people included in AKU unemployment who are neither students nor receiving unemployment/cash benefits and hence are not included in registered unemployment (source: Statistics Denmark). Foreign labour comprises frontier workers and foreign citizens who have been granted residence/work permits after 1 January 2004 and who receive at least kr. 1,000 in income taxed at source from the same company within a given month. The most recent observation is from the 2nd quarter of 2010 (source: Jobindsats.dk). Education and training comprises people eligible for student grants (source: Ministry of Employment's DREAM database). Permanent public benefits comprises recipients of social pensions, flex benefits, waiting allowance (while waiting for flexible job), pre-rehabilitation and rehabilitation benefits (source: Jobindsats.dk). The most recent observation for early retirement is from the 2nd quarter of 2010 (source: Statistics Denmark). Others comprises the unexplained decline in the labour force. The following are not included: foreign labour staying in Denmark for less than three months and foreign self-employed persons not receiving income taxed at source. Own seasonal adjustment of contributions to decline in labour force. Source: Statistics Denmark, Ministry of Employment's DREAM database, Jobindsats.dk and own calculations.

Since 2000, a number of regulatory amendments have been introduced that may have affected the behaviour of the unemployed. Activation efforts have been stepped up, particularly in relation to young people and people close to the early retirement age. At the same time, the rules for receiving supplementary cash benefits have been tightened. The increased influx to the educational system should also be viewed in the light of the efforts in relation to young people with neither jobs nor formal qualifications. Thus, youth unemployment benefits are lower than benefits for more mature people and close to the level of student grants. The degree of activation has been particularly high during the most recent recession, one reason being that the reimbursement system currently gives local authorities a financial incentive to activate the unemployed. Increased activation and Monetary Review - 4th Quarter 2010

CONTINUED Box 2

more people in education and training explain more than half of the decline in the labour force since the peak in the 4th quarter of 2008. It is also worth noting that only a small proportion of those leaving the labour force have shifted to permanent public benefits. This increases the opportunities for attracting labour and expanding the labour force again when this becomes necessary.

cover increased demand for their products using existing labour resources. Over the past decade, productivity growth has been lower in Denmark than in competitor countries, while wage inflation has been higher. Danish business enterprises have thus lost competitiveness to the tune of 15 per cent. Inflation, measured as the Harmonised Index of Consumer Prices, HICP, has risen since the summer of 2009, but from a low level, cf. Chart 17. Annual HICP inflation was 2.4 per cent in October. A major reason for the higher inflation was that indirect taxes were raised; for example, prices for alcoholic drinks and tobacco have risen by around 9 per cent over the last year, primarily as a result of higher excise duties. Stripped of the volatile components, energy and food as well as alcohol and tobacco, prices rose by 1.0 per cent in October compared with the same month of 2009.

INFLATION IN DENMARK AND THE EURO AREA Chart 17

Per cent, year-on-year 5

-1 2004 2005 2006 2007 2008 2009 2010

Euro area - HICP Denmark - HICP Euro area - HICP, unchanged indirect taxes Denmark - HICP unchanged indirect taxes Note: HICP with unchanged indirect taxes assumes a full pass-through from changes in indirect taxes to consumer prices The most recent observations are from September for HICP with unchanged indirect taxes, October for HICP for Denmark and November for HICP for the euro area, the November figure being a flash estimate. Source: Eurostat. Monetary Review - 4th Quarter 2010

Euro area consumer prices rose by 1.9 per cent in October, and preliminary November data point to a similar increase. Inflation has been higher in Denmark than in the euro area in recent years. Adjusted for indirect taxes, inflation rates in Denmark and the euro area have, however, been similar in 2010 to date. Wholesale prices increased by 6.2 per cent in October. Developments in wholesale prices will gradually ripple through the production and distribution chain, which means that higher wholesale prices will exert upward pressure on consumer prices. The rising wholesale prices are mainly attributable to higher com- modity prices, especially for energy. Typically such price increases are not immediately passed on to sales prices. Instead, profits are squeezed.

Forecast for the Danish economy 2010-12 On the basis of the cyclical trends described above, Danmarks National- bank's most recent forecast for the Danish economy is described below. The forecast has been prepared using the macroeconometric model MONA1 and is based on the available economic statistics, including Statistics Denmark's quarterly national accounts for the 3rd quarter of 20102. The underlying assumptions concerning the international economy, financial conditions and fiscal policy are described in Appendix 1. Changes compared with the September 2010 forecast are discussed in Appendix 2. After five quarters of robust growth, GDP is expected to grow at a more subdued pace in the coming quarters, picking up towards the forecast horizon in 2012. However, this will not be enough to bring GDP back at the pre-crisis level. The projected growth profile by and large mirrors that of the euro area – but is weaker than Germany's – and is slightly lower than that of the USA, cf. Chart 18, following a stronger downturn in the Danish economy in 2008 and 2009. Together with exports, private consumption makes the most significant contribution to GDP growth in the projection, cf. Table 3. The households have consolidated themselves after the loss of wealth caused especially by the falling housing prices from 2007 to 2009. The consumption ratio, i.e. private consumption as a percentage of the households' disposable incomes, including pension contributions, is therefore moderate. The consolidation process has not been completed, but with signs pointing to a stable housing market – provided that interest rates rise only modestly from their low levels – there is scope to raise the con-

1 This model is described in Danmarks Nationalbank, MONA – a quarterly model of the Danish

2 economy, 2003. The calculations are based on statistical information up to and including 30 November 2010. Monetary Review - 4th Quarter 2010

GDP GROWTH IN DENMARK, THE EURO AREA AND THE USA Chart 18

Per cent 6 Estimates 5

-1

-2

-3

-4

-5

-6 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Denmark Euro area USA Source: Statistics Denmark, Reuters EcoWin, OECD, Economic Outlook, No. 88, November 2010, and own forecast. consumption ratio and thus to achieve some degree of growth in consumption despite the dampening impact of fiscal consolidation. In the projection, business investment rises from a low level and also contributes to GDP growth. Box 3 analyses the consequences of a faster return to a normal investment ratio. This lifts GDP growth and reduces unemployment, but without loss of competitiveness, as productivity also

KEY ECONOMIC VARIABLES Table 3

Real growth on previous year, per cent 2009 2010 2011 2012

GDP ...... -5.2 2.0 1.9 1.9 Private consumption ...... -4.5 2.1 2.3 2.8 Public consumption ...... 3.1 1.8 0.0 0.5 Residential investment ...... -16.9 -12.5 1.4 4.3 Public investment ...... 4.6 13.4 0.0 -8.1 Business investment ...... -15.9 -5.2 4.6 7.2 Inventory investment1 ...... -2.0 1.1 0.5 0.1 Exports ...... -9.7 2.5 3.6 3.8 Manufactured exports ...... -11.8 8.1 6.2 6.0 Imports ...... -12.5 2.3 4.8 5.1

Total employment, 1,000 persons ...... 2,824 2,764 2,758 2,767 Unemployment, net, 1,000 persons ...... 98 115 124 115 Balance of payments, per cent of GDP ...... 3.6 4.9 4.5 4.0 Government balance, per cent of GDP ...... -2.8 -3.9 -4.8 -3.5 Cash prices, per cent year-on-year ...... -12.0 2.4 0.0 1.5 Consumer prices, per cent year-on-year ...... 1.1 2.2 1.9 1.5 Hourly wages, per cent year-on-year ...... 2.9 2.5 2.5 2.9

1 Contribution to GDP growth. Monetary Review - 4th Quarter 2010

ALTERNATIVE SCENARIOS Box 3

In connection with the downturn, business investment has shrunk considerably. The decline since 2008 has been greater than the fall in output, implying that the investment ratio has been reduced substantially. This is a natural consequence of the substantial spare capacity resulting from the fall in output. As demand picks up, and capacity utilisation increases, it will be necessary to raise the level of investment again. In the forecast, investment ratios grow at a slow pace in the coming years. A stronger increase in investment cannot be ruled out, however, and an alternative scenario illustrates the potential macroeconomic consequences of this development. More specifically, it is assumed that business investment in plant and equipment and in building and construction from the 1st quarter of 2011 raise investment ratios so that they approach the average level by 2013, cf. Chart 19 (left). The decrease in private consumption in 2008 and 2009 has led to a fall in the consumption ratio. Seen in relation to the private sector's total disposable income consumption is modest, but is expected to rise in the projection so that the consumption ratio returns to a more normal level, cf. Chart 19 (right). However, there is still the possibility that households may wish to consolidate further than envisaged in the baseline scenario. The second alternative scenario looks at the consequences of a more subdued propensity to consume, with an unchanged low consumption ratio in 2011 and 2012.

ASSUMPTIONS UNDERLYING THE ALTERNATIVE SCENARIOS Chart 19

Investment ratios Consumption ratio 0.10 0.20 0.75

0.09 0.18 0.73 0.08 0.16

0.07 0.14 0.71

0.06 0.12 0.69 0.05 0.10

0.04 0.08 0.67

0.03 0.06 90 92 94 96 98 00 02 04 06 08 10 12 0.65 Building and construction, baseline 90 92 94 96 98 00 02 04 06 08 10 12 Building and construction, higher investment Plant and equipment, baseline (right-hand axis) Plant and equipment, higher investment (right-hand axis) Baseline Lower private consumption Note: In the right-hand chart, disposable income has been adjusted for pension yield tax.

The stronger upswing in business investment in plant and equipment and in building and construction in scenario 1 will lead to higher Danish output growth than in the baseline scenario, cf. Table 4. GDP growth increases by 0.2 percentage points in 2011 and 1 percentage point in 2012. Higher growth in activity will lead to higher employment, and, unemployment is reduced by 16.000 in 2012. The higher level of investment lifts the capital stock and boosts productivity growth. Wage inflation increases on account of the strong labour market, but this is more than offset by stronger productivity growth so that unit labour costs show a weaker development than in the baseline scenario. The stronger development in investment and the derived effects of the rise in activity (e.g. higher private consumption) will push up imports, and the balance of payments deteriorates by kr. 20 billion in 2012. Monetary Review - 4th Quarter 2010

CONTINUED Box 3

With weaker growth in private consumption in scenario 2, GDP growth is reduced to around 1½ per cent in 2011 and 2012. The lower level of activity leads to slightly lower employment, and in the last year of the projection unemployment is at 124,000, compared with 115,000 in the baseline scenario. Imports will also weaken on account of the lower domestic demand, increasing the current-account surplus. Finally, public finances will deteriorate as a result of lower revenue from direct and indirect taxes.

BASELINE AND ALTERNATIVE SCENARIOS Table 4

1: Higher level 2: Lower Baseline of business private scenario investment consumption

2011 GDP, per cent year-on-year ...... 1.9 2.1 1.4 Unemployment, net, 1,000 persons ...... 124 121 128 Balance of payments, per cent of GDP .... 4.5 4.1 4.9 Government balance, per cent of GDP .... -4.8 -4.7 -5.1 HICP, per cent year-on-year ...... 1.9 1.9 1.9 2012 GDP, per cent year-on-year ...... 1.9 2.9 1.6 Unemployment, net, 1,000 persons ...... 115 99 124 Balance of payments, per cent of GDP .... 4.0 3.0 4.9 Government balance, per cent of GDP .... -3.5 -2.9 -4.1 HICP, per cent year-on-year ...... 1.5 1.4 1.4

increases. Another scenario is also considered, in which private consumption grows at a slower pace, with a negative impact on activity. The forecast assumes zero growth in public consumption in 2011. This means that the target is to some degree exceeded – corresponding to the tendency in previous years – but it is the lowest consumption growth for 20 years, reflecting expectations that the new mechanisms for controlling local government service expenditure will have an effect compared with previous years. Manufactured exports have risen discernibly since the turn of the year, reflecting a recovery among Denmark's trading partners, while the export market share has remained more or less unchanged. Competitive- ness has improved in recent quarters taken as one, reflecting the weakening of the effective exchange rate of the krone since 2009 and higher productivity. All the same, there has been a substantial net deterioration over a number of years. In the projection exports rise, and the market share remains largely constant in 2011 in view of the recent boost to competitiveness. Export growth will be relatively limited in the next couple of quarters and will then pick up as the global economy also gains momentum. Imports outpace exports in the projection due to in- Monetary Review - 4th Quarter 2010

29 creasing demand pressure. As a result, the current-account surplus will gradually fall from just under 5 per cent of GDP in 2010 to 4 per cent in 2012. Employment declined by a good 20,000 in the 3rd quarter of 2010, so despite the flat development in the 1st half a turning point has not yet been reached following the sharp drop in employment in 2009. Hence, employment has not kept up with value added since mid-2009 and productivity has risen, thereby reversing some of the decline seen in previous years. Since the turn of the year, employment has risen in the public sector, but was lower in the 3rd quarter than at end-2009 in most private sectors. The fall in employment in industry has moderated, but has not reversed yet. This has brought industrial productivity back on its growth track, but output is below the pre-crisis level, and the level of employment accentuates the downward trend seen in recent decades. Unemployment has been stable since the autumn of 2009. In the projection, net unemployment rises to a level of around 125,000 in the 1st half of 2011 and then declines a little towards the end of 2012. This reflects a small increase in employment and a slightly larger influx to the labour force in the coming quarters. One of the reasons is that local authorities are expected to send fewer recipients of unemployment and cash benefits into activation as the reimbursement rates for these schemes will be lowered. Consumer price inflation, HICP, has risen from less than 1 per cent year-on-year in late 2009 to more than 2 per cent in recent months. This is attributable to factors such as rising energy prices and is also seen in e.g. the euro area, although Danish prices have risen more than those of the euro area. A significant explanatory factor is the raising of indirect taxes from January 2010, which contributes around 0.5 percentage points to inflation in Denmark. If the impact of changes in indirect taxes is excluded, inflation in both Denmark and the euro area has been around 1.5 per cent year-on-year in recent months. From January 2011 the effect of these increases on inflation will drop out of the calculations, bringing inflation below 2 per cent year-on-year. It will remain at this level throughout the projection horizon, cf. Table 5. This confirms that inflationary pressures are relatively subdued in view of the moderate outlook for the world economy and the weak capacity pressure in the Danish economy. Private sector wage inflation has responded to the weakening of the labour market and has in recent years reached a level of around 2.5 per cent year-on-year. The strongest reaction has been seen in the building and construction sector, where wage inflation fell below 1 per cent year- on-year. Data for the 3rd quarter point to convergence in wage inflation Monetary Review - 4th Quarter 2010

CONSUMER PRICES Table 5

Q3 Q4 Q1 Per cent, year-on-year Weight1 2009 2010 2011 2012 2010 2010 2011

HICP ...... 1.1 2.2 1.9 1.5 2.3 2.7 2.2 Index of net retail prices 100 2.1 2.0 1.8 1.5 2.0 2.2 2.1 Exogenous: Energy ...... 7.1 -6.3 11.8 3.9 1.5 10.9 9.9 5.0 Food ...... 13.1 0.6 -0.3 1.8 1.4 0.5 1.6 2.4 Adm. prices ...... 4.2 4.8 3.9 2.9 2.4 4.0 3.9 4.2 Rent ...... 23.6 4.5 2.6 2.2 2.3 2.4 2.5 2.6 Excl. exogenous ...... 52.0 2.5 0.7 1.3 1.2 0.6 0.9 1.2 Imports ...... 15.6 -3.5 0.8 1.2 2.5 2.5 3.0 2.3 IMI ...... 36.4 5.1 0.7 1.3 0.6 -0.2 0.0 0.7

Note.: In the index of net retail prices, indirect taxes and duties have been deducted from consumer prices, while any subsidies have been added. 1 Weight in the index of net retail prices, per cent. across the major sectors, i.e. industry, building and construction, and services. Wage inflation in the public sector is declining from a notably higher level than in the private labour market. Private sector wage inflation is expected to remain at around the current level in the coming quarters and then to pick up a little in 2012 against the background of a slightly stronger labour market.

Economic policy Denmark is facing considerable economic challenges. In the short term, highly expansionary fiscal policy must make way for an economy increasingly fuelled by private consumption, fixed business investments and exports if the economic upswing is to become self-sustained. The private sector's propensity to consume and invest has been unusually low for some time. Presumably this means that there is some scope for private demand to increase, so that it can drive the upswing. On the export side, the recovery of the Danish economy is supported by relatively high growth in Germany and Sweden, Denmark's two most important trading partners. Both these countries seem to be emerging from the crisis more rapidly than Denmark. One of the reasons why Sweden has fared better than Denmark is its tighter fiscal policy in recent years. In this way, Sweden avoided the strong deterioration of wage competitiveness seen in Denmark in the boom years in the most recent decade, cf. the article on the Danish and Swedish economies in this Monetary Review.1 Germany, too, has seen a more favourable development in wage competitiveness than Denmark for a number of

1 "Economic Developments in Denmark and Sweden in Recent Years", p. 37. Monetary Review - 4th Quarter 2010

31 years, reflecting a long period of wage restraint, targeted streamlining of export enterprises and labour market reforms. In the long term, the economic-policy challenge is to ensure sustainable public finances while also increasing the growth potential of the Danish economy. The financial crisis and the subsequent economic crisis have substantially increased the government debt, thereby adding to the future government interest burden. This reinforces the government financing problem that was already evident before the crisis. Fiscal consolidation will therefore be necessary for a long time to come. Since Denmark is already a high-tax country, the opportunities for consolidation via higher direct and indirect taxes are limited if serious economic distortion is to be avoided. Consolidation must therefore mainly be achieved by reining in expenditure and introducing structural reforms to strengthen the tax base and reduce pressure on government spending. It is positive that the government will present a spring plan for the Danish economy that is to include a consolidation plan for public finances up to the year 2020. To make it as credible as possible, the forthcoming 2020 plan should include specific directions for achieving the necessary consolidation. The EU is currently working to strengthen surveillance of member states' fiscal policies and economic policies in general.1 The aim is to prevent sovereign debt crises in future and to ensure a more balanced economic development across both the euro area and the EU as a whole. It would be very much in the interest of Denmark if these efforts suc- ceed. The stronger focus on stability-oriented fiscal policy means that the 2020 plan will attract more international attention that the previous medium-term plans for the Danish economy (the 2010 and 2015 plans). So will the fact that Denmark is currently subject to the Stability and Growth Pact's excessive deficit procedure. To enhance awareness of the importance of sound public finances, the Minister for Finance might give the Folketing (Danish parliament) an annual account of the status of the plan, e.g. in connection with the submission of the government's annual economic convergence programme to the European Commission. Besides bringing public finances back on track, the second major long- term challenge is to strengthen the growth potential of the Danish economy. Underlying productivity growth has been weak for a number of years, but no satisfactory explanation has been offered so far. There is an evident risk that the money will be wasted if new, budget-intensive initiatives are launched with a view to supporting productivity growth

1 See the article "Strengthened Economic Governance in the EU", p. 63. Monetary Review - 4th Quarter 2010

32 before the causes of the Danish productivity problem have been fully understood. In any case, it will take a long time before initiatives such as investments in education, research and development are fully reflected in productivity. In the short to medium term, the possibilities of strengthening growth will thus to a large extent hinge on whether Danish wage inflation can be kept on the low side of developments in competitor countries. The excess Danish wage increases relative to abroad, combined with weak productivity development in recent years, mean that the Danish industrial sector currently has some of the world's highest unit labour costs, cf. Chart 16. This makes Danish companies and jobs particularly vulnerable to the new international division of work, where emerging economies with large reserves of low-cost labour are surging ahead in the global market, while the economic crisis has intensified price competition in many markets. The need for structural reforms to increase the supply of labour should be seen against this background, among others. Such reforms will not only strengthen public finances in the long term, but will also contribute to curbing wage inflation, thereby boosting competitiveness and employment. Not only the public sector, but also the financial sector is faced with consolidation requirements in the coming years. It is important that the banks have sound capital buffers to meet unforeseen events, cf. the calculations in Danmarks Nationalbank's publication Stress Tests, 2nd Half 2010. Given the requirements resulting from future regulation and the phasing-out of the government capital injections (the Credit Package), this poses a significant challenge. To this should be added the need to strengthen liquidity. The banks' customer funding gap is now to a larger extent financed by way of loans with longer maturities, but this is because the banks have issued bonds on the basis of individual government guarantees expiring in 2013 at the latest. The banks must therefore prepare to source financing without government guarantees, while retaining positive development patterns such as more long-term issues and a reduced level of financing from other credit institutions. Hence, there is still some way to go before the banking sector can stand on its own two feet. After the expiry of the general government guarantee for all deposits and unsecured creditors on 1 October 2010, the banks may now distribute dividends again. However, the need for further consolidation of the sector calls for prudent dividend policies in the next few years.

Monetary Review - 4th Quarter 2010

APPENDIX 1: ASSUMPTIONS IN THE FORECAST FOR THE DANISH ECONOMY

The projection is based on a number of assumptions concerning the international economy, financial conditions and fiscal policy.

The international economy The global economy continued to improve in the 3rd quarter, but at a more subdued pace than in the 2nd quarter, when growth was high in a number of European countries. In Denmark's major export markets, Ger- many and Sweden, growth is expected to be high in 2010 and 2011. Against this background, the assessment of Danish export market growth has been revised upwards compared with the September forecast. The market for Danish exports is expected to grow by 10.9 per cent in 2010, while growth is assumed to be lower in 2011 and 2012, cf. Table 6. Notwithstanding the economic upswing, global price pressures are weak in 2010. Import prices in the countries to which Denmark exports, and export prices in the countries from which Denmark imports are set to decline by around 1 per cent this year and then to pick up in the subsequent year. Due to the relatively high rate of unemployment in most countries, foreign wage inflation is also expected to be modest throughout the projection period.

OVERVIEW OF FORECAST ASSUMPTIONS Table 6

2009 2010 2011 2012

International economy: Export market growth, per cent year-on-year ...... -11.9 10.9 5.9 6.5 Export market price1, per cent year-on-year ...... -0.4 -1.1 1.6 1.3 Foreign price2, per cent year-on-year ...... -0.5 -1.0 1.7 1.3 Foreign hourly wages, per cent year-on-year ...... 1.8 2.3 1.3 2.0

Financial conditions, etc.: 3-month money-market interest rate, per cent p.a. 1.7 0.7 0.9 1.4 Average bond yield, per cent p.a...... 3.8 2.7 3.1 3.7 Effective krone rate, 1980 = 100 ...... 107.8 104.1 103.5 103.5 Dollar exchange rate, DKK per USD ...... 5.4 5.6 5.6 5.6 Oil price, Brent, USD per barrel ...... 62.6 79.6 87.2 88.9

Fiscal policy: Public consumption, per cent year-on-year ...... 3.1 1.8 0.0 0.5 Public investment, per cent year-on-year ...... 4.6 13.4 0.0 -8.1 Public-sector employment, 1,000 persons ...... 830 841 839 840

1 Weighted import price for all countries to which Denmark exports. 2 Weighted export price for all countries from which Denmark imports. Monetary Review - 4th Quarter 2010

Interest rates, exchange rates and oil prices Developments in short- and long-term interest rates in the forecast are based on the expectations of future developments that can be derived from the yield curves in the financial markets. Short-term interest rates have risen in recent months following a fall since the autumn of 2008. The 3-month money-market interest rate was around 0.7 per cent p.a. in November and will rise to 1.4 pct. p.a. towards 2012. Long-term interest rates have also risen a little during the autumn, but remain at a low level. The average bond yield was 2.8 per cent at end-November and rises during the forecast period to reach 3.7 per cent p.a. in 2012. Compared with the September forecast, the nominal effective exchange rate of the krone has increased a little. This development reflects a strengthening of the euro, and thus the krone, vis-à-vis a number of currencies, including the US dollar and the pound sterling. In the projection, the dollar rate and the effective exchange rate of the krone are assumed to be unchanged at the level at the end of November. Since the last forecast, the price of oil has been higher than 80 dollars per barrel, and at the time of the forecast is was just over 85 dollars. In the projection, oil prices are assumed to mirror futures prices and rise slightly from the current level.

Fiscal assumptions The fiscal assumptions in the forecast are based on the announced fiscal- policy stance, including the agreement on the Finance Act for 2011. Real public consumption is assumed to grow by 1.8 per cent this year. Public consumption remains unchanged in real terms in 2011, rising by 0.5 per cent in 2012. Public investments will increase in 2010, partly because a number of investments have been brought forward. Investments are kept at the 2010 level in 2011, but fall in 2012 in step with the planned consolidation.

Monetary Review - 4th Quarter 2010

APPENDIX 2: REVISIONS IN RELATION TO THE PREVIOUS FORECAST

The estimated GDP growth in 2010 has been adjusted upwards from 1.6 per cent in the September forecast to 2.0 per cent in this forecast, cf. Table 7, which shows a breakdown of the revisions of GDP and consumer prices into important underlying factors. The upward adjustment of GDP growth is mainly based on a similar revision of export market growth, primarily motivated by stronger development in the most recent quarters. Looking further ahead, export market growth has also increased, which will contribute to boosting GDP growth in 2011 and 2012. The strengthening of the effective exchange rate of the krone since September will dampen growth and also contribute to slightly lower consumer price inflation. GDP growth will also be curbed because both short- and long-term interest rates have risen a little since September and are ¼-½ percentage points higher in this forecast than in the Sep- tember forecast. The financial conditions, measured in terms of interest and exchange rates, are thus tighter than in the September forecast. Oil prices are slightly higher in this forecast, which will push up inflation in 2011. Other factors, including data revisions, point to lower GDP growth in the projection. For example, a slightly lower level of public consumption in 2011 will have a downward impact on GDP growth.

REVISIONS IN RELATION TO THE PREVIOUS FORECAST Table 7

GDP Consumer prices, HICP

Per cent, year-on-year 2010 2011 2012 2010 2011 2012

Forecast, September 2010 ...... 1.6 1.7 2.0 2.1 1.7 1.6 Contribution to revised estimate from: Export market growth...... 0.5 0.9 0.3 0.0 0.1 0.2 Interest rates ...... 0.0 0.0 -0.1 0.0 0.0 0.0 Exchange rates ...... -0.1 -0.2 -0.2 0.0 -0.2 -0.1 Oil prices ...... 0.0 0.0 0.0 0.0 0.2 0.0 Other factors ...... -0.1 -0.5 -0.1 0.1 0.1 -0.1 This forecast ...... 2.0 1.9 1.9 2.2 1.9 1.5

Note: The transition from the previous to this forecast may not add up due to rounding. "Other factors" includes data revisions.

Monetary Review - 4th Quarter 2010

Economic Developments in Denmark and Sweden in Recent Years

Niels Blomquist, Anders Møller Christensen and Erik Haller Pedersen, Economics

INTRODUCTION AND SUMMARY

Denmark and Sweden are similar in many ways, including in economic terms. This article compares the development in the two countries before, during and after the deep economic crisis that began in the USA in 2007. Sweden experienced stronger growth than Denmark before the crisis and apparently continues to do so after the crisis. The OECD assesses potential growth as higher in Sweden than in Denmark. Consequently, in several important respects Sweden is better prepared to meet the future economic challenges. First and foremost, the two countries have differed considerably in terms of fiscal discipline. Both countries' fiscal policies are based on medium-term plans. But while Denmark has almost systematically exceeded its targets for growth in public consumption, Sweden has stayed within its fiscal framework since the late 1990s. This is paying off now, and Sweden is one of the few EU member states not subject to the excessive deficit procedure. In addition to fiscal discipline, Sweden has managed to improve its wage competitiveness over the last 10-15 years, whereas Denmark's has been eroded. The principal reason is not so much the different monetary and exchange-rate policies pursued. Instead, the explanation is a relatively long period with significantly stronger labour productivity growth in Sweden than in Denmark, combined with a lower rate of wage increase. In terms of prosperity, Sweden has gained on Denmark over the last decade, and the two countries now have almost the same gross domestic product (GDP) per capita, adjusted for price differences. The rate of unemployment in Sweden is slightly higher than in Den- mark, but youth unemployment is significantly higher. As regards Sweden, housing prices soared from an already high level during the boom. This poses a particular risk. Monetary Review - 4th Quarter 2010

REAL ECONOMIC DEVELOPMENT

Output While the pre-crisis boom was even stronger in Sweden than in Denmark in terms of GDP growth, cf. Chart 1, the Swedish economy was not overheated to the same degree, due to higher potential growth, among other factors. The peak-to-trough decline during the crisis years was of the same magnitude as in Denmark. The cyclical reversal in 2009 occurred one quarter earlier in Sweden, but since then the two economies have developed more or less in parallel. According to the OECD, the International Monetary Fund (IMF) and others, next year's growth is expected to be somewhat stronger in Sweden than in Denmark. That Sweden would come out of the crisis faster and stronger than many other countries was not a foregone conclusion. As late as in the summer of 2009, the IMF estimated that Sweden would be one of the last countries to recover from the crisis. One reason given was the Swedish banks' considerable exposure to the Baltic States, on which there was extensive focus at the time, cf. IMF (2009). These concerns were well-founded, but the losses have been smaller than feared.

DEVELOPMENT IN REAL GDP IN A NUMBER OF COUNTRIES Chart 1

Q1 2003 = 100 125

120

115

110

105

100

95 2003 2004 2005 2006 2007 2008 2009 2010 2011

EU Germany UK Sweden Denmark

Note: The most recently published figures are from the 2nd quarter of 2010. The projection is based on the European Commission's estimates of annual growth rates in 2011 and Danmarks Nationalbank's forecast for the Danish economy. Growth in the 4th quarter of 2010 is assumed to correspond to average quarterly growth in 2011. Source: European Commission (2010) and Danmarks Nationalbank. Monetary Review - 4th Quarter 2010

EXPORTS AND PRIVATE CONSUMPTION Chart 2

2000 = 100 160

150

140

130

120

110

100

90 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Denmark, exports Sweden, exports Denmark, private consumption Sweden, private consumption Note: National accounts data. Real quantities. Source: Reuters EcoWin.

Exports and competitiveness Swedish exports have increased at a faster pace than Danish exports since the turn of the business cycle in 2009, cf. Chart 2. There are several reasons for this. Firstly, Swedish exports, consisting to a higher degree of investment goods, are more cyclical than Danish exports. Investment goods account for almost 50%, compared to 25% in Denmark. As a consequence, Swedish industry has benefited from the recent increase in the propensity to invest observed in Germany and China, among other countries. Secondly, Sweden's wage competitiveness has improved since the mid- 1990s, whereas Denmark's wage competitiveness has been eroded, cf. Chart 3. The main reason is that the average annual growth in productivity has been two and a half times stronger in Sweden than in Den- mark, cf. Chart 4. Nevertheless, the rate of wage increase has been lower in Sweden, and the Swedish krona has depreciated during the period. The monetary and exchange-rate policies are discussed below. The lower wage growth reflects that the Swedish labour market has avoided the degree of overheating experienced in Denmark in 2005-07. The rate of unemployment in Sweden has remained a few percentage points above the level seen in Denmark, measured in internationally comparable terms. This difference reflects in particular that Sweden has a youth unemployment rate of 25 per cent or double the Danish rate, cf. Monetary Review - 4th Quarter 2010

COMPETITIVENESS Chart 3

Q1 1995 = 100 160

150

140

130

120

110

100

70 1995 1996 1997 1998 1999 2000 20012002 2003 2004 2005 20062007 2008 2009 2010

Sweden Denmark UK Note: Relative unit labour costs. An increase in the index indicates an adverse impact on competitiveness. Source: OECD (2010).

ANNUAL LABOUR PRODUCTIVITY GROWTH 1996-2008 Chart 4

Average annual growth, per cent 4

0 UK USA Italy EU11 Spain Japan France Ireland Finland Norway Sweden Belgium Australia Germany Denmark

Netherlands Note: The economy as a whole. Source: OECD. Monetary Review - 4th Quarter 2010

UNEMPLOYMENT Chart 5

Per cent 30

0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Denmark Sweden Below 25 years, Denmark Below 25 years, Sweden Note: Internationally comparable unemployment figures. Source: Eurostat.

Chart 5. One reason for Denmark's lower rate of youth unemployment is the Danish youth programme under which only young persons who are in education or training are eligible for state benefits. In Sweden the same unemployment benefit rules apply to everyone. The recent cyclical reversal has led to stagnating unemployment figures and rising employment.

Private consumption and the housing market Private consumption in Sweden declined less than in Denmark during the crisis, cf. Chart 2, and is expected to grow faster in 2011 according to the projections. The increase in the Swedish savings ratio was lower than in Denmark. Swedish housing prices increased at the same rate as in Denmark from the mid-1990s up to 2007, but they have not fallen in recent years, cf. Chart 6. This may be a consequence of the very low interest rates in Sweden and the restructuring and significant reduction of property taxes in 2006-08. In cyclical terms, the timing of the reduction was better than in Denmark where the undermining of the effective property taxes since 2002 had added more steam to property prices during the boom. Since 2000, residential investments in Sweden have had the same profile as in Denmark, but with the important difference that the Swedish level as a ratio of GDP was only two thirds of the level in Denmark. The Monetary Review - 4th Quarter 2010

HOUSING PRICES Chart 6

Jan. 2000 = 100

240

200

160

120

40 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 Sweden Denmark Note: Cash prices of single-family houses. Source: Reuters EcoWin and MONA databank.

contribution to growth from the housing market to the overall economy during the upswing was thus significantly smaller in Sweden. This is also part of the explanation as to why the Swedish labour market has been less tight during the period. Lending from banks and mortgage banks developed in parallel in Denmark and Sweden both before and during the crisis, but Swedish bank write-downs have been considerably lower in recent years. In fact, a large proportion of the Danish banks' write-downs have been related to exposures in the property market. In the spring of 2010, Finansinspektionen (the Swedish Financial Supervisory Authority) issued a circular to the Swedish banks stating that mortgages on real property must not exceed 75-90 per cent of the value of the house. House purchases in Sweden are to a greater extent financed via the banks, so for Denmark this should be compared to total bank and mortgage-bank lending for an owner-occupied dwelling. In 2009, 12 per cent of new borrowers in Sweden had mortgaged more than 90 per cent of the property value. So the Swedish authorities are somewhat concerned about lending growth and general developments in the housing market. In Denmark, mortgage-credit loans may not exceed 80 per cent of the property value, but there are no statutory restrictions on household access to raise supplementary loans in the banks. Monetary Review - 4th Quarter 2010

ECONOMIC POLICY

Fiscal policy Sweden has been much better than Denmark at managing public consumption in relation to budgets. To some extent this may be attributable to the framework for managing public expenditure, but that is hardly the whole explanation. Sweden also seems to have displayed far greater political determination to rein in public spending, including at local government level, cf. Chart 7. The discretionary easing of fiscal policy was less pronounced in Sweden than in Denmark in both 2009 and 2010. At the same time, the automatic stabilisers are slightly smaller than in Denmark. Consequently, the deterioration of the government budget balance from 2008 to 2010 was significantly less pronounced in Sweden – 6 per cent of GDP compared to more than 9 per cent in Denmark. This means that Sweden is one of the few EU member states not subject to the excessive deficit procedure and that it has a healthier underlying budget balance than Denmark. According to the Swedish government's latest forecast, the fiscal policy pursued is only just sustainable. In contrast, Denmark has a sustainability problem. The structural government budget balance – and thus the general health of public finances – has shown markedly diverging patterns in the last five years, significantly deteriorating in Denmark while moving

PUBLIC CONSUMPTION Chart 7

2000 = 100 Per cent 125 40

120 38

115 36

110 34

105 32

100 30

95 28

90 26

85 24 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Public consumption, Denmark Public consumption, Sweden Share of potential GDP, Denmark (right-h. axis) Share of potential GDP, Sweden (right-h. axis) Source: OECD (2010) and Statistics Denmark. Monetary Review - 4th Quarter 2010

STRUCTURAL GOVERNMENT BUDGET BALANCE Chart 8

Per cent of potential GDP 6

-1

-2 2005 2006 2007 2008 2009 2010 2011

Denmark Sweden Note: 2010 and 2011 are OECD estimates. Source: OECD (2010). sideways in Sweden, cf. Chart 8. Government debt, or EMU debt, as a ratio of GDP is more or less the same in the two countries.

Fiscal framework Following the deep crisis in the early 1990s, Sweden introduced a new fiscal and expenditure policy management system. The system consists of three elements: Government finances must show a surplus of minimum 1 per cent of GDP over an economic cycle. Government expenditure is subject to a 3-year spending cap determined by the Swedish parliament (the Riksdag). The budget contains a buffer, which is expedient as cyclical items are also subject to the spending cap. The 3-year spending cap matches the Danish medium-term targets for growth in public consumption, but with the difference that Sweden has met its targets every year since 1997, whereas, with a single exception, the Danish targets have been exceeded every year, in most cases by a considerable margin. The Swedish system has proved better suited than the Danish one to ensure that additional expenditure is matched by simultaneous savings. It is better at preventing temporarily high public revenue from perman- ently boosting public expenditure. This situation was observed in Den- mark for a number of years with Denmark's extraordinarily high revenue from oil and gas production in the North Sea and taxation of pension yields. Monetary Review - 4th Quarter 2010

The Swedish spending cap is determined at current prices. This means that the target is directly comparable with the budgets the various authorities are working with. In contrast, the Danish targets for growth in public consumption are in real terms with an upper limit for public expenditure as a ratio of GDP. Accordingly, the Danish budgets have to go through the national accounts before it can be assessed whether they have been exceeded or not. Unlike the central government, local governments in Sweden are not subject to specific expenditure targets, but their finances must balance or show a surplus. At the same time, the local governments in Sweden are much more cyclically sensitive than in Denmark. This has caused a substantial loss of jobs in the Swedish local government sector during the crisis, while employment in the Danish local government sector has increased considerably. The Swedish local governments receive annual block grants from the central government. In principle the amount is fixed in nominal terms. The Riksdag must actively decide to increase the grant. Another potentially important aspect is that Sweden does not have the same degree of tax redistribution between local governments as Denmark; therefore the local governments' income basis is less protected against slides. Therefore, individual local governments have more interest in keeping good taxpayers in their districts, thereby reducing the need to raise local taxes. Together with the requirement for budget balance, this has given Sweden far better control of its local-government expenditure. In principle, the Swedish fiscal policy structure entails a risk of the public finances becoming procyclical. A binding spending cap means that increased expenditure, e.g. for unemployment benefits, must be offset by savings in other areas.

Structural measures In recent years, Sweden has implemented a number of measures with a view to improving its economic structures and increasing the labour supply, cf. OECD (2008), thus enabling it to reduce the share of people on transfer income. This is partly cyclically conditioned, but Sweden has also implemented reforms which have, inter alia, substantially reduced absence due to illness. Six months ago, Denmark reduced the unemployment benefit entitlement period by half for people who lose their job. This will increase the labour supply in the longer term. In the tax area, Sweden has raised the upper tax bracket threshold, but it still has one of the steepest progression rates among the OECD countries. At the same time, the employment allowance was raised and Monetary Review - 4th Quarter 2010

46 the business enterprises' social contributions reduced. In 2009, corporate tax was lowered from 28 to 26.3 per cent, which is slightly higher than in Denmark. Housing taxes were restructured completely and lowered. The Swedish Ministry of Finance estimates that the tax reforms adopted in the period 2007-09 will increase the labour supply by 2.3 per cent by 2014. In Denmark that would correspond to 64,000 persons. In the assessment of the Swedish Ministry of Finance, the impact on GDP will be 2.2 per cent. In Denmark, income and corporate tax rates have also been cut in recent years, but the impact on the labour supply is not on the same level as in Sweden. Labour-market adjustments have also been made. The Swedish Minis- try of Finance estimates that in the long term the labour-market reforms adopted since 2006 will increase the labour supply by 2 per cent. The impact on GDP is estimated at 1.5 per cent. The labour market in Sweden remains less flexible than in Denmark – for example, the rules for dismissing employees are stricter. This is reflected in higher structural unemployment and, as mentioned, a high youth unemployment rate. Sweden also benefits from the reforms implemented throughout the 1990s after the crisis. While the fiscal and expenditure policy management system was introduced in 1997, a comprehensive programme to reorganise public spending was implemented in 1994-98, corresponding to 7 per cent of GDP, equally distributed on increased revenue and reduced expenditure. The levels of a large number of public services such as unemployment benefits, sickness benefits, early retirement and old- age pension, child allowances, etc. were lowered. On the revenue side, the increased taxes were broadly distributed. As a result of the re- organisation programme, the government budgets showed surpluses again from 1998.

Monetary and exchange-rate policies The euro has been a stabilising factor during the financial and economic crisis. Before the euro was introduced in 1999, financial crises were often followed by currency unrest and devaluations to improve competitiveness among the European countries. Due to Denmark's fixed-exchange-rate policy, the euro has been a stable anchor for the Danish krone. But a fixed-exchange-rate policy makes demands on economic policy as a whole, not just on monetary policy. Paradoxically, despite its floating exchange rate, Sweden has, to a higher extent than Denmark, managed for long stretches of time to pursue the policy required by a fixed-exchange-rate regime, i.e. a tight fiscal policy and a rate of wage increase that does not outpace product- Monetary Review - 4th Quarter 2010

EFFECTIVE EXCHANGE RATES Chart 9

Q1 2000 = 100 125

120

115

110

105

100

80 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Real effective exchange rate, Sweden Effective exchange rate, Sweden Effective exchange rate, Denmark Real effective exchange rate, Denmark Note: Real effective exchange rates have been deflated by hourly wages. Source: Reuters EcoWin and Danmarks Nationalbank.

ivity growth. Since the mid-1990s, Swedish wages have increased almost 10 per cent less than Danish wages. Sweden's immediate response to the crisis was to significantly lower its monetary-policy interest rates. The Swedish krona depreciated, while the effective exchange rate of the Danish krone was initially strengthened, cf. Chart 9. The immediate consequence was improved Swedish competitiveness. However, this temporary improvement is not the primary reason why Sweden comes out the crisis stronger than Denmark. The UK pursues a monetary and exchange-rate policy that is in line with the Swedish policy, but while the immediate depreciation of the pound sterling was even stronger, this did not have any significant positive impact on exports or the economy in general. In contrast to Sweden, the UK does not have sound government finances and did not experience a long preceding period of improving competitiveness, cf. Chart 3. A number of cases have also shown that a fixed-exchange-rate regime is not in itself a guarantee against problems. Several small euro area member states, including Ireland and Portugal, are cases in point. This indicates that, rather than exchange-rate policies, sound long-term economic policies, including fiscal policies, determine how well a country has coped with the crisis.

Monetary Review - 4th Quarter 2010

LITERATURE

European Commission (2010), European Economic Forecast, autumn.

IMF (2009), Staff Report for the 2009 Article IV Consultation on Sweden, August.

IMF (2010), World Economic Outlook, October.

OECD (2008), OECD Economic Surveys, Sweden, December.

IMF (2010), World Economic Outlook, no. 87, May.

Monetary Review - 4th Quarter 2010

Economic Imbalances in the Euro Area

Niels Blomquist and Jakob Ekholdt Christensen, Economics

INTRODUCTION AND SUMMARY

Since the introduction of the single currency in 1999, the euro area has generally enjoyed low and stable inflation and increased intra-euro area trade and investment. The euro has been a significant catalyst for financial market integration, and per capita growth has shown almost the same pattern as in the USA. Nevertheless, the positive development has not prevented mounting internal imbalances. A number of member states have accumulated large, unsustainable current-account deficits, which have been financed by capital inflows from surplus member states such as Germany, the Netherlands, Finland and Austria. After attracting only limited attention for many years, the imbalances in the euro area have taken centre stage during 2010 with sovereign debt crises in several deficit member states. As regards Greece and Ireland, the EU member states, the European Central Bank and the Inter- national Monetary Fund have had to step in with extensive financial assistance measures. This article looks into the drivers of the euro area imbalances. As such, disequilibrium on the balance of payments is not necessarily a problem, but may reflect a natural convergence process whereby relatively poor countries increase their economic potential via productivity-enhancing investments that are partially financed by capital raised abroad. How- ever, we find that the capital inflows did not sufficiently boost productivity in the euro area member states with deficits. They saw a strong increase in domestic demand, partially driven by far too expansionary fiscal policies. Given the inflexible labour markets, this led to extensive wage increases. The result was deterioration of competitiveness and growing current-account deficits. Ultimately, the member states' ability to honour future public and private debt obligations was questioned. As the financial sectors of the surplus member states had built up major exposures to the deficit member states, this problem did not only affect the deficit member states. Furthermore, the article discusses what can and should be done to reduce the imbalances and thus the risk they represent to other economies, including Denmark, whose trade with the euro area is substantial. Monetary Review - 4th Quarter 2010

The deficit member states need to introduce extensive economic austerity measures to boost productivity and reduce their economic imbalances. This process will require considerable depreciation of their real exchange rates, which can only be realised by reducing wages and prices. Structural reforms are an important element in this connection, in view of the inflexible labour and product markets of most of the deficit member states. Member states that fail to implement such reforms may experience a prolonged period of low economic growth and high unemployment. In the short term, the surplus member states cannot solve the problems of the deficit member states via higher domestic demand and wages, as trade with the deficit member states is limited. Structural reform of service sectors and labour markets, on the other hand, may eventually contribute to raising the investment potential of the surplus member states and thus to reducing the imbalances in the euro area. The framework for economic-policy cooperation has proved to be inadequate when it comes to preventing unsustainable imbalances and risks. The steps taken on the road to strengthening economic governance, as adopted by the European Council in October 2010, are therefore welcomed.

THE ACCUMULATION OF IMBALANCES IN THE EURO AREA

During most of the period since the introduction of the euro, the current account of the euro area's balance of payments has more or less balanced.1 However, there is considerable divergence across the member states. While Germany, Austria, Luxembourg, the Netherlands and Fin- land have posted current-account surpluses, other member states, such as Greece, Ireland, Italy, Portugal and Spain (GIIPS member states) have shown deficits. Until around 1999, the gap between surplus and deficit member states was not great, but from 2000 until 2007 the imbalances grew, cf. Chart 1. The introduction of Stage 3 of EMU entailed a single monetary-policy interest rate for all euro area member states and removed the exchange- rate uncertainty within the euro area. According to Sinn (2010), this resulted in large capital flows from the surplus member states to the GIIPS member states, in pursuit of higher returns. The increased supply of capital pushed market interest rates downwards in the GIIPS member states, which resulted in a marked increase in domestic private-sector demand. As shown in Table 1, all GIIPS member states recorded a considerable fall in private savings ratios, whereas the total private-sector

1 In this article, we look at economic developments in the 12 original euro area member states. Monetary Review - 4th Quarter 2010

EURO AREA IMBALANCES Chart 1

Balance of payments, current account, per cent of EU 12 GDP 3

-1

-2

-3 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Surplus member states Deficit member states Note: The surplus member states are Finland, the Netherlands, Luxembourg, Germany and Austria. The deficit member states are Greece, Ireland, Italy, Spain and Portugal. Source: Eurostat and European Commission, Ameco database. investment ratio rose in all member states except Portugal. Moreover, the structural government budget balances of Greece and Ireland deteriorated strongly, i.e. fiscal policy contributed to further growth in domestic demand. The strong growth in demand in the deficit member states

CHANGES IN PRIVATE AND PUBLIC SAVINGS AND INVESTMENT 1998-2007 Table 1

Private investment Savings Structural Public surplus government Private Public invest- = Balance of balance Per cent of GDP, unless savings savings Housing Other ment payments (per cent of otherwise stated (1) (2) (3) (4) (5) (6) potential GDP) Deficit member states Greece ...... -5.1 -1.8 -1.1 3.4 -0.2 -8.9 -3.8 Ireland ...... -3.3 -0.3 6.7 -4.2 1.9 -8.1 -3.7 Italy ...... -3.8 1.6 1.8 0.1 1.0 -4.1 -0.8 Spain ...... -7.2 5.9 6.1 0.9 0.7 -9.0 4.1 Portugal ...... -6.3 -1.0 -2.9 -0.1 -1.7 -2.5 0.7 Surplus member states Finland ...... -1.0 3.3 3.0 -0.8 -0.4 0.5 2.0 Netherlands ...... 1.6 1.4 0.3 -2.9 0.4 5.2 0.0 Germany ...... 3.5 2.0 -2.9 1.0 -0.4 7.8 0.7 Austria ...... 1.7 1.1 -1.6 0.2 -0.8 5.1 1.0

Note: Public savings are calculated as the government surplus plus public investment. The balance of payments is calculated as (1) + (2) – (3) – (4) – (5) = (6). Source: European Commission, Ameco database. Monetary Review - 4th Quarter 2010

BALANCE OF PAYMENTS AND GDP PER CAPITA Chart 2

Accumulated balance of payments surplus 1998-2007, per cent of GDP

150

R2 = 0.8208

100 Luxembourg

Finland 50 Netherlands Belgium Germany France Austria 0 Italy Ireland

Spain -50 Greece Portugal

-100 0 50 100 150 200 250 GDP per capita in 1998 (EU12 = 100)

Source: IMF, World Economic Outlook, database and Eurostat. generated wage increases that were out of proportion to the underlying growth in productivity. The resultant price inflation caused the real effective exchange rates of the member states to appreciate. The deterioration of competitiveness increased the current-account deficits. For example, the deficits accumulated from 1999 to 2007 in Portugal, Greece and Spain amounted to 76, 72 and 49 per cent, respectively, of the gross domestic product, GDP, cf. Chart 2. Ireland's deficit accelerated substantially from around 0 in 1999-2003 to 5.3 per cent of GDP in 2007. In contrast, the surplus member states built up external assets in the same period. This was achieved through wage restraint and improved competitiveness, a pronounced propensity to save and reduced investment ratios. For example, Germany's savings ratio has risen by more than 5 percentage points. From 1999 to 2007, Germany accumulated a current- account surplus of 24 per cent of GDP.

WHAT MADE THE IMBALANCES IN THE EURO AREA UNSUSTAINABLE?

In a monetary union, external imbalances are not a currency-related problem, since the country-specific exchange-rate risk has been eliminated. Via the financial markets, the surplus member states will be able to finance the deficits of the deficit member states without the intervention of a monetary authority.1 However, the sustainability of the

1 Financing may also be provided by third countries. Monetary Review - 4th Quarter 2010

53 external imbalances may be influenced by problematic factors. For example, the imbalances may reflect inexpedient use of the capital or unhealthy overheating of the domestic economy and excessive risk in the financial system. It must be possible to finance a current-account deficit by increasing net exports in the future. Sustainability is therefore only achieved if the investment surplus (deficit on the balance of payments) creates the foundation for future increased output of internationally traded goods.

Economic convergence and the balance of payments According to economic theory and empirical evidence, poorer countries will experience economic convergence. In the long term, this will bring them to the same level of prosperity as comparable countries. According to theory, the poorer countries will post deficits on their balances of payments in the convergence period. Firstly, investment in these countries will generally be profitable for investors from richer countries, generating an inflow of capital to the developing countries. Moreover, the population of the poorer countries will tend to consume rather than save in this phase, in the expectation of higher future income. Invest- ment will thus typically exceed savings, resulting in a current-account deficit for the country. The theory matches the actual development in the euro area. In 1998, GDP per capita was significantly lower in the GIIPS member states than in the other euro area member states. Subsequently, they experienced the strongest overall deterioration of the balance of payments, cf. Chart 2. Wages and thus the general price level in the whole economy will rise in step with increasing productivity in the export sector. An increase in the price level relative to the trading partners of the convergence countries causes the real effective exchange rate to appreciate. As shown in Chart 3, this has generally been observed for the GIIPS member states. The Chart also reveals more persistent trends in the real effective exchange rates of these member states after the introduction of the single currency. This pattern thus matches expectations. However, the development in the price levels of the GIIPS member states, and hence in their real effective exchange rates, does not reflect extraordinary productivity gains in the export sector. Instead, it reflects a general productivity lag, cf. Box 1.

Unsustainable imbalances As mentioned, a precondition of sustainable deficits on the balance of payments is that capital flows are used to finance productive investment. In the GIIPS member states, the inflow of capital led to strong Monetary Review - 4th Quarter 2010

REAL EFFECTIVE EXCHANGE RATES OF THE EURO AREA MEMBER STATES Chart 3

Index 1999 = 100 130

120

110

100

70 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

Germany Greece Spain Ireland Italy Portugal Finland Note: Real effective exchange rates in relation to the other euro area member states. The GDP deflator has been used as the price index. Source: European Commission.

growth in lending to households and non-financial corporations. In the period 1998-2007, lending as a ratio of GDP grew by 132 percentage points in Ireland and 90 percentage points in Spain. The inflows of capital to the GIIPS member states had adverse effects. In Ireland and Spain, external financing was channelled mainly to the housing market, cf. Table 1. In Greece, it was used to finance the government deficit, while in Portugal it led to accumulation of private-sector external debt due to the strong private consumption. In Italy, Spain and Portugal, growth in total factor productivity has been zero or negative. Resi- dential investment and high private consumption are not enough to underpin the long-term growth potential of the economy. Moreover, the GIIPS member states have seen a strong increase in unit labour costs relative to the other euro area member states. This entails wage growth without corresponding growth in productivity. As a result, the competitiveness of these member states has deteriorated. Consequently, it stands to reason that the excessive private-sector and public-sector demand in the GIIPS member states was unsustainable in the long term, since it essentially generated additional domestic inflation and thus unfavourable appreciation of the real effective exchange rates of these member states. The costs of financing these deficits increased due to the financial crisis. Hence, the member states Monetary Review - 4th Quarter 2010

BALASSA-SAMUELSON EFFECTS Box 1

One explanation of developments in real effective exchange rates in the euro area could be the Balassa-Samuelson effect, named after Balassa (1964) and Samuelson (1964) and described in more detail in e.g. Sinn (2010) and the European Commission (2009). The effect is observed in a model with a developed and a less developed economy. Each of the economies is assumed to consist of two sectors: one with goods trade in the world market and one with goods trade in the domestic market. There is free labour mobility between the domestic sectors. Higher productivity in the export sector is assumed to lead to higher real wages in the sector. Given the labour mobility, this will also entail an increase in wages in the domestic market sector, which will push prices for the sector's goods upwards. Consequently, productivity growth in the export sector will result in additional inflation in the domestic market sector relative to the export sector. A positive correlation is thus expected between higher productivity growth in the export sector and additional inflation in the domestic market sector. The model also assumes that the potential for productivity growth in the export sector is greater in the less developed economy than in the developed economy. The less developed economy will therefore experience higher wage increases in the export sector and thus higher inflation in the domestic market sector, compared with the more developed economy. This results in a general price increase in the less developed economy relative to the rest of the world, i.e. an appreciation of the real effective exchange rate. The appreciation does not reflect an unsustainable development, it merely reflects a relative improvement of productivity and thus higher prosperity in the less developed economy.

BALASSA-SAMUELSON EFFECTS IN THE EURO AREA? Chart 4

Additional inflation in domestic market sector, percentage points

0.45 Finland 0.40

0.35 Incl. Finland R2 = 0.5345 0.30

Portugal 0.25

Netherlands 0.20 France Excl. Finland R2 = 0.1255 0.15 Belgium Spain Austria 0.10

Italy 0.05 Greece Germany Luxembourg 0.00 0 0.1 0.2 0.3 0.4 0.5 0.6 Additional inflation in productivity of export market sector, percentage points Note: The X axis denotes the difference in productivity growth between the export sector and the domestic market sector. The Y axis denotes the difference between price increases in the domestic market sector and the export sector. Ireland has been excluded from the estimation due to lack of data. The sectoral breakdown follows Schmillen (2010). Source: OECD STAN database and own calculations. Monetary Review - 4th Quarter 2010

CONTINUED Box 1

As Chart 4 shows, there is a significant positive correlation between the relative developments in productivity and prices in the economies, as implied by the theory1. Furthermore, as appears from the Chart, productivity growth has generally been stronger in the export sector than in the domestic market sector. However, the dispersion of member states is not in accordance with the theory. Chart 3 shows that the real effective exchange rates have indeed appreciated most in the poorest economies. However, Chart 4 shows only limited additional growth in the productivity of the export sector in these member states. It follows that the appreciation in the GIIPS member states cannot be attributed to particularly strong productivity growth in the poor euro area member states' sectors for internationally traded goods.

1 The significance of the results are sensitive to the inclusion or exclusion of Finland from the estimation.

have had to implement measures to boost productivity and contain wage growth. The imbalances in the euro area not only presented a problem for the deficit member states. Over the years, the financial institutions of the surplus member states had become more and more exposed to the GIIPS member states, including through considerable purchases of GIIPS government bonds. French, German and Dutch banks in particular had accumulated substantial claims, corresponding to 25, 15 and 10 per cent, respectively, of total foreign lending. This made them vulnerable to deterioration of the economies of the GIIPS member states. In the following we discuss what the euro area member states must do to reduce their external imbalances.

MEASURES TO REDUCE IMBALANCES IN THE EURO AREA

Some of the imbalances have already been reduced in the wake of the economic crisis which erupted after the collapse of Lehman Brothers, cf. Chart 1. Since 2008, Greece and Spain have reduced their current- account deficits as a ratio of GDP by 3 and 4 percentage points, respectively. One underlying factor is that access to external financing diminished in the wake of the collapse of Lehman Brothers. Consequent- ly, the reduction of the European imbalances was driven mainly by cyclical, rather than structural, factors in line with the reduction of the global imbalances, cf. Blomquist and Thamsborg (2010). The current- account deficits remain substantial and further reduction would require reform. Since the banks in the surplus member states still have considerable claims on the GIIPS member states, it is important to reduce the imbalances with a view to stability in the euro area. Monetary Review - 4th Quarter 2010

Strict economic diet in the deficit member states The deficit member states all face tough economic-policy measures and extensive reforms. The measures are targeted at improving public finances and boosting competitiveness in the member states. Devalua- tion is not an option in EMU. Instead, the member states have to follow an internal devaluation strategy whereby domestic prices and wages are reduced relative to those of their trading partners. The result is depreciation in real terms, making the products of these member states cheaper and contributing to improving their external balances. Kohlhas and Nielsen (2010) have estimated the internal devaluation required for reduction of the external imbalances in this way only. According to their calculations, depreciation of the real effective exchange by 30 per cent is required for Greece to eliminate its current- account deficit. The depreciation required for Spain and Portugal is 27 and 30 per cent, respectively, while it is only 10 per cent for Ireland, whose exports are more sensitive to fluctuations in the real effective exchange rate. The extent of these adjustments is in line with 25 historical balance-of-payments adjustments in industrialised countries cf. Freund (2000). In most of these countries the adjustment was achieved by means of depreciation of the nominal exchange rate. Only a few countries, namely Canada, Denmark and Singapore, pursued an actual internal devaluation strategy, back in the 1980s.1 Given the general convergence process of the deficit countries, it can be argued that they need not eliminate their external imbalances completely. The ongoing fiscal tightening will contribute to internal devaluation. Greece is implementing tightening measures under an economic stabilisation programme supported by the IMF and other euro area member states. Moreover, a similar programme has been agreed for Ireland. The other crisis-stricken member states have also announced marked fiscal tightening measures. This will contribute to dampening domestic demand. At the same time, they have announced wage reductions in the public sector. Weaker domestic demand and wage reductions in the public sector will reduce inflationary pressures in the economy and thus boost competitiveness. The effect of lower wages in the public sector can be reinforced if it leads to lower wages in the private sector. However, this depends on the flexibility of wage formation. In this respect, especially Greece, Italy, Spain and Portugal are facing major challenges. Studies at company level by Dickens et al. (2007) indicate that these member states' labour

1 The Baltic States have recently conducted extensive external adjustments through internal devaluation. A common feature is their very flexible labour markets, which have enabled them to reduce wages in nominal terms. Monetary Review - 4th Quarter 2010

SHARE OF EMPLOYEES COMPRISED BY WAGE RIGIDITIES Chart 5

Per cent 70

0 Italy France Greece Ireland Austria Finland Belgium Portugal Germany Denmark Switzerland Netherlands Real Nominal Note: The Chart shows the share of employees potentially comprised by downward real and nominal wage rigidities. Wage rigidities are defined as cases in which the wages or salaries of employees who are, for personal or external reasons, facing a nominal or real wage reduction are instead frozen in nominal or real terms. Source: Dickens et al. (2007). markets are characterised by considerable sluggishness as regards the scope for reducing wages in nominal and real terms, cf. Chart 5. The labour markets of Ireland and Denmark are among the most flexible. Consequently, it is not surprising that Ireland has already succeeded in implementing wage adjustments and recovering much of the competitiveness lost since 2008. The other GIIPS member states have to enhance the flexibility of their labour markets and wage formation. The governments of both Spain and Greece adopted labour market reforms during the summer. Portugal is also planning labour market reforms. Moreover, the member states can considerably boost competitiveness by strengthening productivity. Jaumotte and Sodsriwiboon (2010) estimate that if productivity in Italy, Portugal and Spain is brought in line with the best performing euro area member states (Finland and the Netherlands), the balances of payments of the three member states will improve by 2-2.5 per cent of GDP due to significantly stronger competitiveness.

Should the surplus member states contribute to reducing the imbalances? The surplus member states have sometimes been encouraged to ease the adjustment burden for the deficit member states by boosting their domestic demand. The necessary real depreciation of the exchange rates Monetary Review - 4th Quarter 2010

GERMAN IMPORTS FROM SELECTED EURO AREA MEMBER STATES IN 2009 Chart 6

Per cent of GDP of exporting member state 16

0 Italy Spain France Greece Ireland Austria Finland Belgium Portugal Netherlands Luxembourg Source: IMF, Direction of Trade Statistics, and World Economic Outlook, database.

of the deficit member states will thus partially take place via higher inflation in the surplus member states, which will reduce the extent of wage adjustment required in the deficit member states.1 In the short term, the effects on the deficit member states depend on the volume of trade between the surplus and deficit member states. As shown in Chart 6, exports from the deficit member states to Germany are modest as a ratio of GDP. Consequently, stronger demand in Ger- many will have no significant effect on the economic activity and real effective exchange rates of the deficit member states. Similarly, IMF (2010) finds that easing of Germany's fiscal policy by 1 per cent of GDP will improve the southern European balances of payments by less than 0.1 per cent of GDP. In the longer term, however, structural reforms in the surplus member states may contribute to stimulating domestic demand and thus reduce the imbalances in the euro area. The reforms must be targeted especially at enhancing labour market flexibility and strengthening the basis for growth in the service sector, cf. IMF (2010). This will provide more domestic investment opportunities and stimulate consumption of domestic

1 Sinn (2010) points out that part of the adjustment process in the euro area will probably take place automatically. The reason is that investors in the surplus member states will increasingly tend to invest their savings domestically, as the opportunities of a good return will probably be better than in the deficit member states, which will be burdened by low economic growth for a substantial number of years. Monetary Review - 4th Quarter 2010

60 services. This applies especially in Germany and Austria, the euro area member states with the most extensively regulated service sectors.

EU reforms to avoid new unsustainable imbalances The crises in the euro area in 2010 have demonstrated that the imbalances among the member states play an important role, notwithstanding the single currency. The framework for economic-policy cooperation has proved to be inadequate when it comes to preventing unsustainable imbalances and risks. The decision of the European Coun- cil in October 2010 on a pronounced strengthening of the framework for economic governance, based on the preparations of the Van Rompuy Task Force, is therefore welcome.1 Moreover, the aim is that the strengthened surveillance under the new European Systemic Risk Board will capture macroprudential risks for the financial sector at an earlier stage so that they can be addressed earlier and more efficiently. In the first instance, it is up to the deficit member states themselves to get things in order, but the stronger framework will make it more difficult to use the single currency as an excuse to lean back and postpone necessary adjustments.

1 See also the article "Strengthened Economic Governance in the EU", p. 63. Monetary Review - 4th Quarter 2010

LITERATURE

Balassa, Bela (1964), The Purchasing Power Parity Doctrine: A Reappraisal, Journal of Political Economy, No. 72.

Blomquist, Niels and Susanne Hougaard Thamsborg (2010), Global Imbalances – a Threat to the Upswing?, Danmarks Nationalbank, Monetary Review, 3rd Quarter.

Dickens, William T., Lorenz Goette, Erica L. Groshen, Steinar Holden, Julian Messina, Mark E. Schweitzer, Jarkko Turunen and Melanie E. Ward (2007), How Wages Change: Micro Evidence from the Inter- national Wage Flexibility Project, Journal of Economic Perspectives, Vol. 21, No. 2.

European Commission (2009), Quarterly Report on the euro area, March.

Freund, Caroline L. (2000), Current Account Adjustment In Industrialized Countries, Board of Governors of the Federal Reserve System, Inter- national Finance Discussion Papers, Vol. 692.

Kohlhas, Alexandre N. and Erik F. Nielsen (2010). Goldman Sachs, European Weekly Analyst, No. 10/33.

IMF (2010), Euro Area Policies, Staff Report for the 2010 Article IV Consultation with Member Countries, July.

Jaumotte, Florence and Piyaporn Sodsriwiboon (2010), Current Account Imbalances in the Southern Euro Area, IMF Working Paper, No. 139.

Samuelson, Paul (1964), Theoretical notes on Trade Problems, Review of Economics and Statistics, Vol. 23.

Schmillen, Achim (2010), Are Wages Equal Across Sectors of Production?, Osteuropa-Institut Regensburg, Working Papers, No. 285.

Sinn, Hans-Werner (2010), Rescuing Europe, CESifo Forum.

Monetary Review - 4th Quarter 2010

Strengthened Economic Governance in the EU

Thomas Pihl Gade and Jesper Ulriksen Thuesen, Economics

INTRODUCTION AND SUMMARY

Developments in the government deficits and government debt of the EU member states have had a major impact on the way the economic and financial crisis has evolved in the EU. It has become evident that the current framework for economic governance has not been sufficient. This applies especially – but not only – to the fiscal ground rules laid down in the Treaty and the Stability and Growth Pact, SGP. In March, the European Council set up a Task Force chaired by its President, Herman Van Rompuy, to investigate the need to strengthen economic governance in the EU, including in particular the need to improve budget discipline. In October, the Task Force submitted its final report to the European Council, which endorsed its recommendations. At the same time, the European Commission has been preparing concrete proposals for the necessary new regulation. On 29 September the Commission presented its proposals, which are the formal basis for the ongoing negotiations on the new framework. This article provides an overall description of the contents of the Commission proposals and their interaction with the Task Force recommendations. The focus is mainly on fiscal ground rules. The negotiations are currently in progress and potentially significant issues still need to be resolved. Nevertheless, a picture is emerging of a clear improvement of economic cooperation and a much stronger framework for fiscal discipline in the EU. Especially economic governance in the euro area will be strengthened and will include better analyses of macroeconomic imbalances and tightening of enforcement measures under the SGP. But it should be borne in mind that neither tighter surveillance nor more severe sanctions are guarantees of fiscal discipline. There will still be national fiscal auton- omy within the EU, and ultimately it will hinge on political will whether member states observe the fiscal rules in future. Monetary Review - 4th Quarter 2010

Since Denmark does not participate in Stage 3 of EMU – the single currency – only part of the strengthened framework for economic governance will apply to Denmark. Being an ERM II member state, Denmark would benefit from being subject to the same rules as the euro area member states. In any case, a strengthening of the framework for economic governance in the EU is assessed to be an advantage for Denmark. The new initiatives represent an important step in the direction of increased economic stability in the EU – and notably in the euro area – and thus for some of Denmark's major trading partners.

OUTLINE OF THE COMMISSION'S PROPOSALS

On 29 September 2010, the Commission presented a package of proposals for new EU regulation that is to ensure new, tighter and more credible rules for economic policy coordination within the EU. The Commission's proposals are based on the existing SGP1 and aims to strengthen the Pact by 1) expanding and clarifying its provisions, 2) equipping it with more effective enforcement instruments and 3) com- plementing it with provisions on national fiscal frameworks. In addition, there are a number of proposals to strengthen economic coordination by introducing a better regime for prevention and correction of macroeconomic imbalances. The Commission's proposals are generally very much in line with the recommendations of the Van Rompuy Task Force. The primary objective is to restore confidence in long-term fiscal sustainability. But there are still a number of outstanding issues that could have a major impact on the credibility and effectiveness of the new rules. In a wider perspective, the proposals from the Commission and the Task Force should be viewed in the context of the Europe 2020 strategy and the establishment of the "European semester", which coordinates all major economic governance mechanisms, including the broad economic policy guidelines and the national reform programmes, cf. Chart 1.

1 Overall, the proposals are a further elaboration on the articles on economic cooperation in the Treaty on the Functioning of the European Union, TFEU, notably Articles 121 and 126. In this context, the new article 136 is taken as the basis for special provisions aimed at euro area member states. The SGP comprises Council Regulation 1466/97/EC (the preventive arm), Council Regulation 1467/97/EC (the corrective arm) and the European Council Resolution of 17 June 1997 on the Stability and Growth Pact. The Regulations were amended in 2005 by Council Regulation 1055/2005/EC and Council Regulation 1056/2005/EC, which were also complemented by the Council's report of 20 March 2005. Monetary Review - 4th Quarter 2010

THE EUROPEAN SEMESTER Chart 1 Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct

The European semester

The The Commission Political Mem ber Political Commission prepares responsibility states res ponsibility pr epa res

Fiscal policy: Council positions on Euro- Submit the stability European Eurogroup programmes group (SGP and TFEU economic policy Stability Pre pares Article 136) Approves report program- contribution mes and positions Economic to annual EU national and Asse ss es eco nomic economic imbalances pre pares The European Euro area reform developments, summit and growth: recommen- Council program- Recommenda- ebrstates member economic mes tions (TFEU dations imbalances and the Articles (July orSeptember) implementation of 121/136) previous Council Approves positions and coun tr y-sp ecific re com mendations. Fiscal policy: recommendations, Council TFEU Article 121 Also assesses Submit position on Ecofin Ecofin (and 136 for euro pro gr es s to wards convergence area member Conver- programmes the economic states) gence (SGP) Ad opts targets and Prepares positions program- de ter mi nes contribution and structural reform to annual EU mes prepares priorities f or the EU economic and Economic recommen- imbalances and the euro area summit national dations

The European Council – annual EU economic summit reform and growth: Non-euro area member states program- Recommenda- mes tions (TFEU Adopts conclusions with guidelines for achieving the economic the targets achieving for Adopts with conclusions guidelines Article 121)

Source: European Commission.

STRENGTHENING THE PREVENTIVE AND CORRECTIVE ARMS OF THE STABILITY AND GROWTH PACT

Together with the Treaty, the SGP is still at the core of EU surveillance of its member states' public finances. The SGP has two arms: the preventive arm includes requirements of government budgets in balance or surplus in the medium term. The corrective arm includes a requirement to correct any excessive budget deficits in member states. The Commission's proposals envisage strengthening both arms of the SGP.

The main proposals for amending the preventive arm of the SGP In principle, the backbone of the preventive arm of the SGP will remain unchanged. The basic requirement will still be that member states should aim for government budgets in balance or surplus. If a member state needs to make adjustments, this should be done within the shortest possible number of years, always observing the medium-term objectives, MTOs, which vary from state to state. The MTOs depend on the magnitude of the adjustments required. In any case, the structural budget balance must always be improved by at least 0.5 per cent of the gross domestic product, GDP, annually during the adjustment process. Monetary Review - 4th Quarter 2010

Among other things, the Commission proposes that member states should observe "prudent fiscal policy making", cf. the European Com- mission (2010e). This means that growth in government spending must normally not exceed the estimated average annual GDP growth in the medium term. Increases in government spending beyond this growth rate must be offset by discretionary increases in government revenue, and likewise discretionary decreases in government revenue must be matched by cuts in government spending. A member state that does not observe its MTOs will be subject to even more stringent requirements to curb growth in government spending. The prudent fiscal policy making proposal is elaborated on in Box 1.

THE COMMISSION'S PROPOSAL FOR PRUDENT FISCAL POLICY MAKING Box 1

For each member state, a prudent estimate must be made for average GDP growth in the medium term. The estimate is based on 10-year projections to be updated on a regular basis. The estimate is applied to the provisions listed below. The structure of a member state's fiscal policy must observe the following requirements: • For a member state that observes its MTO, the basic rule is that annual growth in government spending must not exceed the estimated average annual GDP growth, cf. above, unless the excess spending is matched by discretionary increases in government revenue. • For a member state that does not yet observe its MTO, annual growth in government spending must not exceed a predetermined growth rate, which is lower than the estimated average annual GDP growth, unless the excess spending is matched by discretionary increases in government revenue. The "permitted" growth in government spending must allow for the necessary correction with a view to meeting the MTO. • Discretionary reductions of government revenue items must be matched by either reductions in spending or discretionary increases in other government revenue items (or both).

One of the aims of the prudent fiscal policy making rule is to ensure that unexpected (not budgeted for) government revenue is used for debt reduction rather than for increased government spending. When assessing whether the requirements have been met, the Council will have to take into account whether major structural reforms have been implemented that could help to reduce long-term government spending and/or increase the growth potential of the economy. In periods of severe economic downturns of a general nature, member states may be given permission to deviate from these requirements for a limited period of time. If a member state fails to observe the rules, the Commission may issue a warning. In the event of repeated violation, the Council, at the proposal of the Commission, may make a recommendation to the member state. Monetary Review - 4th Quarter 2010

The new prudent fiscal policy making principle will serve as a benchmark for assessing whether a member state's stability or convergence programme meets EU fiscal requirements. In principle, the rules will apply to all member states, irrespective of whether they are inside or outside the euro area. Requirements for euro area member states will be tightened further. A recommendation from the Council may result in sanctions such as an interest-bearing deposit amounting to 0.2 per cent of GDP. This is an entirely new sanction that may come into force under the preventive arm of the SGP, i.e. it may apply even if there is not (yet) an excessive budget deficit in the euro area member state in question. This new sanction for euro area member states is based on the new Article 136 which was introduced by the Treaty of Lisbon. A rule on prudent fiscal policy making can contribute to strengthening fiscal discipline also under the preventive arm of the SGP. The specific formulation of the rule may be discussed in the forthcoming negotiations, but in any case it is positive that focus is on responsible management of government spending and that the rules will apply to all member states.

The main proposals for amending the corrective arm of the SGP As regards the corrective arm of the SGP, the Commission also envisages maintaining the basic principles and adding new proposals to the existing set of rules so as to tighten the rules and strengthen enforcement. The most significant amendment will be that long-term fiscal sustainability will be taken more into account than previously. This is mainly achieved by increasing focus on the size and composition of the government debt and interaction between debt and budget deficit. Whereas the practical implementation of the SGP previously mostly focused on the requirement of government budgets in balance or surplus and the reference value of 3 per cent of GDP for the government deficit, the reference value of 60 per cent of GDP for government debt will now come much more into focus. Assessments of the impact of the debt will be considered, both when deciding whether an excessive budget deficit exists – and thus whether the Excessive Deficit Procedure, EDP, should be initiated – and when assessing whether a member state observes the Council's recommendations and decisions1 in relation to reducing an excessive budget deficit. The Commission proposes that, as a main rule,

1 The Council may adopt recommendations or decisions. A recommendation is not legally binding on a member state, while a decision is legally binding in all details for the member state(s) concerned. Monetary Review - 4th Quarter 2010

68 debt reduction is deemed to be sufficient if the difference between the debt (as a percentage of GDP) and the reference value of 60 per cent of GDP – measured over the most recent three-year period – has been reduced by 1/20 annually, cf. the European Commission (2010c). Again, the Commission's proposals are much in line with the recommendations of the Task Force, although the latter does not recommend a specific target for debt reduction, but simply states that such a target should be laid down in subsequent legislation. The less precise recommendations of the Task Force reflect how a number of member states with high debt ratios have been unwilling to accept a numeric measure that could potentially tighten the requirements for fiscal consolidation beyond the MTOs currently in place, which will already require a large effort in the current situation. Enforcement measures are also to be strengthened under the corrective arm of the SGP – but only for euro area member states. This is achieved by retaining the existing regime and adding new sanctions. As a new element, the Commission proposes that, as soon as an excessive budget deficit formally exists, a euro area member state must in principle make a non-interest-bearing deposit of 0.2 per cent of GDP. This deposit may later be converted into a fine if the euro area member state does not comply with subsequent recommendations from the Council to correct the excessive budget deficit.1 For both the preventive and corrective arms of the SGP, it will be stipulated that special circumstances may apply, including strong cyclical downturns and crises, and that such circumstances must be taken into account when assessing whether member states meet their obligations.

Economic sanctions: a brand new voting mechanism entailing potentially large transfers As a special measure, the Commission envisages a reverse voting mechanism for decisions relating to economic sanctions – under both the preventive and corrective arms of the SGP, cf. the European Commission (2010c and 2010e). This means that any proposals made by the Com- mission concerning economic sanctions in the form of interest-bearing deposits, non-interest-bearing deposits and fines will be deemed to have been adopted unless the Council within 10 days rejects the Commission's

1 The 0.2 per cent of GDP corresponds to the fixed part of the amount to be deposited under the existing EDP. This procedure may still be escalated by a variable part if the member state fails to comply with obligations to reduce its budget deficit. Any additional deposits will be equal to 1/10 of the difference between the budget deficit measured as a percentage of GDP and the reference value of 3 per cent of GDP. The upper limit for deposits will be 0.5 per cent of GDP. Under the existing procedure, deposits may also be converted into fines if the member state has not complied with the Council's recommendation to reduce the excessive budget deficit after two years. Monetary Review - 4th Quarter 2010

69 proposal by a qualified majority. The new voting mechanism is also recommended by the Task Force. The proposed new voting mechanism is a significant element of both the Commission's and the Task Force's proposals to enhance the enforcement measures by increasing automatism, thereby strengthening the expectations that the sanctions will actually be applied. In contrast, the current economic sanctions have not been applied in practice, not even in the case of Greece. In practice the greater part of the economic gain for a member state conducting a sustainable fiscal policy and observing the rules of the SGP will be reflected in lower yields on issuance by the member state in question. In addition to the economic incentive directly contained in the new enforcement regime, the distribution of any income from non-interest- bearing deposits and fines provides a further economic incentive for member states to observe the rules. This incentive is larger for small than for large member states. Under the Commission's proposals – and in line with the current rules – income from non-interest-bearing deposits and fines is to be distributed among the euro area member states that are not subject to the EDP in proportion to their gross national product, GNP. Hence, in the current situation in which Luxembourg and Estonia from 1 January 2011 are the only euro area member states not subject to the excessive deficit procedure, assuming the extreme case in which all other euro area member states are fined 0.2 per cent of GDP1, Luxem- bourg and Estonia would receive income of 31 and 43 per cent of their respective GDPs. The asymmetry can be illustrated by substituting Ger- many and France for Luxembourg and Estonia. A similar calculation would transfer approximately 0.2 per cent of their respective GDPs to Germany and France. The introduction of a higher degree of automatism – including the reverse voting mechanism and expectations of economic sanctions for euro area member states as soon as an excessive budget deficit is discovered – will represent a step in the direction of ensuring more effective implementation of the SGP.

Inclusion of EU budgetary funds in the enforcement regime As outlined above, the expansion of the economic sanctions will initially apply to euro area member states only. The new provisions are based on

1 A non-interest-bearing deposit will, however, only be converted into a fine if the Council, at the recommendation of the Commission, decides that the member state in question has not taken efficient steps to reduce its excessive deficit. Furthermore, the fine may, according to the Commission proposal, be reduced or waived completely in extraordinary circumstances. Monetary Review - 4th Quarter 2010

70 the new Article 136 of the Treaty of Lisbon; this Article applies to euro area member states only. Both the Commission and the Task Force are in favour of ultimately expanding the economic sanctions to also include various parts of the payments from the EU's budget, cf. the European Commission (2010b) and the Task Force established by the March 2010 European Council (2010). This could be done in connection with future negotiations on the EU's multi-annual budgetary framework, known as the financial perspectives. However, neither the Commission's proposals nor the recommendations from the Task Force include specific sugges- tions in this respect. Therefore it remains uncertain which elements of the EU budget might be included and if so under which conditions1. But it is clear that the economic sanctions can be applied to euro area member states only and thus cannot affect e.g. individual persons or companies receiving EU funding – even if such funding is managed by member states. It will also be a condition that the sanctions are in harmony with the objectives of the EU policy area, e.g. EU structural funds, from which the budgetary funds are taken.

Transition to the new regime There will be a number of challenges linked to the transition to the new regime. Neither the Commission nor the Task Force specifies how the new rules are to be implemented in the current situation when most member states are already subject to the EDP. For instance, it is still an open question whether the rules can be introduced with partial retro- active effect, e.g. by imposing the new sanctions on member states that do not – under the coming rules – observe requirements laid down under the existing rules.

TIGHTER REQUIREMENTS FOR THE NATIONAL FISCAL FRAMEWORKS OF MEMBER STATES

An important element of especially the Commission's proposals is to lay down a number of specific requirements and minimum standards for the national fiscal frameworks of member states, i.e. the conditions for conducting fiscal policy in each member state and the possibilities for surveillance by outsiders, including the Commission, cf. the European Commission (2010d). While it is envisaged that the other elements of the Commission's proposals be implemented by way of regulations (which apply directly in all member states), the requirements for national fiscal frameworks are

1 Under Protocol 15 of the Treaty this will not apply to the UK. Monetary Review - 4th Quarter 2010

OUTLINE OF THE COMMISSION'S PROPOSALS FOR NATIONAL FISCAL FRAMEWORKS Box 2

• Numerical targets and rules that are in compliance with the EU rules. Effective measures must be in place to monitor whether the numeric rules are observed – this might be done by, say, an independent national institution – and the consequences in the event of non-compliance must be defined. • The national rules must include a multi-annual planning horizon that is in accordance with the MTOs of the member states under the EU provisions. • Standards for public accounting systems and their quality, applying to all parts of the public sector. • Standards for the quality, audit and transparency of fiscal statistics. • Standards for the quality of macroeconomic and budgetary projections. For example, alternative macroeconomic scenarios must be applied, and deviations from the Commission's forecasts must be explained. Furthermore, it must be ensured that the methodologies and assumptions applied are transparent. • Regular reassessment of macroeconomic and budgetary projections.

Source: European Commission (2010d). to be implemented via a directive (which must be transposed into national legislation). The rules will apply to all member states. The Com- mission's proposals are outlined in Box 2. Some of the proposals relate to very basic issues such as efficient government accounting systems, audits and reliable statistics, reflecting the lessons learned from the case of Greece, among others. Others have a broader focus in terms of improving fiscal discipline by consistently introducing national rules that reflect the member states' obligations within the EU. Strong forces – headed by Germany – have argued that it is necessary to anchor the EU provisions on fiscal discipline in national legislation.

INCREASED SURVEILLANCE AND PREVENTION AND CORRECTION OF MACROECONOMIC IMBALANCES

Already in connection with the preliminary report by the Task Force to the European Council in June, the European Council made it clear that macroeconomic surveillance was to be strengthened, and that special consideration should be given to the situation of the euro area member states, cf. the European Council (2010b). The European Council thus signalled that the new set of rules would make an even greater distinction between euro area and non-euro area member states. The Commission's proposals for prevention and correction of macroeconomic imbalances, cf. the European Commission (2010f and 2010h), are structured as a "light" version of the Stability and Growth Pact Monetary Review - 4th Quarter 2010

72 applying to all member states. The first part relates to the establishment, under the auspices of the Commission, of an alert mechanism. On the basis of a set of indicators, the Commission is to monitor whether a member state has excessive macroeconomic imbalances. The specific set of indicators and the guideline threshold values are not included in the current proposals, but is evident that the indicators cannot stand alone, and that it will be necessary to make concrete assessments on the basis of the national characteristics of the various member states. Warnings issued by the new European Systemic Risk Board1 may be included as part of the assessment basis. If undesirable macroeconomic imbalances are discovered, the Council may issue a recommendation to the member state in question. If serious imbalances are discovered with a potential adverse effect on EMU, the Council may decide that excessive imbalances exist and order the member state to take remedial action by a given deadline. The member state will thus be subject to the new Excessive Imbalance Procedure, EIP. Under this procedure, as under the EDP, sanctions may be escalated, but they are not as extensive. The Council may adopt recommendations with detailed orders to the member state to implement specific measures to correct the imbalances within a given deadline. The Council may opt to publish its recommendations at a later date. Again, a tighter enforcement regime will apply to euro area member states. If the Council has twice set a deadline for a euro area member state's initiatives to reduce its macroeconomic imbalances and the member state in question continues to disregard the Council's recommendations, an annual fine of 0.1 per cent of the member states' GDP must be imposed. Income from such fines is to be distributed among the euro area member states not subject to the EIP. If the rules on macroeconomic imbalances are not observed, this will also be seen as an aggravating circumstance in connection with the assessment of excessive budget deficits under the SGP. In order to improve the surveillance of measures to correct excessive imbalances, both the Commission and the Task Force also propose that the Commission can conduct missions to individual member states as required. For euro area and ERM II member states, it is proposed that this be done in cooperation with the ECB.

1 The European Systemic Risk Board, ESRB, was formally adopted by the Council on 17 November 2010 following negotiations and approval by the European Parliament. The ESRB will be tasked with oversight of macrofinancial stability in the EU. Monetary Review - 4th Quarter 2010

A PERMANENT CRISIS RESOLUTION MECHANISM

In connection with the escalation of the crisis in the European sovereign debt markets in the first part of 2010, the EU finance ministers on 9 May adopted a temporary crisis resolution mechanism. It primarily comprises the European Financial Stability Facility1, EFSF, for euro area member states, as well as the European Financial Stability Mechanism2, EFSM. These two mechanisms supplement the EU's facility for non-euro area member states suffering balance of payments difficulties3. Part of the Task Force's work was to investigate the opportunities for establishing a permanent crisis resolution mechanism. As early as in March, i.e. before the establishment of EFSF and EFSM, the German finance minister, Wolfgang Schäuble, proposed the establishment of a permanent facility by way of a European Monetary Fund, EMF4. Previously there was by no means agreement on whether – and if so, how – to establish an EMF. Indeed, it does entail a number of challenges. Firstly, an EMF would have to be designed so as to avoid clashing with the no bail-out provisions of the Treaty of Lisbon.5 Right from the outset of the discussions on a single currency it has been a fundamental principle that a member state must not be liable for commitments made by other member states or their respective public authorities. Nor may member states have privileged access to financial institutions. Clear provisions to this effect are Treaty-bound – alongside the prohibition of monetary financing via national central banks. Secondly, the moral hazard issue needs to be addressed. If fiscally squeezed member states have reason to expect that an EMF will ultimately support them, this may weaken the incentives under the SGP that are currently being strengthened. Thirdly, it will be a challenge to determine the conditions6 for loans from an EMF. If the EMF is to be more than simply a loan facility for member states with fiscal problems, the loans must be subject to conditions, as is the case for loans granted by the International Monet- ary Fund, IMF. An EMF will not be able to impose requirements on a euro area member state in relation to monetary and foreign-exchange

1 The decision to establish the EFSF was taken at the Ecofin Council meeting on 9 May 2010. The EFSF has been set up by the euro area member states to finance loans to euro area member states in financial difficulties. The EFSF may raise loans up to a total of 440 billion euro guaranteed by the

2 euro area member states. http://www.efsf.europa.eu/ The decision to establish the EFSM was taken at the Ecofin Council meeting on 9 May 2010. The EFSM has been set up as an EU mechanism to finance loans to EU member states in financial difficulties.

3 The EFSM may raise loans up to a total of 60 billion euro guaranteed under the EU budget. Based on TFEU, Article 143. 4 5 Financial Times, Why Europe's monetary union faces its biggest crisis, 11 March 2010. 6 TFEU, Article 125. In loan programmes often referred to as "conditionalities". Monetary Review - 4th Quarter 2010

74 policy. This in itself eliminates much of the room for manoeuvre compared with the IMF borrowing programmes. Under the SGP, the Council is already empowered to order member states to tighten their fiscal policies and lay down specific values for the size of the annual tightening, as well as related deadlines. As in the case of Greece, the Council may also require a member state to implement fairly specific changes to its national government budget, and requirements in relation to structural policy initiatives have also been set. Moreover, when requirements imposed on a member state under the EDP are included in a decision from the Council, the requirements become legally binding in all details for the member state concerned. As stated above, the provisions of the SGP will now be strengthened further. It is therefore a challenge to determine which type of conditions an EMF may independ- ently impose in connection with its lending activities1. The Task Force discussions gave little result in this respect. In its final report to the European Council in October, the Task Force simply recommended that a permanent crisis resolution mechanism for the euro area be established in the medium term and that solutions be found that do not create moral hazard, while also being founded on stringent credit conditions cf. the Task Force established by the March 2010 European Council (2010). Furthermore, it is mentioned that the potential role of the IMF should be clarified and the possibilities of involving private investors in crisis resolution should be looked into. Such involvement would not take effect until the expiry of the temporary EFSF in 2013. Apart from that, it is merely noted that further clarification of the actual framework for a crisis resolution mechanism for the euro area requires more work2. Since then, more clarity has been achieved. In October, the European Council decided that a permanent crisis resolution mechanism should be established and that this should be done without amending the no bail- out provisions of the Treaty. In December 2010, the European Council will make a final decision on the outline of the new crisis resolution mechanism and the limited amendment to the Treaty that will enable the establishment of a permanent mechanism instead of the current temporary EFSF. Officially, the Commission and the President of the European Council must make the preparatory work in this respect. At the time of the announcement on 28 November of a financial assistance package for Ireland, the Eurogroup also issued a statement providing a more detailed framework for the forthcoming permanent

1 2 The list of challenges presented here is not exhaustive. Several proposals have been presented for the structure of such a crisis resolution mechanism, cf. e.g. Gianviti et al. (2010). Monetary Review - 4th Quarter 2010

75 crisis resolution mechanism, the European Stability Mechanism, ESM. ESM loans will have to be approved by a unanimous Eurogroup. The ESM will be based on the same model as the EFSF. Loans may be granted to distressed euro area member states following negotiations on loan programmes with strict requirements as to the economic recovery plans of the recipient member states. Such programmes will have to be negotiated with the Commission and the IMF in collaboration with the ECB, based on a thorough analysis of the sustainability of the recipient member state's government debt performed by the three institutions. A key element is the involvement of private investors in the future. For this purpose, the prospectuses for all new government bonds issued by euro area member states from June 2013 onwards must contain Collective Action Clauses, CACs. If a member state is unable to honour its payment obligations, CACs will make it considerably easier to conclude agreements on amended payment conditions, e.g. by extending the maturity, changing the yield or cancelling part of the debt. The CACs may stipu- late that such agreements can be concluded by a qualified majority of creditors with binding effect on all creditors. There will be a common standard for the CACs applying to euro area government bonds. Issuance with CACs means that the price of government debt will to a higher degree reflect the relevant country risk. The involvement of the private sector is emphasised in the Eurogroup's statement in that only loans from the IMF will rank before ESM loans in the event that a euro area member state is unable to meet its payment obligations. It is stipulated that the involvement of private creditors will not take effect until mid-2013. According to the Eurogroup's statement, the President of the Euro- pean Council has indicated that his forthcoming proposal to the Euro- pean Council to amend the Treaty will reflect the Eurogroup's ESM proposal. The necessary amendments to the Treaty must be ratified by mid-2013 at the latest, as this is when the EFSF and the EFSM expire.

FUTURE PERSPECTIVES

The Commission's proposal of 29 September 2010 is the formal basis for the coming negotiations on strengthened economic surveillance and cooperation in the EU. In October, the European Council set a target for the Council (Ecofin) and the European Parliament to reach agreement on the new set of rules by the summer of 2011. As stated above, the Commission's proposals for new regulation and the Task Force's recommendations still leave a number of issues to be settled. But it is evident that the proposals and recommendations will Monetary Review - 4th Quarter 2010

76 lead to an even greater gap between the EU member states within and outside the euro area in terms of coordinating economic policies. This is part of a natural and expected development, which has been accelerated by the lessons learned from the existing cooperation during the economic and financial crisis. Since Denmark does not participate in Stage 3 of EMU – the single currency – only some parts of the strengthened framework for economic cooperation will apply to Denmark. It will still not be possible to impose economic sanctions on Denmark in the event of violation of the SGP provisions on excessive budget deficits and debt, or of non-compliance with Council recommendations in connection with the EIP. It is also to be expected that the situation of the euro area member states will attract the greatest attention and resources in connection with coming analyses and assessments of macroeconomic imbalances. Many of the basic elements of the new rules will also apply to Denmark, however. Thus, the Commission's proposed minimum standards for member states' national fiscal frameworks will have to be implemented in Denmark, although most of them are already observed. Being an ERM II member state, Denmark would benefit from being subject to the same rules as the euro area member states. For example, this would further underpin confidence in Denmark's fixed-exchange-rate policy. In any case, strengthening of the framework for economic cooperation in the EU is assessed to be an advantage for Denmark. The new initiatives represent an important step in the direction of increased economic stability in the EU – notably in the euro area – and thus for some of Denmark's major trading partners.

Further tightening – and Treaty amendments? On 18 October 2010 – the day of the last meeting so far of the Task Force – Germany and France issued a joint declaration, cf. the Franco- German declaration (2010). In this declaration, Chancellor Merkel and President Sarkozy expressed Franco-German agreement that the Treaty of Lisbon should be reopened to allow for a permanent crisis resolution mechanism, and to suspend the voting rights of member states that systematically violate the fiscal rules1. These proposals are neither included in the Commission's proposals of 29 September nor in the Task Force's recommendations, both of which focus on possible amendments based on the current Treaty. The Franco-German declaration also ex-

1 In the Franco-German declaration it is proposed that the Task Force should, prior to the European Council in March 2011, prepare concrete options for the establishment of a permanent crisis resolution mechanism. Furthermore, it is proposed that member states must ratify a revised Treaty by 2013. Monetary Review - 4th Quarter 2010

77 pressed agreement that escalation of the EDP must be adopted by the Council (Ecofin) by a qualified majority – that is, with less automatism, and apparently without the reverse voting rule that the Commission and the Task Force recommend for parts of the EDP. Finally, the Franco- German declaration expresses agreement that the European Council should discuss the situation for member states with persistent macroeconomic imbalances. As indicated above, the Franco-German agreement was only partially reflected in the conclusions of the European Council in October: the Treaty was reopened with a view to establishing a permanent crisis resolution mechanism, but the reverse voting mechanism survived, cf. the European Council (2010c). The issue of suspension of voting rights remains unresolved after the European Council in October, despite op- position from many member states and despite the fact that this is likely to require a more fundamental amendment to the Treaty. The Franco-German declaration of 18 October is the most recent result of a number of announcements by these two member states. Especially Germany has regularly urged that the forthcoming rules be sufficiently tight. In Germany's opinion, this would require an amendment to the Treaty. As early as in March 2010, Chancellor Merkel broke a taboo when, speaking to the German Parliament, she emphasised that a Treaty amendment was required to enable the exclusion of member states from the euro area if they repeatedly violated the common fiscal ground rules. Before that, the German finance minister, Wolfgang Schäuble, had, as mentioned above, tabled the proposal to establish an EMF, which was to be combined with new Treaty provisions on the terms and conditions for excluding member states from the euro area. In July, Mr Schäuble and the French finance minister, Christine Lagarde, made a joint contribution to the Van Rompuy Task Force, cf. the Franco-German paper (2010), in which they insisted that if member states violate the fiscal ground rules it should be possible to suspend their voting rights in the Council.1 Hence, there will presumably still be strong forces working to maintain, as a minimum, the tightness of the amendment proposals already presented by the Commission and the Task Force.

1 This would require an amendment to the Treaty. Monetary Review - 4th Quarter 2010

CONCLUDING REMARKS: POLITICAL WILL IS OFTEN THE DECISIVE FACTOR

The political will to observe the rules of the Treaty and the Stability and Growth Pact on sustainable government finances has proved to be insufficient in several cases. The proposals currently on the table envisage a clear improvement of the framework. Whether member states will meet their obligations in future will, however, still depend very much on political will. This means both the EU's political will to enforce the new, tighter rules and the individual member states' political will to comply with the rules. At EU level it will ultimately still be up to the Council (Ecofin), at the recommendation of the Commission, to decide whether a member state is in compliance. Consequently, it will also be a political decision whether economic sanctions are to be imposed on a member state. At national level, it will also ultimately be a question of political will to make the necessary decisions so that the member state can meet its obligations. Monetary Review - 4th Quarter 2010

LITERATURE

European Council (2010a), 25-26 March 2010, Conclusions.

European Council (2010b), 17 June 2010, Conclusions.

European Council (2010c), 28-29 October 2010, Conclusions.

European Commission (2010a), Communication from the Commission […] Reinforcing economic policy coordination, COM(2010) 250, final.

European Commission (2010b), Communication from the Commission […] Enhancing economic policy coordination for stability, growth and jobs – Tools for a stronger EU economic governance, COM(2010) 367/2.

European Commission (2010c), Proposal for a Regulation amending Regulation (EC) No 1467/97 on speeding up and clarifying the implementation of the excessive deficit procedure, COM(2010) 522, final.

European Commission (2010d), Proposal for a Council Directive on requirements for budgetary frameworks of the Member States, COM(2010) 523, final.

European Commission (2010e), Proposal for a Regulation of the Euro- pean Parliament and of the Council on the effective enforcement of budgetary surveillance in the euro area, COM(2010) 524, final.

European Commission (2010f), Proposal for a Regulation of the Euro- pean Parliament and of the Council on enforcement measures to correct excessive macroeconomic imbalances in the euro area, COM(2010) 525, final.

European Commission (2010g), Proposal for a Regulation of the Euro- pean Parliament and of the Council amending Regulation (EC) No 1466/97 on the strengthening of the surveillance of budgetary positions and the surveillance and coordination of economic policies, COM(2010) 526, final.

European Commission (2010h), Proposal for a Regulation of the Euro- pean Parliament and of the Council on the prevention and correction of macroeconomic imbalances, COM(2010) 527, final. Monetary Review - 4th Quarter 2010

European Council (2010), The President, Press remarks by Herman Van Rompuy, President of the European Council following the first session of the European Council, 29 October.

Franco-German Declaration (2010), Statement for the France-Germany- Russia Summit, Deauville, 18 October.

Franco-German Paper (2010), European Economic Governance, a Franco- German paper, 21 July.

German Government (2010), Key proposals to strengthen the euro area, 19 May.

Gianviti, Francois et al. (2010), A European Mechanism for Sovereign Debt Crisis Resolution: A Proposal, Bruegel Blueprint, November.

Task Force established by the March 2010 European Council (2010), Strengthening economic governance in the EU, Final report by the Task Force to the European Council, 21 October.

Monetary Review - 4th Quarter 2010

The Crisis in European Sovereign Debt Markets

Søren Lejsgaard Autrup, Jacob Wellendorph Ejsing and Uffe Mikkelsen, Financial Markets

INTRODUCTION AND SUMMARY

The repercussions of the financial crisis have triggered a sovereign debt crisis in Europe. For the first time in the history of the euro, a euro area member state has been on the verge of default. Extensive and controversial measures have been necessary to maintain financial stability in the euro area. This article describes how such a far-reaching crisis could arise in the European sovereign debt markets. The crisis has hit European sovereign debt markets to different extents and for different reasons. Some countries seemed to have a sound fiscal basis, but the downturn in the property market fed through to their banking systems and real economies. Other countries did not use the economic upswing ahead of the financial crisis to reduce their sovereign debt. They were therefore particularly vulnerable to shocks to the public finances. At first, the financial crisis caused turmoil in the sovereign debt markets. Following a more stable period in 2009, the turmoil escalated in 2010. A bleaker growth outlook and rising interest expenses led to a significant reassessment of fiscal sustainability. A vicious spiral was created where declines in the creditworthiness of sovereign issuers and banks reinforced each other. The establishment of the European Financial Stability Facility, EFSF, and the European Central Bank's purchases of government bonds have bought time, but the situation remains fragile. Long-term stabilisation of the European sovereign debt markets requires ambitious and growth- promoting structural reforms in the individual countries. Even before the sovereign debt crisis, the European countries were facing decades of rising expenditure and declining revenues as a consequence of the ageing population. The crisis has brought forward these challenges. Monetary Review - 4th Quarter 2010

MONETARY UNION AND CONVERGENCE IN GOVERNMENT YIELDS

In the years ahead of and after the introduction of the euro, yields on euro area government securities converged significantly, cf. Chart 1. As was the case for many other financial assets, lower yields and reduced macroeconomic and financial uncertainty caused risk premiums on government securities to narrow markedly. However, government securities markets in the individual euro area member states remained different in terms of size, liquidity, issuer's creditworthiness etc. Many countries did not exploit the economic upswing before the financial crisis to consolidate public finances. After several years of high economic growth, the average level of debt in the euro area was 68 per cent of gross domestic product, GDP, in 2006 – unchanged from 2002. Investors focused more on the prospect that the monetary union would eliminate foreign-exchange risks between the euro area member states and create expectations of low and stable inflation in future. With low interest rates and a positive view on future economic growth, government debt sustainability did not cause widespread concerns. The fact that member states were not forced to consolidate via higher government yields meant that the euro area was very vulnerable to any shocks to the member states' public finances. Such a shock came after the collapse of Lehman Brothers in September 2008.

10-YEAR GOVERNMENT YIELDS FOR SELECTED EURO AREA MEMBER STATES Chart 1

Per cent 13

2 1995 1996 1997 1998 1999 2000 20012002 2003 2004 2005 2006 2007 2008 2009 2010

Germany France Italy Spain Portugal Ireland Greece Note: 10-year par yields. Data for Italy and Greece not available for the entire period. Source: Bloomberg. Monetary Review - 4th Quarter 2010

FINANCIAL CRISIS AND INTENSIFYING PRESSURE ON GOVERNMENT SECURITIES MARKETS

The downturn in the US housing market led to rising uncertainty in financial markets during the summer of 2007. Initially, this uncertainty triggered a flight to safe assets, which for a period benefited the government securities markets. However, the reduced risk appetite also caused some countries' yield spreads versus Germany to widen.

Transfer of risk from the private to the public sector With the adoption of extensive rescue packages for national banking systems in the autumn of 2008, significant risk was transferred from the private to the public sector. The explicit and implicit guarantees for large parts of the financial systems had two effects on sovereign credit risk premiums. Firstly, they led to a shift in the level of the premium that investors had to pay to protect themselves against default. Secondly, the guarantees increased the governments' vulnerability to potential escalation of the crisis, cf. Ejsing and Lemke (2011). At this juncture, the economic crisis had primarily hit Northern and Eastern European countries. Common features of many of these countries were that property prices had soared before the crisis and that credit growth had been high. Many of these countries were considered particularly risky for a while.

Increased focus on deficit and debt After September 2008, focus shifted towards the underlying sustainability of the countries' public finances. Schuknecht et al. (2010) shows that before the crisis yield spreads between EU government securities were primarily driven by a common factor, which is interpreted as global risk aversion. The market reassessed the risk on government securities, and differences in debt and deficits began to have a significantly stronger effect on government yields.

Government securities no longer risk-free During the last months of 2008, the central banks' aggressive rate cuts led to a sharp decline in the general interest-rate level. However, since early 2009, investors have required risk premiums to hold even highly rated government securities. Even Germany – whose government securities had hitherto been viewed as risk-free – saw rising government yields relative to swap rates in this period, cf. Chart 2. Monetary Review - 4th Quarter 2010

10-YEAR SWAP SPREADS FOR SELECTED EURO AREA MEMBER STATES' GOVERNMENT BONDS Chart 2

Basis points

300

250

200

150

100

-50 2007 2008 2009 2010

Germany France Italy Spain Note: Spreads are calculated as the difference between the member states' 10-year zero-coupon yields and the fixed rate on Eonia swaps with the same maturity. Source: Bloomberg, Nordea Analytics and own calculations.

Rising issuance volume in a stressed government securities market Lower tax revenues as a consequence of the recession combined with higher expenditure for financial rescue packages and fiscal stimuli caused the countries' financing requirements to rise sharply from the autumn of 2008. Moreover, issues from many commercial banks were backed by government guarantees. This meant that government issues met increasing competition from non-government issues with high ratings. In spite of the flight to safe and liquid assets, government securities markets were stressed. Spreads between bid and ask prices in the sec- ondary markets were high in the turbulent period. As a result, trading in government securities fell drastically. It became more difficult for governments to issue securities. Consequently, governments issued short-term debt massively from October 2008, cf. Chart 3. This continued for the rest of the year and into 2009. The governments' dependence on access to the market increased as the burden of refinancing grew.

Rising uncertainty and risk of credit rationing Wide fluctuations in demand for government bonds made it difficult to plan issuance activity in early 2009. Investors began to focus on whether Monetary Review - 4th Quarter 2010

NET ISSUANCE OF GOVERNMENT SECURITIES IN THE EURO AREA Chart 3

Billion euro 50

-10

-20 2007 2008 2009 2010 Short-term issues Long-term issues Note: 3-month moving average of seasonally adjusted net issuance from the EU16 countries. Short-term issues have maturities of up to one year. Source: ECB.

governments could finance the increased issuance requirement in the short and medium term. Investors were no longer just worried about the governments' debt fundamentals, but also about their refinancing risks.

EXPANSIONARY MONETARY POLICY AND LOW GOVERNMENT YIELDS

In spring 2009, central banks worldwide introduced extensive unconven- tional monetary policy measures. This reflected that the scope for reducing monetary-policy interest rates was effectively exhausted. The Bank of England purchased almost all of the year's net issuance of government bonds in 2009, while the Federal Reserve primarily purchased mortgage bonds, but also Treasury securities. In contrast, the ECB mainly responded by increasing the volume and maturity of its monetary-policy loans.1

The ECB expands its liquidity facilities With effect from June 2009, the ECB expanded its liquidity facilities by giving the banks access to unlimited liquidity for up to 12 months at a fixed interest rate of 1 per cent. These loans attracted large demand, and as a result most of the ECB's liquidity allotment in the 2nd half of

1 The ECB also purchased covered bonds for 60 billion euro beginning in early July 2009. Monetary Review - 4th Quarter 2010

THE ECB'S LIQUIDITY ALLOTMENTS, 2007-10 Chart 4

Billion euro 1,000

900

800

700

600

500

400

300

200

100

0 2007 2008 2009 2010

All LTROs Weekly liquidity 12-month LTROs Note: Longer-term refinancing operation, LTRO, denotes the Eurosystem's lending with maturities of more than one week. Source: ECB.

2009 and in the 1st half of 2010 consisted of loans with relatively long maturities, cf. Chart 4.

Long-term liquidity and lower short-term government yields After the expansion of the ECB's liquidity facilities, European government securities markets stabilised notably. Risk appetite returned to the financial markets, and the short-term yield spreads on government securities narrowed sharply in the spring of 2009, cf. Chart 5. The ECB's new liquidity facilities gave the banks access to unlimited loan-financed purchase of e.g. government securities. The fixed interest rate on the loans eliminated the funding risk associated with investing in short-term government securities, and the 12-month LTRO paved the way for a significantly longer investment horizon. The ECB (2009) shows that the euro area banks increased their government bond holdings considerably in this period. The Greek 2-year yield spread to Germany had narrowed to 50 basis points by the summer of 2009, and the Spanish yield spread was less than 10 basis points. The ECB's expanded liquidity facilities led to lower refinancing risks for governments. That the government bond yield spreads subsequently narrowed was primarily a consequence of the access to unlimited liquidity and the return of risk appetite to the financial markets. Monetary Review - 4th Quarter 2010

2-YEAR GOVERNMENT YIELD SPREADS TO GERMANY Chart 5

Basis points up to about 1,800 basis points 1,200

1,000

800

600

400

200

0 2008 2009 2010 Denmark Ireland Greece Spain France Italy Portugal Note: 2-year par yields. Source: Bloomberg.

THE SOVEREIGN DEBT CRISIS

Following a prolonged period of recovery, fresh turmoil arose in the European government securities markets in autumn 2009. One of the triggers was that the new Greek government in October 2009 had to revise the Greek budget deficit sharply upwards. In the following months, this caused gradual widening of the Greek yield spread and several downgrades of the country's rating, cf. Box 1.

Fears of Greek default The assessment of the fiscal sustainability in Greece and several other countries quickly changed due to the combination of a rapidly growing deficits and downward revisions of growth expectations. The resultant increase in debt ratio forecasts caused government yields to rise. Via a self-reinforcing effect on deficits, the risk of uncontrollable debt dynamics increased, and investors began to consider Greek sovereign default a real risk. Not even the ECB's expanded liquidity measures and the continued option to use Greek bonds as collateral with the ECB could prevent Greek yields from rising. In step with the accelerated widening of the Greek yield spread in early 2010, increasingly clear signs of contagion to other euro area member states emerged. As the Greek economy accounts for Monetary Review - 4th Quarter 2010

SOVEREIGN CREDIT RATINGS DURING THE CRISIS Box 1

During the crisis, the credit rating agencies have downgraded the GIIPS countries (Greece, Ireland, Italy, Portugal and Spain) several times, cf. Chart 6. The first round came in early 2009. Only Greece has lost its Investment Grade status. When it happened in the 1st half of 2010, Greek yields rose sharply. Of all the euro area member states that have been downgraded, only Ireland and Spain had the highest possible credit rating before the crisis broke out. This shows that the market was informed that the creditworthiness of countries such as Greece and Portugal was lower already before the crisis.

DEVELOPMENT IN SOVEREIGN CREDIT RATINGS DURING THE CRISIS Chart 6

Average of three credit ratings

AAA

BBB Investment Grade status Junk status

BB 2007 2008 2009 2010

Germany, Denmark et.al. Greece Ireland Italy Portugal Spain Note: Average of Moody's, Fitch and Standard & Poor's. Standard & Poor's scale is used. Source: Moody's, Fitch and Standard & Poor's.

The IMF (2010b) focuses on the role of credit rating agencies during the sovereign debt crisis. The IMF finds that credit ratings play an important role by spreading information about issuers and thus provide issuers with access to credit markets. Credit ratings of governments have prediction power as to the ranking of credit risk on governments, but cannot be interpreted as quantitative estimates of e.g. the likelihood of default. Credit ratings provide the basis for collateral requirements and are included in many investors' investment mandate. This means that changes in the credit rating per se can have an effect on yields. In this connection, crisis-stricken countries have criticised the credit rating agencies for downgrading countries facing difficult market conditions.

merely 2.6 per cent of euro area GDP, this contagion was not attributable to real economic mechanisms. It rather reflected uncertainty over the EU's handling of a situation in which Greece would no longer be able to issue government securities. If Monetary Review - 4th Quarter 2010

89 the EU did not help Greece, it would reduce the likelihood that other member states could receive assistance at a later stage. Investors' changing views on the likelihood of a rescue therefore had a knock-on effect on other countries' yield spreads. There were two main risks linked to immediate Greek default. Firstly, there were widespread fears that a Greek default would immediately bar a number of other euro area member states from the international capital markets. The consequences would be difficult to foresee. Secondly, there was a risk that some European banks, whose capital base had already been eroded by the financial crisis, had considerable holdings of government securities issued by the GIIPS countries.1 There were fears that new substantial losses just 18 months after the collapse of Lehman Brothers could lead to renewed destabilisation of the financial system.

Rescue packages from the EU and the IMF Different views on the balancing of acute risks and consideration for the monetary union's underlying principles gave rise to contradictory announcements from the euro area member states' governments for a long period. In this phase, doubts arose about the cohesion of the euro area among market participants, which contributed to widening of yield spreads and substantial weakening of the euro. In the context of the escalating market turmoil, the EU and the International Monetary Fund, IMF, reached agreement on an extensive financial rescue package for Greece in April 2010. However, this was not sufficient to dampen market turmoil, and in early May it spread beyond Europe and contributed to sharp stock market declines. Against this backdrop, representatives from EU governments and the IMF agreed on far-reaching financial guarantees over the weekend of 8 and 9 May.2 Furthermore, on 10 May, the ECB took the controversial step of inter- vening via direct purchase of government securities from member states with high yield spreads. The weekly purchases were considerable in the first weeks, cf. Chart 7. Since early July, the ECB's purchases have decreased considerably, though. The announcement of the rescue package for the euro area and the ECB's purchases of government securities initially put a damper on both short- and long-term yields in the most exposed euro area member

1 2 The GIIPS countries are Greece, Ireland, Italy, Portugal and Spain. For a detailed description of the EU and IMF initiatives, see Danmarks Nationalbank (2010). Monetary Review - 4th Quarter 2010

THE EUROSYSTEM'S PURCHASES OF GOVERNMENT BONDS Chart 7

Billion euro Billion euro 17.5 70

15.0 60

12.5 50

10.0 40

7.5 30

5.0 20

2.5 10

0.0 0 May 10 Jun 10 Jul 10 Aug 10 Sep 10 Oct 10 Nov 10

Weekly purchases Accumulated purchases (right-hand axis) Source: ECB.

states. The stress test of the European banks in July 2010 also had a certain soothing effect on markets.

Ireland the next country that needed help Since August 2010, yield spreads for e.g. the GIIPS countries have widened again. The turmoil in the Irish sovereign debt market escalated when the Irish Department of Finance on 30 September announced that the 2010 budget deficit would come to around 32 per cent of GDP due to expenditure for crisis-stricken Irish banks. The banks could not fund themselves in the market and were dependent on liquidity from the ECB. It became clear that Ireland once again needed to inject capital into the financial sector. There was strong pressure on Ireland to enter into negotiations with the EU and the IMF due to contagion to other countries. In November, Ireland reached agreement with the EU and the IMF on an 85 billion euro rescue package, of which the Irish government contributes 17.5 billion euro from the national pension fund and a cash reserve. Drawing on the EFSF has thus already been necessary. The mere existence of the facility was not enough to calm investors. The rescue of Ireland has not stabilised European sovereign debt markets notably. There are widespread concerns that Ireland will not be the last country in the euro area in need of external help. Monetary Review - 4th Quarter 2010

REASONS FOR AND POTENTIAL WAYS OUT OF THE CRISIS

The financial crisis and the ensuing recession have seriously eroded many European countries' public finances, cf. Chart 8. The countries have been affected to different extents and for different reasons, cf. Box 2. Some apparently had a sound fiscal basis, but especially the collapse of the property markets fed through to the banks and the real economy. Other countries had failed to benefit from the economic upswing before the financial crisis to reduce their debt and were therefore particularly vulnerable to shocks to their public finances. Rising government yields have in some countries been self-reinforcing due to the effect on expected future deficits. Moreover, the declines in the creditworthiness of sovereign issuers and banks have been mutually reinforcing. The escalating yield spreads in the euro area in 2010 have underlined how suddenly these mechanisms can cut off a member state's access to capital markets.

Acute problems and substantial short-term financing requirement The European countries are facing continued large deficits in the years ahead. Major obligations fall due and are to be refinanced as the governments have to a higher degree than previously relied on short- and medium-term financing. The continued dependence on access to

DEBT AND DEFICITS OF SELECTED COUNTRIES, 2002-11 Chart 8

EMU debt, per cent of GDP 160 2011 140

2011 120 2002 2002 100 2011

2011 2011 80 2011

2011 2002 60 2002 2011 2002 2002 40 2002

20 Stability and Growth Pact 0 -18 -15 -12 -9 -6 -3 0 3 6 Budget balance, per cent of GDP Euro area Germany France Greece Italy Spain Ireland Denmark Note: Data for 2010-11 are forecasts and are illustrated as the dashed part of the graphs. The Irish deficit forecast for 2010 is 32 per cent of GDP. Source: European Commission's autumn forecast, November 2010. Monetary Review - 4th Quarter 2010

92 the market is therefore a significant risk factor. Furthermore, banks will have to refinance major obligations in the years ahead, including government-guaranteed issues. If market conditions deteriorate, it could be a challenge for the market to absorb the rising total issuance volumes. The EU's financial stabilisation packages and the ECB's purchase of government securities have so far prevented acute refinancing problems.

CO-VARIATION IN EUROPEAN GOVERNMENT YIELDS Box 2

Before the collapse of Lehman Brothers, there was close co-variation in government yields in the euro area, cf. Chart 9 (left).1 In the following period, the distances increased, cf. Chart 9 (right). A group of euro area member states, including France, the Netherlands, Austria and Spain continued to have relatively short distances to Germany. The assessment of the systemic risk in the financial sector was of crucial importance to developments in the markets for government securities. Thus, Ireland and some Nordic countries had large banking sectors and approved extensive government guarantees at an early stage. Against this backdrop, the distance to Germany increased – especially for short-term government bonds. The necessity of defending the Danish krone also had a strong impact on the Danish market for government securities in this period.

CO-VARIATION IN EUROPEAN GOVERNMENT BOND MARKETS, 2007-09 Chart 9

Mid-2007- mid-Sep 2008 Mid-Sep 2008 - Mar 2009 Belgium Belgium UK Denmark UK Denmark Sweden Finland Sweden Finland

Spain France Spain France

Portugal Greece Portugal Greece

Austria Netherlands Austria Netherlands 10Y Norway Ireland Norway Ireland 10Y 2Y Italy Italy 2Y

In the period after the turning point in the financial markets around April 2009, distances between European government securities markets remained large, cf. Chart 10 (left). However, short-term government bond spreads to Germany narrowed markedly compared with the period of acute financial turmoil. Investors' concerns gradually shifted towards Southern Europe, and the Nordic region was increasingly seen as a safe haven. From the end of 2009, the government securities market in the euro area was no longer homogeneous, cf. Chart 10 (right). Yields in the GIIPS countries and Belgium actually developed in the opposite direction of German yields. The Nordic region was generally favoured by a starting point with low debt due to consolidation before the crisis. The risk sentiment towards the Nordic region had improved significantly, and – in line with Germany – the region was considered safe. Despite having its own currency, Denmark became the government securities market that co-varied most closely with the German market. Monetary Review - 4th Quarter 2010

CONTINUED Box 2

CO-VARIATION IN EUROPEAN GOVERNMENT BOND MARKETS, 2009-10 Chart 10

Apr 2009 - Oct 2009 Nov 2009 - Nov 2010 Belgium Belgium UK Denmark UK Denmark

Sweden Finland Sweden Finland

Spain France Spain France

Portugal Greece Portugal Greece

Austria Netherlands Austria Netherlands

10Y Norway Ireland Norway Ireland 10Y 2Y Italy Italy 2Y

1 A short distance to the centre indicates high positive correlation between yield changes in the relevant country and Germany. Weekly yield changes are calculated on the basis of maturity-adjusted par yields. Germany is used as benchmark, as German government securities are usually viewed as the most liquid and safest government securities in Europe.

The short-term rescue measures have merely bought the crisis-ridden countries time to implement fiscal tightening and structural reforms.

How do we avoid new sovereign debt crises? The Stability and Growth Pact criteria were not met in the period ahead of the crisis when a number of countries systematically pursued irrespon- sible fiscal policies. To encourage them to comply with the provisions of the Stability and Growth Pact in future, it is necessary to strengthen it with more automated and credible sanction mechanisms. In October, the European Commission presented proposals for new fiscal rules, cf. the article on page 63. In addition to credible political sanctions, it is essential that market discipline towards member states that pursue unsustainable fiscal policies is sharpened. Higher government yields will intensify the pressure to consolidate before debt spirals out of control. The low yield spreads before the crisis indicated that investors did not see sovereign default in a euro area member state as a real risk. To make market discipline work in future, this perception will have to change. So far, financial rescue packages have prevented private investors from incurring losses on euro area government bonds. However, particularly Germany has argued for involving private investors in connection with any future restructuring of euro area member states' debts. Concurrently with the presentation of the rescue package for Ireland on 28 November, euro area ministers of finance tabled a proposal that all government bond issues in the euro area from June 2013 contain Collective Action Clauses. These clauses are to ensure that a qualified Monetary Review - 4th Quarter 2010

94 majority of creditors can negotiate debt restructuring on behalf of all creditors. The aim is for any future restructuring to proceed faster and with greater transparency. Thus, the systemic risks are reduced, and the involvement of private investors becomes a real alternative to further financial assistance from other member states. The proposal only concerns bonds issued from June 2013. The wide yield spreads suggest that investors still consider losses on existing loans likely.

Long-term challenges persist – and have been brought forward The crisis has brought forward the challenge of ensuring fiscal sustainability in the long term. Even before the sovereign debt crisis, the European countries were facing decades of rising expenditure and declining revenues as a consequence of the ageing population, cf. Dan- marks Nationalbank (2010). The serious budget deterioration in recent years has caused this challenge to increase markedly. The only road to long-term stabilisation of European sovereign debt markets therefore seems to be ambitious and growth-promoting structural reforms in the individual member states. Monetary Review - 4th Quarter 2010

LITERATURE

Attinasi, Maria-Grazia, Christina Checherita and Christiane Nickel (2009), What explains the surge in euro area sovereign spreads during the financial crisis of 2007-09?, ECB Working Paper, No. 1131.

Cecchetti, Stephen G., M. S. Mohanty and Fabrizio Zampolli (2010), The future of public debt: prospects and implications, BIS Working Paper, No. 300.

Christensen, Jakob Ekholdt and Rasmus Tommerup (2010), Fiscal Challenges in Advanced Countries, Danmarks Nationalbank, Monetary Review, 2nd Quarter.

Danmarks Nationalbank (2010), Monetary Review, 2nd Quarter.

Ejsing, Jacob and Wolfgang Lemke (2011), The Janus-headed salvation: Sovereign and bank credit risk premia during 2008-09, Economic Letters, Vol. 110, No. 1.

ECB (2009), Monthly Bulletin, September.

Gilmore, Claire G., Brian M. Lucey and Marian W. Boscia (2010), Co- movements in government bond markets: A minimum spanning tree analysis, Physica A, Vol. 389, No. 21.

IMF (2010a), Global Financial Stability Report, April.

IMF (2010b), Global Financial Stability Report, October.

Schuknecht, Ludger, Jürgen von Hagen and Guido Wolswijk (2010), Government bond risk premiums in the EU revisited: the impact of the financial crisis, ECB Working Paper, No. 1152.

Sgherri, Silvia and Edda Zoli (2009), Euro area sovereign risk during the crisis, IMF Working Paper, No. 222.

Monetary Review - 4th Quarter 2010

Basel III: Macroprudential Regulation by Means of Countercyclical Capital Buffers

Mads Peter Pilkjær Harmsen, Financial Markets

INTRODUCTION AND SUMMARY

The financial crisis revealed that the financial system was insufficiently capitalised to withstand a period of high losses. One reason is that the regulation of the banking sector did not, to the extent necessary, take into account systemic risk, i.e. the risk of events that prevent the financial system from functioning as an efficient provider of capital and financial services to such a degree as to significantly affect economic growth and welfare. Experience from the crisis has shown that regulation based on strengthening the resilience of individual credit institutions, or microprudential regulation, is inadequate. In future, regulation will also be based on risks in the financial system as a whole, also known as macroprudential regulation. The future capital-adequacy rules, Basel III, will impose more rigorous requirements with a view to ensuring a future, more robust financial system, including a higher capital requirement, better quality of Tier 1 and Tier 2 capital, and the introduction of statutory buffers in excess of the capital requirement. In addition, the introduction of an additional capital requirement for systemically important institutions is being considered. The objective of macroprudential regulation is to limit systemic risk, as periods of financial instability have large social costs. One measure is the introduction of a countercyclical capital buffer with the primary purpose of ensuring that credit institutions hold enough capital to weather periods of being simultaneously hit by high losses. The buffer is to be built up in good times, when systemic risk is mounting, and it is to be reduced in bad times. The actual build-up phase in good times is likely to dampen credit growth, and the buffer will therefore reduce the build- up of systemic risk. An indicator of the effect of the new capital requirements and the buffer is whether they would have improved the capitalisation of the Danish banking sector at the onset of the financial crisis. According to the Basel Committee's proposal, aggregate credit as a ratio of the gross Monetary Review - 4th Quarter 2010

98 domestic product, GDP, is to form the basis for determination of the size of the countercyclical capital buffer. In Denmark, this ratio has been a good indicator of both the Nordic banking crisis in the late 1980s and the early 1990s and the financial crisis. The analysis shows that if the new rules had been fully implemented, the banking sector would have been better capitalised, and the buffers to absorb losses would have been higher at the onset of the crisis.

BASEL III1

The purpose of the future Basel III rules is to strengthen the resilience of the financial system to periods of economic and financial stress, thereby supporting economic growth and stability. This is achieved through a combination of higher capital requirements, narrower capital definitions, better risk coverage (including liquidity risk and trading book risk), and the introduction of a maximum leverage ratio for credit institutions and of capital buffers. The common equity requirement is raised from 2 per cent of risk-weighted assets to 4.5 per cent; the Tier 1 capital requirement is raised from 4 to 6 per cent, while the Tier 2 capital requirement remains unchanged at 8 per cent of risk-weighted assets, cf. Chart 1. The introduction of a capital buffer in excess of the capital requirement is a new measure. It consists of a fixed element – the capital conservation buffer – and a variable element – the countercyclical capital buffer. The capital conservation buffer has been set at 2.5 per cent of risk-weighted assets, and the countercyclical buffer will be set within the range of 0 to 2.5 per cent. Thus the total buffer will be 2.5 per cent in normal times and may be built up to 5 per cent in times of excess credit growth. The purpose of the capital buffer is to ensure that the credit institutions hold capital in excess of the capital requirement that can absorb losses in periods of stress. If an institution fails to comply with the capital buffer, it will become subject to dividend payment restrictions. This is in contrast to the capital requirement which must be complied with at all times if the institution is to continue operations. Basel III will be phased in over the period 2013-23. The higher capital requirements will be phased in from 2013 to 2015, while the capital buffer will be phased in from 2016 to 2018. In case of excessive credit growth, the phase-in of the capital buffer may be speeded up. The new,

1 The exact structure of the regulation is not currently known. The description of the Basel III rules and the countercyclical capital buffer is based on the thoughts of the Basel Committee described in Basel Committee on Banking Supervision (2010a and b). Monetary Review - 4th Quarter 2010

CAPITAL REQUIREMENTS UNDER BASEL II AND BASEL III Chart 1

Per cent of risk-weighted assets 14

0 Basel II Basel III Basel II Basel III Basel II Basel III Common equity Tier 1 capital Total capital Fixed buffer Fixed buffer Fixed buffer Variable buffer Variable buffer Variable buffer Note: Common equity is comprised by the definition of Tier 1 capital, and Tier 1 capital is comprised by the definition of total capital. Thus, the calculation of Tier 1 capital comprises common equity, and common equity and Tier 1 capital are comprised by total capital. At present, it has not been determined whether the capital buffer will be implemented for all types of subordinated capital (illustrated) or only for capital of the highest quality, i.e. common equity. Source: Basel Committee on Banking Supervision (2010b).

narrower definitions of Tier 1 and Tier 2 capital will be phased in by 2023.1

Determining and releasing countercyclical capital buffers Countercyclical capital buffers must be built up when systemic risk is building up in the financial system. The gap between the aggregate credit-to-GDP ratio and its trend will play a key role in determining the buffer.2 In Denmark, the gap has varied considerably over time, peaking in the periods up to the Nordic banking crisis in the late 1980s and early 1990s and up to the present crisis, cf. Chart 2. The countercyclical buffer will be implemented when the gap between the credit-to-GDP ratio and its trend reaches a certain level. The total capital buffer thus increases in step with the gap, until it reaches a certain level where the countercyclical buffer peaks at 2.5 per cent of risk-

1 For example, Tier 1 capital must have neither a maturity date nor an incentive to redeem it. At the same time, Tier 1 capital must have full flexibility of dividend payments. Such payments will be considered a distribution of earnings under the capital buffer. See also Basel Committee on Banking Supervision (2009). 2 Detken and Smets (2004) show that periods during which the aggregate credit-to-GDP ratio exceeds a certain level are often followed by financial slowdown and economic downturn. Borio and Lowe (2004) also show that the development in the aggregate credit-to-GDP ratio is the best indicator of financial instability. Pedersen and Sørensen (2009) examine changes in asset prices, debt, fiscal policy and lending in Denmark in the period up to the financial crisis. Monetary Review - 4th Quarter 2010

100

AGGREGATE CREDIT-TO-GDP RATIO IN DENMARK Chart 2

Per cent of GDP Percentage points 300 40

250 30

200 20

150 10

100 0

50 -10

0 -20 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 Deviation from trend (right-hand axis) Aggregate credit-to-GDP ratio Aggregate credit-to-GDP ratio trend Note: Quarterly data for lending by banks and mortgage banks as a ratio of GDP. The trend is calculated recursively using a Hodrick-Prescott filter with a high smoothing parameter (lambda = 400,000), cf. Detken and Smets (2004). The first 32 quarters are applied to initialise the trend, which is then calculated recursively by adding one quarter at a time. Source: Statistics Denmark and own calculations.

weighted assets.1 However, according to the Basel Committee on Bank- ing Supervision (2010a), focusing on the credit-to-GDP ratio alone is not enough to ensure that the buffer is always built up in a timely manner, and other indicators should therefore be taken into account when determining its size. The countercyclical capital buffer should be released when systemic risk diminishes again, either because it materialises or because the credit-to-GDP ratio falls back to its trend without a crisis. The buffer can be released at once or gradually.

Sanctions in case of non-compliance with the buffer The capital buffer is added on top of the minimum capital requirement and a possible additional individual capital need under Pillar 2. Institu- tions that meet the capital buffer requirement will have a certain margin to the capital requirement. The buffer is therefore expected to reduce the risk that an institution changes from being a "going concern" to being a "gone concern".

1 In the Basel Committee's proposal, the build-up of the countercyclical capital buffer begins when the gap between the credit-to-GDP ratio and its trend exceeds 2 per cent, and the buffer reaches its maximum level when the gap is 10 per cent. Monetary Review - 4th Quarter 2010

101

POSSIBLE CALIBRATION OF THRESHOLDS FOR SANCTIONS IN CASE OF NON- COMPLIANCE WITH THE BUFFER REQUIREMENT Table 1

Percentage of the total required capital buffer by which an Minimum capital conservation rate institution's capital exceeds the capital requirement (as a percentage of earnings)

0-25 per cent ...... 100 per cent 25-50 per cent ...... 80 per cent 50-75 per cent ...... 60 per cent 75-100 per cent ...... 40 per cent More than 100 per cent ...... 0 per cent

Note: The minimum capital conservation rate indicates the proportion of the surplus that is to be withheld with a view to capital buffer build-up. The figures are for illustrative purposes only and do not represent any proposed calibration. Source: Basel Committee on Banking Supervision (2010a).

In case of non-compliance with the requirements entailed by the capital buffer, an institution will be subject to restrictions on distribution of profits in the form of bonus payments, dividend payments, share buy- backs, etc. The closer the institution's capital ratios are to the capital requirement, the tighter the restrictions will be, cf. Table 1. For example, 40 per cent of the institution's earnings must be retained if it is in the top quartile of the buffer zone, while all earnings must be retained if it is in the bottom quartile of the buffer zone. The distribution restrictions on the institution will not be lifted until its capital exceeds the buffer requirement. From the time when an institution no longer meets the requirements set by the capital buffer, it has 12 months to restore the capital before the restrictions are implemented. This period and the gradually increasing severity of the sanctions emphasise that the buffer is not an additional capital requirement that has to be complied with at all times.

Countercyclical capital buffers in individual credit institutions The capital requirement and the capital buffer both apply to all credit institutions in the system. For institutions which only operate in Den- mark, the countercyclical capital buffer will be of the same size and be determined by the Danish authorities based on systemic risk in Denmark. For internationally active credit institutions, including Danish institutions with activities abroad and foreign institutions with activities in Denmark, the buffer will be determined by a weighing of buffers set in the countries in which the institution concerned has activities. This means that credit granted to borrowers in Denmark must be weighted by the buffer determined in Denmark, irrespective of the lender's home country. Capital held to cover the capital buffer cannot also be used to meet the requirements set out under Pillar 2. If high credit growth in a single institution is deemed to indicate that the institution has relaxed its Monetary Review - 4th Quarter 2010

102 credit policy and is assuming higher risks, the Danish Financial Supervi- sory Authority may determine a higher individual capital need under Pillar 2. If the countercyclical capital buffer has been implemented to address the build-up of systemic risk, the institution must comply with both requirements.

SYSTEMIC RISK INDICATORS IN DENMARK

The countercyclical capital buffer is determined on the basis of the gap between the credit-to-GDP ratio and its trend. This should be supplemented with a number of other indicators to ensure timely implementation of the buffer. The set of indicators must be able to indicate the build-up and materialisation of systemic risk (the Appendix illustrates the development in a number of supplementary indicators). The build-up and materialisation of systemic risk in the form of high, simultaneous credit losses will typically be related to the correction of an asset value imbalance (e.g. in the property market). When at some point the imbalances begin to readjust, there is the risk that the credit institutions need to reduce their leverage ratios, resulting in a reversal of the credit cycle and self-reinforcing dynamics, see e.g. Geanakoplos (1997) and Kiyotaki and Moore (1997). It is reasonable to manage the countercyclical buffer on the basis of indicators that measure those imbalances. To ensure efficient determination of the buffer it is important to take into account the development in the overall financial system, not just lending by credit institutions. Risk may build up in many places and spread to the rest of the financial system, e.g. through fire sales of assets, thereby limiting the lending capacity of the system.

Credit-to-GDP ratio in relation to trend The countercyclical capital buffer is determined on the basis of the development in the gap between the aggregate credit-to-GDP ratio and its trend. In a Danish context, this has been a good indicator of the build- up of systemic risk, cf. Chart 3. In the periods up to the Nordic banking crisis in the late 1980s as well as the financial crisis in the second half of the 2000s – i.e. those times during the period when it might have been relevant to build up the buffer – it would have been implemented and have reached its maximum level before the crisis. As the credit-to-GDP ratio only approached the trend relatively late during the crises, the gap would have been less suitable as a guide to managing the release of the countercyclical buffer. This emphasises the need to include other indicators when determining the buffer. Monetary Review - 4th Quarter 2010

103

GAP BETWEEN THE AGGREGATE PRIVATE SECTOR CREDIT-TO-GDP RATIO AND ITS TREND AND THE SIZE OF THE COUNTERCYCLICAL CAPITAL BUFFER Chart 3

Per cent of risk-weighted assets Percentage points 3.0 40

2.5 30

2.0 20

1.5 10

1.0 0

0.5 -10

0.0 -20 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10

Buffer size Deviation from trend (right-hand axis) Note: The countercyclical capital buffer size is calculated as 0.3125 (= 2.5 / 8) times the deviation from the trend level when the deviation is between 2 and 10. When the deviation is less than 2, the countercyclical buffer is 0, and when the deviation is greater than 10, it is 2.5. Source: Statistics Denmark and own calculations.

Other macro-based indicators The development in the credit-to-GDP ratio can be broken down by contributions from households and non-financial corporations, respectively. This may provide an indication of the underlying factors. Another approach to assessing the build-up of systemic risk is to consider whether the credit institutions have sufficient capital to withstand a correction of asset prices, and whether such a correction is likely. Therefore, the formation of an asset price bubble may indicate a need to build up the countercyclical capital buffer. In the period up to the present crisis, prices of shares, homes and commercial properties were considerably higher than the trend. For all asset classes the spread between the development and the trend is the widest just before or at the beginning of a crisis, cf. Appendix Chart 5. This indicates that asset price deviations are relevant supplementary indicators with a view to determining the countercyclical buffer.

Indicators using credit institutions' income statements and balance sheets Interest margin reduction and rapid expansion of total assets may be indicators of excessive optimism with regard to credit institutions' credit Monetary Review - 4th Quarter 2010

104 policies and thus the build-up of systemic risk. On the other hand, increases in the institutions' write-downs and interest-rate margins as well as balance sheet reductions may indicate a need to release the buffer. The development in the institutions' leverage ratios may give an indication of the robustness of the banking sector to a correction of asset prices. The higher the leverage ratio, the more vulnerable the sector will be to losses. Similarly, the wider the customer funding gap, the more dependent the sector will be on market funding.1 The institutions' interest-rate margins narrowed and their total assets increased considerably during the period up to the financial crisis, cf. Appendix Chart 6. At the same time, their leverage ratios increased and the customer funding gap widened. In the 2nd half of 2008, interest- rate margins and particularly write-downs began to increase significantly, and the balance sheet began to fall. As regards the current crisis, the indicators have provided good early warnings of both build-up and materialisation of systemic risk.

Market-based indicators The development in the credit institutions' market value and the price of credit default protection provides information on the market participants' assessment of the risks in the sector. Pricing – e.g. the "price-to- book ratio" – is an expression of market expectations of the institutions' earnings, including write-downs and losses. An expression of the institutions' estimated failure rates can be calculated on the basis of their capitalisation and the variation in the way their assets are priced in the market. Yields on and the covariation of bank shares can be seen as indica- tions of the extent to which the market attributes developments to the conditions in individual institutions and conditions in the financial system as a whole. All market-based indicators show deviation at the beginning of the crisis and/or in the 2nd half of 2008, cf. Appendix Chart 7. Accordingly, they are most suitable as indicators of the materialisation of systemic risk.

Lending survey indicators Danmarks Nationalbank's lending survey is an indicator of whether the credit institutions have changed their credit quality requirements. The survey is based on the qualitative assessment by the institutions' credit managers of credit policy developments. Declining institution lending

1 A relatively large customer funding gap may make individual institutions vulnerable to continued access to credit in the financial markets, but it may also be an indication that an institution is diversi- fying its credit portfolio by making use of long-term stable funding in the financial market. Whether this reduces the risk of liquidity problems depends on the specific characteristics of the funding. The banks' liquidity is discussed in further detail in Danmarks Nationalbank (2010). Monetary Review - 4th Quarter 2010

105 rates, collateral requirements and increasing risk appetite may indicate the build-up of systemic risk and vice versa. The lending survey was introduced in the 4th quarter of 2008, so it does not cover developments during the period up to the crisis.1 The survey indicators show a major increase in the assessment of risk and a decline in risk appetite in the 4th quarter of 2008. At the same time, lending rates increased and collateral requirements were tightened. During the current crisis the indicators have thus provided good signals of the need to release the buffer.

Discretion in determining the buffer The assessment of indicators signalling build-up of systemic risk is based on the development over the last 40 years. At the same time, it is an open question whether it is relevant to use historical correlations to predict future ones. The structure of the economy and of the financial system develops over time. This makes it difficult to identify unsustainable imbalances at the time of build-up and to distinguish them from structural changes in the economy. It is therefore difficult to envisage an indicator that will be viable in all cases, and some discretion in determining the countercyclical capital buffer will be necessary. Consequently, this is not the only factor to be taken into account, but it supplements the capital requirements and the fixed conservation buffer.

THE COUNTERCYCLICAL CAPITAL BUFFER AND THE CRISIS

There is no knowing for certain how the financial crisis would have developed – if at all – if the future rules had been implemented at an earlier stage. Nevertheless, a review of the banks' historical capitalisation and comparison with the new rules may contribute to the assessment of the Basel III proposal. This comparison does not take into account that the Tier 1 capital quality requirements will be tightened. Nor does it take into account any Pillar 2 requirements which could mean that some institutions would have to hold more capital. Therefore, the figures should be regarded as a lower limit for the amount of additional capital the institutions should have held if the future rules had been in effect in the years prior to the financial crisis. At the same time, it is important to keep in mind that the behavioural changes that will be the result of the changes in the capital-adequacy rules have not been included.

1 However, similar surveys from other countries show that credit policy developments are closely correlated with factors such as lending, consumption and investments, cf. Jensen and Sass (2009). Monetary Review - 4th Quarter 2010

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DANISH BANKS' TIER 1 CAPITAL AND THE BUFFER IN THE PERIOD UP TO THE CRISIS Chart 4

Per cent of risk-weighted assets 90th percentile 24 75th percentile Median 25th percentile 22 10th percentile

8 Buffer zone 6

4 Tier 1 capital requirement

0 2001 2002 2003 2004 2005 2006 2007 2008

2001 2002 2003 2004 2005 2006 2007 2008 Note: The banks' Tier 1 capital ratio is at banking group level. The build-up of the buffer is assumed to follow the gap between the actual credit-to-GDP ratio and its trend in Denmark, cf. Chart 3. The buffer reaches its maximum level in 2005. The fact that some banks have foreign exposures for which the buffer requirement would have been different has not been taken into account, nor has the fact that the banks' risk-weighted assets cover other exposures besides credit exposures. Another factor not taken into account is that the new rules tighten the requirements for the type of capital that can be included as Tier 1 capital. Source: Accounts and own calculations.

In the period up to the crisis, a large part of the Danish banking sector would not have met the capital buffer requirement, cf. Chart 4. From 2005, when the buffer reached its maximum size, this applies to more than every fourth bank in groups 1-3.1 At the end of 2007, 41 out of 104 banks would have needed additional Tier 1 capital to be above the buffer requirement. Particularly the large and medium-sized banks should have held more capital than they did in the pre-crisis period. Four out of five financial institutions in the Danish Financial Supervisory Authority's group 1 had a Tier 1 capital ratio that would have been within the buffer zone at end- 2007.2 Similarly, the Tier 1 capital ratio of nine out of 10 institutions in group 2 would have been within the buffer zone. For the large and medium-sized banks as a whole to have been able to observe the future rules they would have needed extra capital in the

1 The banks are grouped on the basis of their working capital. Groups 1-3 comprise banks with a working capital of more than kr. 250 million, i.e. the grouping is dynamic. The end-2007 breakdown is applied to all periods here (even though some banks changed groups over the period). 2 At end-2007, the five banks in group 1 were Danske Bank, Nordea Bank Danmark, Jyske Bank, Sydbank and FIH Erhvervsbank. Cf. also note 1 of Table 2 regarding the transition from Basel I to Basel II at the end of 2007. Monetary Review - 4th Quarter 2010

107 amount of kr. 41 billion. This is equivalent to 25 per cent additional Tier 1 capital. Alternatively, the build-up of the sector's risk-weighted assets should have been more moderate. As a result, the risks might not have reached such a high level in the period leading up to the crisis. In total, the five institutions in group 1 should have held additional Tier 1 capital of more than kr. 32 billion to be above the buffer zone, and the 10 institutions in group 2 should have held just under kr. 9 billion more if the new rules had been implemented at the end of 2007, cf. Table 2. Another interesting question concerns the size of the losses that the buffer can absorb before the capital of the institutions no longer meets the statutory minimum requirement. For the five institutions in group 1 the buffer zone would have covered the equivalent of an immediate loss of almost kr. 78 billion. For the 10 group 2 institutions it would have covered just over kr. 17 billion. Half the buffer can be attributed to the countercyclical capital buffer, which is assumed to have reached its maximum level at that time. In comparison, the five group 1 institutions wrote down almost kr. 52 billion in the period 2008-09. With total profits of kr. 13 billion for the period concerned, the banks also had earnings to absorb losses. For four of the five largest banks, the statutory capital buffer held by the banks would have exceeded the actual excess capital over the Tier 1 capital requirement, cf. Table 2. For these banks the capital buffer would have represented an increase in the banks' reserves. The majority of small institutions voluntarily held reserves in excess of the buffer.1 The requirement for improved quality of the credit institutions' subordinated capital and the introduction of the capital buffer does not necessarily prevent institutions from becoming insolvent and imposing losses on their creditors. This is not the object of the buffer. The object is to enable the financial system as a whole to withstand a period of substantial write-downs and to prevent the winding-up of individual institutions from causing stress in the rest of the system on account of concerns that the capitalisation of the system as a whole is insufficient to absorb the losses. From this point of view it is likely that the capital buffer would have mitigated the negative impact on the rest of the financial system when an institution such as Roskilde Bank is wound up, imposing losses on its creditors.

1 This is probably attributable to the fact that small banks have less opportunity to issue hybrid capital instruments. Monetary Review - 4th Quarter 2010

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DANISH BANKS' VOLUNTARY TIER 1 CAPITAL BUFFER, COUNTER-FACTUAL CAPITAL BUFFERS AND INCREASED CAPITAL NEED AS A RESULT OF BASEL III, END OF 2007/BEGINNING OF 20081 Table 2

Insufficient capital Buffer relative to to comply with a 4% Tier 1 Countercyclical Total capital new (Tier 1) capital require- capital buffer – buffer – capital buffer Kr. million ment2 2.5% of RWA3 5% of RWA4 requirement5

Group 1 Danske Bank ...... 45,181 23,862 47,724 21,633 FIH Erhvervsbank ...... 4,032 2,291 4,581 2,382 Jyske Bank ...... 5,599 2,982 5,964 2,751 Nordea Bank Danmark ..... 15,269 8,122 16,244 7,472 Sydbank ...... 4,727 1,583 3,165 - Group 2 Alm. Brand Bank ...... 1,129 523 1,045 334 Amagerbanken ...... 1,200 714 1,428 800 Arbejdernes Landsbank .... 1,598 493 986 - Fionia Bank ...... 1,073 671 1,341 805 Forstædernes Bank ...... 1,136 789 1,578 1,073 Nykredit Bank ...... 2,573 1,994 3,988 3,010 Roskilde Bank ...... 1,280 1,067 2,134 1,707 Spar Nord Bank ...... 2,357 1,091 2,183 698 Sparbank ...... 1,103 431 862 103 Vestjysk Bank ...... 723 548 1,096 811

Note: The buffers, the countercyclical capital buffer, the capital buffer and the banks' insufficient capital are calculated at banking group level. The fact that some institutions have foreign exposures for which the buffer requirement would have been different has not been taken into account, nor has the fact that the institutions' risk-weighted assets cover other exposures besides credit exposures. Similarly, the calculation of the voluntary capital buffer does not take the institutions' corporate relations into account. Thus, Nordea Bank Danmark, Alm. Brand Bank and Nykredit Bank are subsidiaries of Nordea Bank, Alm. Brand and Nykredit, respectively. These relations may affect the institutions' choice of capital structure. Source: Accounts and own calculations. 1 Danish banking institutions were required to calculate risk-weighted assets according to Basel II from 1 January 2008. The transition from Basel I affected institutions using an internal rating-based approach the most, i.e. Danske Bank, Jyske Bank, Nordea Bank Danmark, Sydbank and Nykredit Bank. The calculations in the table for these institutions are based on risk-weighted assets on 1 January 2008 (without observing transitional arrangements). For the other institutions risk-weighted assets on 31 December 2007 is shown based on Basel I. 2 The banking institutions' "buffer relative to the 4% Tier 1 capital requirement" is calculated as the difference between the institution's Tier 1 capital and 4 per cent of the institution's risk-weighted assets (corresponding to the existing minimum Tier 1 capital requirement for the institutions). 3 "Countercyclical capital buffer – 2.5% of RWA" is calculated as 2.5 per cent of each institution's risk-weighted assets at end-2007, corresponding to the countercyclical capital buffer if the latter had been fully built up. 4 "Total capital buffer – 5% of RWA" is calculated as 5 per cent of each institution's risk-weighted assets at end- 2007/beginning of 2008, corresponding to the total capital buffer if the fixed part of the buffer had been fully phased in and the countercyclical capital buffer had been fully built up. 5 "Insufficient capital to comply with new (Tier 1) capital buffer requirement" is calculated as the difference between 11 per cent of the institution's risk-weighted assets – corresponding to 6 per cent of the Tier 1 capital requirement and the fixed part of the capital buffer having been fully phased in and the countercyclical capital buffer having been fully built up – and the Tier 1 capital actually held by the institution at end-2007/beginning of 2008.

SYSTEMIC RISK, BASEL III AND MACROPRUDENTIAL REGULATION

The Basel III rules address systemic risk through macroprudential regulation that remains constant over time as well as by means of macroprudential instruments that vary over time. The constant regulation of systemic risk includes improved capital quality requirements, a fixed capital Monetary Review - 4th Quarter 2010

109 buffer, requirements concerning the leverage ratios of credit institutions, requirements for increased use of central counterparties and, if applicable, an additional capital requirement for systemic institutions. Macroprudential regulation that varies over time is a new phenomenon, and experience is limited. The effects of these instruments should be monitored and investigated further as experience is gained with regard to their use. One risk factor is that the capital buffer may replace the voluntary reserves previously held by the institutions, and failure to significantly improve the total reserves of the banking sector.1 In order for the countercyclical capital buffer to become an efficient macroprudential instrument it has to be implemented correctly. Experi- ence from the crisis shows that it is difficult to identify and assess risks to the financial system. At the same time, there will no doubt be political pressure not to build up the buffer in good times. Its size should therefore be determined by a politically independent authority. To ensure the functioning of the buffer, the market must regard it as a buffer and not a higher capital requirement.2 When a credit institution collapses, the losses are often remarkably high, cf. e.g. James (1991), even though the institution was close to complying with the capital requirement. The high losses impose losses not only on the institution's shareholders but also on its creditors. The losses may also create uncertainty in the market about the institutions. If the buffer is regarded as a capital requirement, institutions will lose their access to liquidity as soon as they approach the buffer zone, and their total reserves will be smaller than expected. In such cases the capital buffer will give a false feeling of security. The countercyclical capital buffer will apply to credit institutions, but many other financial enterprises will not be comprised, e.g. pension funds, hedge funds, etc. It may be feared that, as a result of the buffer, activity will move to other parts of the financial system not covered by the buffer. It is therefore important for the entire financial system to be monitored and incorporated in the macroprudential regulation.

CONCLUDING REMARKS

Ideally, cross-border implementation of the countercyclical capital buffer should be as consistent as possible to ensure maximum transparency when determining its size. However, setting an indicator that has relia-

1 2 In principle, this can be addressed by increasing the buffer size. The challenge is that the sanctions for non-compliance with the capital buffer requirement should be sufficiently hard so as to ensure compliance by the credit institutions and that their reserves increase. At the same time, they should be sufficiently soft to ensure that the market does not view them as binding, so the buffer is actually able to absorb losses. Monetary Review - 4th Quarter 2010

110 bly predicted financial crises over time and across borders is difficult, see e.g. Drehman et al. (2010) and Basel Committee on Banking Supervision (2010a). Some discretion will therefore be required in terms of both national determination and release of the buffer.

LITERATURE

Baldvinsson, Cato, Torben Bender, Kim Busck-Nielsen and Flemming Ny- toft Rasmussen (2005), Dansk Bankvæsen, 5th edition, Forlaget Thomson (in Danish only).

Basel Committee on Banking Supervision (2009), Strengthening the resilience of the banking sector, Consultative Document.

Basel Committee on Banking Supervision (2010a), Countercyclical Capital Buffer Proposal, Consultative Document.

Basel Committee on Banking Supervision (2010b), Group of Governors and Heads of Supervision announces higher global minimum capital standards, press release.

Borio, Claudio and Philip Lowe (2004), Securing sustainable price stability: Should credit come back from the wilderness?, BIS Working Paper, No. 157.

Danmarks Nationalbank (2010), Stress Test 2nd Half.

Detken, Carsten and Frank Smets (2004), Asset price booms and monetary policy, ECB Working Paper, No. 364.

Drehmann, Mathias, Claudio Borio, Leonardo Gambacorta, Gabriel Jiménez and Carlos Trucharte (2010), Countercyclical capital buffers: exploring the options, BIS Working Papers, No. 317.

Geneakoplos, John (1997), Promises Promises, in W. Brian Arthur, Steven N. Durlauf and David A. Lane (ed.), The economy as an evolving complex system II, Addison-Wesley.

James, Christopher (1991), The losses realized in bank failures, Journal of Finance, Vol. 46, No. 4.

Jensen, Carina Mosegaard and Tania Al-Zagheer Sass (2009), Danmarks Nationalbank's Lending Survey – New Statistics for Changes in Banks' and Mortgage-Credit Institutes' Credit Policies, Danmarks Nationalbank, Monetary Review, 1st Quarter. Monetary Review - 4th Quarter 2010

111

Kiyotaki, Nobuhiro and John Moore (1997), Credit Cycles, Journal of Political Economy, Vol. 105, No. 2.

Pedersen, Erik Haller and Søren Vester Sørensen (2009), Economic Activ- ity, Asset Prices and Credit, Danmarks Nationalbank, Monetary Review, 4th Quarter. Monetary Review - 4th Quarter 2010

112

APPENDIX

OTHER MACRO-BASED INDICATORS Chart 5

Lending to households Lending to non-financial corporations Per cent Percentage points Per cent Percentage points 160 30 80 20 140 25 70 15 120 20 60 10 100 15 50 5 80 10 40 0 60 5 30 -5 40 0 20 -10 20 -5 10 -15 0 -10 0 -20 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10

Deviation from trend (right-hand axis) Deviation from trend (right-hand axis) Lending to households/GDP Lending to non-financial corporations/GDP Lending to households/GDP trend Lending to non-financial corporations/GDP trend Development in real housing prices Development in real stock prices 2000 = 100 Per cent 2000 = 100 Per cent 160 40 180 60 30 120 40 80 20 60 20 10 0 0 0 0 -10 -60 -20 -80 -20 -120 -40 -30 -160 -40 -180 -60 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 Deviation from trend (right-hand axis) Housing prices Housing prices trend Deviation from trend (right-hand axis) Stock prices Stock prices trend Development in real property prices 2000 = 100 Per cent 160 50

80 25

0 0

-80 -25

-160 -50 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10

Deviation from trend (right-hand axis) Commercial property prices Commercial property prices trend

Note: Quarterly data for lending by banks and mortgage banks as a ratio of GDP. The trend is calculated recursively using a Hodrick-Prescott filter with a high smoothing parameter (lambda = 400,000), cf. Detken and Smets (2004). The first 32 quarters are applied to initialise the trend, which is then calculated recursively by adding one quarter at a time. Quarterly data for price indices. The trend is calculated recursively using a Hodrick-Prescott filter with a high smoothing parameter (lambda = 400,000). The first 32 quarters are applied to initialise the trend, which is then calculated recursively by adding one quarter at a time. Source: Statistics Denmark and own calculations.

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BALANCE SHEET-BASED INDICATORS Chart 6

Interest margins Losses and write-downs as a ratio of total lending Percentage points Per cent 10 5.5 9 4.5 8

7 3.5 6 5 2.5 4 1.5 3 2 0.5 1 0 -0.5 83 85 87 89 91 93 95 97 99 01 03 05 07 09 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 Total losses Losses, private sector Average (all sectors) Corporate sector Households Losses, corporate sector Write-downs Balance sheet and leverage ratio Balance-sheet relations Kr. billion Leverage ratio Per cent 5,000 30 20 1.6 4,500 18 1.4 4,000 25 16 1.2 3,500 20 14 3,000 12 1.0 2,500 15 10 0.8 2,000 8 0.6 10 1,500 6 0.4 1,000 5 4 500 2 0.2 0 0 0 0.0 86 88 90 92 94 96 98 00 02 04 06 08 10 86 88 90 92 94 96 98 00 02 04 06 08 10 Grp 1: Bal. sheet Grps 1-3: Bal. sheet Grp 1: (Bal. sheet-cap.)/capital Grps 1-3: (Bal. sheet-cap.)/capital Grp 1: Lev. ratio (right-h. axis) Grps 1-3: Lev. ratio (right-h. axis) Grp 1: Len./dep. (right-h. axis) Grps 1-3: Len./dep. (right-h. axis) Note: The two charts at the top are based on quarterly and monthly data, and the two charts at the bottom are based on half-year data, where the half year before 2000 is determined by linear interpolation. The leverage ratio is calculated as total assets as a ratio of Tier 1 capital. Source: Accounts, the Danish Financial Supervisory Authority, MFI statistics, Baldvinsson et al. (2005) and own calculations. Monetary Review - 4th Quarter 2010

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MARKET-BASED INDICATORS Chart 7

The banks' price-to-book ratio Average market value Price-to-book ratio Kr. billion Kr. billion 3.0 160 8 140 7 2.5 120 6 2.0 100 5 1.5 80 4 60 3 1.0 40 2 0.5 20 1 0.0 0 0 2007 2008 2009 2010 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Groups 1 and 2 Group 1 Group 2 Nordic financial groups Group 1 Group 2 (right-hand axis) Yield and covariation Estimated failure rates, banks Per cent Share Per cent 30 0.9 1.2

20 0.8 1.0

10 0.7 0.8

0 0.6 0.6

-10 0.5 0.4

-20 0.4 0.2

-30 0.3 0.0 2003 2004 2005 2006 2007 2008 2009 2010 2007 2008 2009 2010 2007 2008 2009 2010 Group 1 Group 2 Smallest yield Largest yield Share of covariation (right-hand axis) Averages Minimum Maximum Note: Banks' estimated failure rates are calculated using the formula

 1  Φ=  ()− ()+− 2  σσ e PD ln individual solvency ln(solvency yE) g e    2  

where is the market capitalisation trend,σ 2 is the stock price variance over the last three months, and ρ (yE g) e is an expression of each bank's weighted sensitivity to sectors, i.e. the approximative correlation with the market sector, as seen from the lending portfolio. ()⋅Φ is the cumulative standard normal distribution. Source: Bloomberg, accounts and own calculations.

LENDING SURVEY INDICATORS Chart 8

Expected risk Expected credit terms

Private Corporate Private Corporate 40 40

20 20

0 0

-20 -20

-40 -40

-60 -60

-80 -80

-100 -100 2008 2009 2010 2008 2009 2010 2008 2009 2010 2008 2009 2010 Institutions' risk assessments Institutions' risk appetite Institutions' prices Institutions' collateral requirements

Note: The lending survey is an interview survey based on responses from a wide range of representatives of the Danish financial sector. The data for the 4th quarter of 2010 are based on the conditional assumption for the 4th quarter given by the institutions in the 3rd quarter of 2010. Source: Danmarks Nationalbank. Monetary Review - 4th Quarter 2010

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The Foreign-Exchange Market 2010

Maria Sinding-Olsen, Statistics

INTRODUCTION AND SUMMARY

Every three years, the Bank for International Settlements, BIS, compiles statistics of turnover in the foreign-exchange market in cooperation with central banks worldwide. The most recent survey shows that on average foreign-exchange trading in the Danish market totalled 120 billion dollars per banking day in April 2010, with global turnover of 3,981 billion dollars. This is the highest turnover since BIS launched the survey in 1989. The most actively traded currency is the dollar followed by the euro. The market share of the euro has risen every year since its introduction. From 2004 to 2007, foreign-exchange trading in Denmark doubled, and total global trading also rose sharply. Over the past three years, turnover has risen, albeit at more moderate rates of 24 per cent in Denmark and 20 per cent globally. In Denmark, most of the increase is related to transactions without exchange of liquidity. Turnover in Den- mark gained 10 per cent in the 3-year period, excluding transactions without exchange of liquidity. Developments in global foreign-exchange market turnover can be partly explained by the emergence of more participants, both financial and non-financial clients. Technological advances have made foreign- exchange trading more accessible, and intraday trading in foreign exchange (high-frequency trading) has become more common. Foreign exchange is increasingly viewed as an independent asset class for institutional investors, and hedge fund activity in the foreign- exchange market has increased in this period, particularly on a global scale. With total turnover in Denmark of 120 billion dollars, transactions in all currencies in the Danish market account for 2.4 per cent of the global market, making it the ninth largest market. Throughout the entire history of the survey, Denmark has ranked relatively high con- sidering the size of the economy. This is rooted in a long-standing tradition of foreign-exchange trading in Denmark, and the fact that several of the Nordic banking groups having centralised their trading in Denmark. Monetary Review - 4th Quarter 2010

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TURNOVER IN THE DANISH FOREIGN-EXCHANGE MARKET PER BANKING DAY IN APRIL, BROKEN DOWN BY INSTRUMENTS Chart 1

Billion dollars 140

120

100

0 1995 1998 2001 2004 2007 2010 FX swaps Spot transactions Outright forwards Currency swaps FX options Source: Danmarks Nationalbank.

FOREIGN-EXCHANGE MARKET DEVELOPMENTS

Foreign-exchange market turnover is divided into spot transactions and four other related foreign currency instruments, cf. Box 1 and Chart 1. FX swaps are the dominant instrument, accounting for 60 per cent. Turnover in FX swaps in Denmark was 11 per cent higher in 2010 than in 2007, while it rose by only 3 per cent globally after having more than doubled from 2004 to 2007. In 2010, 62 per cent of turnover in FX swaps in Denmark was generated by instruments with maturities of less than seven days, compared with 76 per cent in 2007. FX swaps are e.g. used for daily liquidity management and for hedging foreign-exchange risk. Growth in turnover in the Danish market since 2001 is therefore related to the banks' liquidity management, among other things. Moreover, the financial crisis has uncovered a need for investors to hedge more risks, including counterparty risk. FX swaps can be viewed as a loan in one currency against collateral in another currency. They have therefore increasingly been used as secured liquidity during the financial crisis. With daily turnover of 33 billion dollars, spot transactions account for the second largest share of the foreign-exchange market in Denmark. They have contributed strongly to foreign-exchange market growth in the past three years, both on a global scale and in Denmark. In this con- Monetary Review - 4th Quarter 2010

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INFORMATION ABOUT THE INTERNATIONAL SURVEY Box 1

The international survey in 2010 comprised the largest market players in 53 countries. The Danish part included six banks, estimated to account for more than 95 per cent of turnover of the foreign-exchange and derivatives products included in the survey. Foreign-exchange trading is attributed to the country location of the sales desk, meaning that the comparability of the individual surveys may be affected by reloca- tion of intra-group activities. The survey only includes transactions concluded and settled directly between two parties (OTC contracts) and does not comprise exchangetraded contracts. All reported trades are concluded by the banks' entities in Denmark and include intra-group trades concluded on market terms. Duplicated reporting of transactions between two local reporting dealers, i.e. the two counterparties, has been eliminated for Denmark. All data for the overall global market has been adjusted for the duplicated reporting of transactions involving both domestic and foreign reporting banks, once for each counterparty, unless otherwise indicated. Turnover is stated as the nominal or notional value of all transactions and contracts concluded on all banking days in April 2010. Results are stated in billion dollars in order to ensure comparability between national surveys. Consequently, the exchange rate at the time of reporting affects total turnover. This means that e.g. two identical contracts in kroner for yen concluded in 2007 and 2010, respectively, are included in the survey at different values, depending on the exchange rates. A more true picture of the development is achieved by adjusting for exchange-rate developments. However, between 2007 and 2010 the general trend in exchange rates did not have any significant impact on turnover. For all contracts, turnover is broken down by currency and counterparty, and for outright forwards and FX swaps also by original maturity. Turnover is broken down by three counterparty categories, namely "other reporting dealers", "other financial institutions" and "non-financial customers". For each category, a distinction is also made between local and cross-border counterparties. Unlike previous surveys, the 2007 and 2010 surveys include foreign-exchange transactions (spot transactions, outright forwards and currency swaps) without exchange of liquidity on the value date. Instead of an actual exchange of liquidity, only the difference between the exchange rates on the trade and value dates is exchanged. SAXO Bank's transactions belong to this category, and the bank has therefore provided data for the 2010 survey and for revision of the survey in 2007. In 2004 and before, these transactions are not included. In 2010, SAXO Bank's daily turnover in the foreign-exchange market totalled 23 billion dollars compared with 9 billion dollars in 2007. As supplementary information for the survey, the market participants overall have described turnover in April 2010 as "normal". The following instruments have been applied in the survey of the foreign-exchange market: • Spot transaction: Foreign-exchange trade for settlement within two banking days of the trade date.Outright forward: Foreign-exchange trade for settlement later than two banking days after the trade date. Monetary Review - 4th Quarter 2010

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CONTINUED Box 1

• FX swap: Transaction that combines a spot transaction with a forward transaction in the opposite direction. • Currency swap: A transaction involving ongoing swaps of interest payments and principals in different currencies. • FX option: A transaction that grants one party the right, but not the obligation, to buy or sell an amount in a given currency at an agreed price at an agreed future point in time.

The results of the global survey can be found at the BIS website, www.bis.org/publ/rpfx10.htm. The website also provides further information on sources and methodologies (Statistical notes).

text, it should be noted that the 2007 and 2010 surveys also include transactions in which no liquidity is exchanged on the value date. In this type of transactions, only the difference between the exchange rates on the trade and the value dates is exchanged. Turnover in this type of transactions explains the increase in spot transactions in Denmark, while turnover in spot transactions with liquidity exchange on the value date fell from 2007 to 2010. The trades can both be used for hedging currency positions and for speculation in future exchange-rate developments. Trading without liquidity exchange is cheaper for clients, as settlement costs are lower as are liquidity requirements. Finally, outright forwards, currency swaps and currency options are included in the survey. Turnover in outright forwards has risen by 10 per cent, while currency swaps and FX options have seen the largest increase in relative terms. However, turnover in these types of transactions remains very limited compared with FX swaps, spot transactions and outright forwards.

GEOGRAPHICAL LOCATION OF THE FOREIGN-EXCHANGE MARKET

The UK has the largest foreign-exchange market with turnover of 1,854 billion dollars per banking day in April 2010, cf. Table 1. The UK's share of foreign-exchange trading has grown in recent years and now accounts for 37 per cent of the global market, partly because large international banks often choose to locate their trade desk in London. By historical standards, the Danish market has been large relative to the size of the Danish economy and still is. From 2001 to 2010, turnover in Denmark outpaced global turnover growth, cf. Chart 2. Turnover in the Danish market is also higher than in the rest of the Nordic region. One of the reasons is that the Nordic banks' foreign- Monetary Review - 4th Quarter 2010

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TURNOVER PER BANKING DAY IN APRIL IN THE 20 LARGEST MARKETS Table 1

1998 2004 2010

Billion Percentage Billion Percentage Billion Percentage dollars share dollars share dollars share

UK ...... 685 32.6 835 32.0 1.854 36.7 USA ...... 383 18.3 499 19.1 904 17.9 Euro area ...... 339 13 472 9.0 Of which: France ...... 77 3.7 67 2.6 152 3.0 Germany ...... 100 4.7 120 4.6 109 2.1 Luxembourg ...... 23 1.1 15 0.6 33 0.7 Belgium ...... 27 1.3 21 0.8 33 0.6 Finland ...... 4 0.2 2 0.1 31 0.6 Spain ...... 20 1.0 14 0.5 29 0.6 Italy ...... 29 1.4 24 0.9 29 0.6 Japan ...... 146 7.0 207 8.0 312 6.2 Singapore ...... 145 6.9 134 5.1 266 5.3 Switzerland ...... 92 4.4 85 3.3 263 5.2 Hong Kong SAR ...... 80 3.8 106 4.1 238 4.7 Australia ...... 48 2.3 107 4.1 192 3.8 Denmark ...... 28 1.3 42 1.6 120 2.4 Canada ...... 38 1.8 59 2.3 62 1.2 Sweden ...... 16 0.8 32 1.2 45 0.9 Korea ...... 4 0.2 21 0.8 44 0.9 Russia ...... 7 0.3 30 1.1 42 0.8 India ...... 2 0.1 7 0.3 27 0.5

Note: In all countries, turnover is adjusted for domestic double-counting of transactions between two reporting institutions, but not for double-counting of transactions between two reporting institutions from two different countries, cf. Box 1. Source: BIS (2010).

3-YEAR GROWTH RATES IN FOREIGN-EXCHANGE MARKET TURNOVER IN DENMARK AND GLOBALLY Chart 2

Per cent 140

120

100

-20

-40 2001 2004 2007 2010 Denmark Globally Source: BIS (2010). Monetary Review - 4th Quarter 2010

120 exchange trading is centralised in Denmark, which is to some extent ascribable to a long tradition of foreign-exchange trading in Denmark. Furthermore, the Danish capital market is highly developed and notably has a large and liquid mortgage-credit market, which attracts international interest. This may also contribute to the relatively high international of the Danish foreign-exchange market.

TURNOVER BROKEN DOWN BY CURRENCIES

Most trades are in dollars and euro, both in Denmark and globally, cf. Table 2. The euro has gained market shares every year since it was introduced. Denmark's geographical location and economic relations are key de- terminants of the most frequently traded currencies. Obviously, Danish kroner make up a large share of turnover, but the euro's share is also larger in Denmark than globally. Liquidity in the various foreign- exchange instruments is higher in euro than in Danish kroner. Due to the fixed-exchange-rate policy vis-à-vis the euro, a dollar/euro FX swap, which is highly liquid, can be used for hedging foreign-exchange risk instead of a dollar/krone trade, which is less liquid. This increases euro turnover in Denmark. Finally, the proportion of trades in Swedish kronor and Norwegian kroner is markedly higher in Denmark than globally.

TURNOVER IN DENMARK AND GLOBALLY, BROKEN DOWN BY CURRENCIES Table 2

Denmark Globally

2007 2010 2007 2010 Per Per Billion dollars cent Billion dollars cent Per cent Per cent Dollars ...... 72.1 74 85.8 71 86 85 Euro ...... 45.9 47 68.1 57 37 39 Swedish kronor ...... 16.5 17 21.3 18 3 2 Danish kroner ...... 24.1 25 20.8 17 1 1 Swiss francs ...... 9.5 10 16 13 7 6 Pounds sterling ...... 5.8 6 8.9 7 15 13 Norwegian kroner . 10.1 10 7.4 6 1 1 Yen ...... 5.3 5 6.6 6 17 19 Other ...... 4.6 5 4.5 5 33 34

Note: As the currencies are included in pairs, e.g. Danish kroner versus dollar will be included in both "Danish kroner" and "Dollars". Therefore, turnover by currencies sums up to 200 per cent. The currencies are ranked by per- centages in Denmark in 2010. Source: BIS (2010). Monetary Review - 4th Quarter 2010

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CONTRIBUTIONS TO FOREIGN-EXCHANGE MARKET DEVELOPMENTS

There are several contributory factors to the rising foreign-exchange turnover. Especially technological advances and continued globalisation have had an impact in recent years.

Technological advances play a significant role Foreign-exchange trading becomes increasingly accessible to banks, companies and private individuals. The short way to the market, e.g. via online trading platforms and high-frequency trading, intensifies foreign- exchange trading activity among both small and large players. The Danish market participants point out that particularly investments in IT platforms offering broader access for both wholesale and retail participants contribute to developments in the Danish market. BIS states that the global market reflects hedge funds' increasing use of high-frequency trading, which pushes up turnover. High-frequency trading is based on sophisticated computer algorithms, exploiting arbi- trage opportunities in exchange rates. The transactions are executed on the basis of pre-defined models and, given the high frequency, they have a considerable impact on total turnover in the global foreign- exchange market. More transactions are now settled via CLS (Continuous Linked Settle- ment), cf. Chart 3. The system is primarily used by banks and investment funds to settle various types of foreign-exchange transactions, including spot transactions, outright forwards and FX swaps. The system reduces the counterparty risk on settlement, as the two legs of the foreign-exchange trade are settled simultaneously. The limited counterparty risk makes foreign-exchange trading more attractive to banks and investment funds. The number of indirect participants1 in the system has risen sharply and now totals more than 9,000, up from about 2,000 in 2007, cf. Chart 3.

Exchange rate developments affect turnover Market participants indicate that there is a positive correlation between volatility in exchange rates and turnover in the foreign-exchange market. The most frequently traded currency pair in the global survey is dollar/euro. Daily fluctuations in exchange rates were wider in February- April 2010 than in February-April 2007, cf. Chart 4. The increased volatility may have had a positive impact on turnover in the 2010 survey compared with 2007, as higher volatility provides scope for higher returns.

1 Indirect participants are participants who both report and settle foreign-exchange transactions via the direct participants. The direct participants are typically large international banks. Monetary Review - 4th Quarter 2010

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GROSS VALUE OF GLOBAL FOREIGN-EXCHANGE TRANSACTIONS SETTLED VIA CLS – AND THE NUMBER OF INDIRECT PARTICIPANTS Chart 3

Billion dollars Participants 110.000 10.000 100.000 9.000 90.000 8.000 7.000 80.000 6.000 70.000 5.000 60.000 4.000 50.000 3.000 40.000 2.000 30.000 1.000 20.000 - 2004 2005 2006 2007 2008 2009 2010 2005 2006 2007 2008 2009 2010 Turnover in all currencies in billion dollars Banks Funds Others Note: The Chart shows turnover per month and not per banking day. In the calculation of the gross values of settled trades, FX spot and outright forwards are included in duplicate, and FX swaps are included in quadruplicate, as each leg leads to a payment instruction. Data for November 2004 and February 2005 has been adjusted for two extreme observations. The gross value of the transactions settled in CLS is not directly comparable with the turnover data from the BIS survey, as there may be differences in the geographical statement and types of instruments. Source: CLS Bank International.

Moreover, market participants state that developments in the equity and capital markets affect foreign-exchange market turnover. Steadily rising equity and bond markets may lead to higher foreign-exchange trading, as more investors are attracted, and existing investors have more funds available for trading. Further, rising exchange rates may mean that institutional investors will have to rebalance their currency exposure against a benchmark more often.

NUMERICAL DAY-TO-DAY CHANGE IN THE DOLLAR/EURO RATE Chart 4

Per cent 1,6

1,4

1,2

1,0

0,8

0,6

0,4

0,2

0,0 Feb-Apr 2007 Feb-Apr 2010

Dollar/Euro Source: Danmarks Nationalbank. Monetary Review - 4th Quarter 2010

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DENMARK’S EXTERNAL ASSETS AND LIABILITIES Chart 5

Kr. billion Per cent 5.000 300

4.500 280

4.000 260

3.500 240

3.000 220

2.500 200

2.000 180

1.500 160

1.000 140

500 120

- 100 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 External assets External liabilities External assets as a percentage of GDP (right-hand axis) Note: GDP is stated as annual GDP. Data is shown as at the end of the 1st quarter of each year. Source: Danmarks Nationalbank and Statistics Denmark.

Correlation between foreign-exchange turnover and globalisation Cross-border trading in assets naturally generates turnover in the foreign-exchange market. Denmark's total external assets and liabilities have risen sharply since the 2007 survey, cf. Chart 5. External assets totalled kr. 3,503 billion at the end of the 1st quarter of 2007 and kr. 4,361 billion at the end of the 1st quarter of 20101. On the asset side, which is primarily denominated in foreign exchange, the rise in direct investments and Danish investors' holdings of foreign bonds has been particularly significant. Both components could contribute slightly to lifting turnover in the foreign-exchange market. The contribution may come from an initial need for foreign exchange via spot transactions in connection with acquisition of assets/liabilities, but also subsequently in the form of ongoing hedging of the foreign-exchange risk. Hedging of assets and liabilities in foreign exchange prompts more than one foreign-exchange transaction. Thus, an investor may conclude a swap with a bank that subsequently concludes an opposite swap with another bank, which in turn has a counterparty with an opposite hedging need. The increase in external assets and liabilities bears evidence of ongoing internationalisation, which can increase foreign-exchange market turnover.

1 Source: Danmarks Nationalbank. Monetary Review - 4th Quarter 2010

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About 40 per cent of Denmark's external assets and liabilities consist of residents' portfolio investments abroad and non-residents' portfolio investments in Denmark. Cross-border securities trading leads to turnover in the foreign-exchange market. In April 2010, turnover in the Danish securities market totalled kr. 2,830 billion or kr. 157 billion per banking day. Non-residents accounted for 23 per cent of trading, corresponding to kr. 36 billion per banking day.1 Non-residents' trading in Danish securities and residents' trading in foreign securities contribute strongly to foreign-exchange market turnover. Cross-border trading in securities thus plays a significant role in foreign-exchange market turnover, while trade in goods and services affects turnover only slightly. In April 2010, Denmark imported goods and services worth kr. 35.7 billion, and exports totalled kr. 42 billion.2 As stated above, daily foreign-exchange market turnover was 120 billion dollars, drastically exceeding foreign trade.

LITERATURE

Bank for International Settlements (2010), Triennial Central Bank Survey: Foreign exchange and derivatives market activity in April 2010 – Preliminary results.

Danmarks Nationalbank (2010), Survey of the Danish foreign-exchange and derivatives market turnover in April 2010, Financial statistics, Special report, 1 September.

Egstrup, Rune and Birgitte Damm Fischer (2007), Foreign-Exchange and Derivatives Markets in 2007, Danmarks Nationalbank, Monetary Review, 4th Quarter.

Galati, Gabrielle and Alexandra Heath (2007), What drives the growth in FX activity? Interpreting the 2007 triennial survey, Bank for International Settlements Quarterly Review, December 2007.

1 2 Source: VP Securities A/S. Source: Statistics Denmark. Monetary Review - 4th Quarter 2010

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The IMF's Quota and Governance Reform 2010

Helene Kronholm Bohn-Jespersen, Economics

INTRODUCTION AND SUMMARY

After political agreement had been reached by the G20 central bank governors and ministers of finance on 22-23 October 2010, the Executive Board of the International Monetary Fund, IMF, on 5 November approved a quota and governance reform.1 This is the most fundamental reform of the IMF since its establishment after World War II. The aim is to increase the legitimacy and efficiency of the Fund and to bring it up to date with the needs and composition of the world economy. The reform increases the influence of the leading emerging economies, while smaller countries in particular will lose some of theirs. The reform will take effect when it has been approved by the IMF's Board of Governors. It is hoped that this will be achieved in connection with the IMF's and the World Bank's Annual Meetings in Egypt in 2012.

KEY ELEMENTS OF THE REFORM2

The key elements of the reform concern the increase and distribution of quotas as well as the size and composition of the Executive Board.

Total IMF quota increase The IMF's loans to member countries in difficulties are mainly financed by the Fund's quotas, which are paid up by the member countries from their foreign-exchange reserves. The reform will entail a doubling of total IMF quotas to 476.8 billion SDR (approximately kr. 4,050 billion), including the quota increases under the IMF's 2008 quota and voice reform3. The doubling of the quotas is to contribute to ensuring that the

1 G20 communiqués can be downloaded from www.imf.org/external/np/g20/. The IMF's press release on the Executive Board's approval of the reform proposal can be downloaded from

2 www.imf.org/external/pubs/ft/survey/so/2010/NEW110510B.htm The overall proposal approved by the Executive Board on 5 November 2010 is described in the IMF

3 paper "IMF Quota and Governance Reform Elements of an Agreement" of 31 October 2010. The 2008 reform includes a new formula for calculating quotas, a second round of ad hoc quota increases (after the first round adopted in Singapore in 2006) based on the new quota formula, a tripling of basic votes that will increase the voting shares of small countries, particularly low-income countries, and allowing the two African Board members to appoint an additional Alternate Executive Director each. Monetary Review - 4th Quarter 2010

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IMF remains a quota-based institution, thereby reducing its dependence on borrowed resources. Each member country is assigned a quota based on its relative position in the world economy, openness, variability of export revenue and foreign-exchange reserves.1 The quota determines the country's financial obligations to the IMF, its voting power and its access to IMF financing. In connection with the quota increase, the size of the bilateral New Arrangements to Borrow, NAB, will be reviewed in November 2011 at the latest with a view to a corresponding reduction. The NAB is an ar- rangement between the IMF and a group of members, including Dan- marks Nationalbank, who have committed themselves to making further lending resources available to the IMF.2 As a result of the financial and economic crisis, an agreement has been made to increase the NAB from 34 billion SDR to 367.5 billion SDR. This increase is expected to take effect in the 1st half of 2011. When the quota and governance reform enters into force, the increase of the NAB will thus have to be partially rolled back.

Quota distribution The reform will entail a quota shift of 6.2 percentage points from over- represented to under-represented member countries, as well as a shift to under-represented emerging economies and low-income countries of 5.7 percentage points.3 60 per cent of the quota increase will be distributed on the basis of the IMF's quota formula from 2008, while the remainder will be distributed according to a number of ad hoc indicators. The ad hoc increases will be based on e.g. a calculation of which member countries are under-represented, measured by a GDP blend variable comprising gross domestic product, GDP, at market price (60 per cent) and purchasing power parity (PPP)-adjusted GDP (40 per cent). These countries will be entitled to ad hoc increases of their quotas, subject to certain conditions, however. As a further contribution to the realignment of quotas, all advanced economies will be asked voluntarily to forego 1.35 per cent of their quota (1.37 per cent for the advanced G20 members).

1 For a further description of the quota system, including the 2008 reform, see Helene Kronholm Bohn- Jespersen, The IMF Undergoing Change, Danmarks Nationalbank, Monetary Review, 4th Quarter 2008. 2 See www.imf.org/external/np/exr/facts/gabnab.htm for further information about the NAB. Den- mark's obligations to the IMF are described in more detail in Thomas Krabbe Jensen and Søren Vester Sørensen, Danmarks Nationalbank's Financial Accounts with the International Monetary Fund, IMF,

3 Monetary Review, 4th Quarter 2009. Data from the IMF's new quota tables, which are available at www.imf.org/external/pubs/ft/survey/so/2010/NEW110510B.htm Monetary Review - 4th Quarter 2010

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QUOTA DISTRIBUTION IN THE NORDIC-BALTIC CONSTITUENCY Table 1

Calculated Quotas Quotas after Per cent quotas 15 Nov. 2010 2010 reform

Sweden ...... 0.94 1.10 0.93 Denmark ...... 0.73 0.76 0.72 Norway ...... 0.81 0.77 0.79 Finland ...... 0.51 0.58 0.51 Lithuania ...... 0.11 0.07 0.09 Latvia ...... 0.09 0.06 0.07 Iceland ...... 0.10 0.05 0.07 Estonia ...... 0.07 0.03 0.05

Total ...... 3.37 3.42 3.23

Note: The calculated quotas are the quotas according to the IMF's 2008 quota formula. The quotas after the 2010 reform include ad hoc increases for 54 member countries that have not yet been implemented. Source: IMF.

For the Nordic-Baltic constituency, to which Denmark belongs, the reform will entail a small overall reduction of the quota share, see Table 1. After the reform, the constituency will have a total quota share of 3.23 per cent, compared with the current 3.42 per cent of the IMF's total quota. Part of the reduction is attributable to the Danish quota share being reduced from 0.76 to 0.72 per cent. Together with the other three large Nordic countries, Denmark will shift from being slightly over- represented to being slightly under-represented relative to the 2008 quota formula. The quota shares of the three Baltic states will be increased, but the increases are relatively smaller than those of the large emerging economies. After the reform, the 10 largest members of the IMF will be the USA, Japan, China, Germany, the UK, France, Italy, India, Russia and Brazil, cf. Chart 1. The BRIC countries (Brazil, Russia India and China) will thus all be in the top 10. The BRIC countries are among those that have seen their quotas increase substantially since 2008. The IMF's low-income members are protected against reduction of the individual voting shares assigned to them under the 2008 reform. This applies to member countries eligible for loans from the IMF's Poverty Reduction and Growth Trust, PRGT, and with a per capita income below the International Development Association's lower limit of 1,135 dollars in 2008 (the double amount applies to "small" countries). This definition covers 49 member countries plus Zimbabwe, which is not currently eligible for loans from the PRGT. Realignment of IMF quotas should be a continuous process, so that the distribution will always reflect changes in the world economy. The IMF's quota formula is due for a comprehensive review before January 2013, Monetary Review - 4th Quarter 2010

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QUOTA DEVELOPMENTS OF THE 10 LARGEST MEMBER COUNTRIES Chart 1

Per cent 18

0 USA Japan China Germany UK France Italy India Russia Brazil

Before 2008 reform After 2008 reform After 2010 reform Calculated Note: The calculated quotas are the quotas according to the IMF's 2008 quota formula. The quotas after the 2010 reform include ad hoc increases for 54 member countries that have not yet been implemented. Source IMF.

and the next general quota review will be brought forward by approximately two years, to January 2014.

Size of the Executive Board The reform will leave the Executive Board unchanged in terms of size, although the USA, among others, has previously expressed a wish for a smaller Board. In 1992 the Executive Board was expanded from 20 to 24 members to accommodate the influx of new member countries, including from the former Soviet Union. However, the expansion has not been included in the IMF's Articles of Agreement and is thus not permanent. Consequently, since 1992 the Board of Governors of the IMF has had to approve the expansion of the Executive Board to 24 members in connection with regular elections to the Executive Board, which usually take place before 1 November every other year. The current reform includes a political, but not a legally binding obligation for members to keep the size of the Executive Board at 24 in future. In addition, its composition will be reassessed every eight years once the quota reform has entered into force. Constituencies comprising seven or more countries will be given the option to appoint an additional Alternate Executive Director at the first election to the Executive Board after the adoption of the reform. This will also apply to the Nordic Baltic constituency. Monetary Review - 4th Quarter 2010

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Composition of the Executive Board The IMF's Articles of Agreement will be amended so that all Executive Directors must be elected. So far the largest five member countries have been entitled to appoint an Executive Director each. Furthermore, the reform will entail that the most advanced European countries must reduce their total representation on the Executive Board by two seats, which will pass to the emerging and developing countries. This was brought about by pressure from the USA, supported by the emerging economies, which have long been of the opinion that the advanced European countries have been over-represented on the Execu- tive Board. The consolidation of the European representation must be in place by the first election to the Board after the quota reform has entered into force. The most recent regular election took place in No- vember 2010.

IMPLEMENTATION

The approval of the quota and governance reform by the IMF's Executive Board is the first step in the ratification process, cf. Chart 2. The reform will not take effect until it has been approved by the IMF's Board of Governors, comprising one governor from each of the 187

QUOTA AND GOVERNANCE REFORM PROCESS Chart 2 Quotes Executive Board Timeline 2008 voice reform takes effect All Executive Directors are up for election

By: The advanced European 14th General Review of contries’ representation on 2012 Annual Quotas adopted the Executive Board is Meetings reduced by two

The composition of the Executive Board is reviewed January 2013 Review of quota formular every 8 years

January 2014 15th General Review of Quotas completed

Note: The arrows indicate internal dependencies. Source: IMF. Monetary Review - 4th Quarter 2010

130 member countries, and subsequently accepted by the member countries. Governor Nils Bernstein, Danmarks Nationalbank, is Denmark's member of the Board of Governors. The Executive Board will recommend the reform for adoption by the IMF's Board of Governors, which will then vote on it. The votes must be cast by 15 December 2010, and the reform must be adopted by a majority of 85 per cent of the votes. After that, the IMF member countries must indicate whether they can accept the amendments to the Articles of Agreement. A double majority of 85 per cent of the votes and three fifths of the members is required. In a number of countries, the amendments must be approved by the national parliaments, which means that the process could be lengthy. The most recent quota and voice reform from 2008 has not yet been approved by all countries. As of 30 November 2010, 98 members, including Denmark, had voted in favour of the reform, corresponding to 82.8 per cent of the total votes. For the 2008 reform to take effect, 85 per cent of the votes and three fifths of the members (113) must vote in favour of the proposals. Ratification of the 2010 reform is conditional upon approval of the 2008 reform.

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Speech by Nils Bernstein at the Annual Meeting of the Danish Bankers Association on 6 December 2010

The world economy is slowly emerging from the crisis. Global developments are diverse, with strong growth in the Asian emerging economies and parts of South America and slower growth in the old industrialised countries. It remains uncertain to which extent private consumption in the USA and Europe will take over when the government stimulus programmes expire and the necessary fiscal consolidation starts. High rates of unemployment and uncertainty about the future will dampen private consumption. Investment will gradually begin to fuel the economy again, while the contribution from stock rebuilding will fade away. In Germany and Sweden – Denmark's two largest export markets – growth has been surprisingly positive so far. For Denmark, Danmarks Nationalbank expects growth in the coming year to be just under 2 per cent, driven by moderate increases in private consumption, business investments and exports. The outlook is still subject to considerable uncertainty. The economy is presumably more likely to underperform than to exceed expectations. The developments on the Korean Peninsula remind us how strongly we can be influenced by uncontrollable events far from our part of the world. In Europe we have recently witnessed at close hand what the consequences can be when markets lose confidence in the ability of sovereign states to manage their own debt problems. First it was Iceland, then Latvia, then Greece and now Ireland. Where will it all end? Fortunately, Europe has so far been willing and able to lend a hand in collaboration with the IMF. But if confidence is to be restored, the member states in question must make drastic cuts in public-sector wages, pensions, etc. while also raising taxes substantially. This goes hand in hand with social unrest and loss of international reputation. Denmark is also facing a number of fiscal challenges. They are not as severe as in many other countries, but nevertheless they must be addressed in time so that they do not grow. The economic recovery plan deals with the period until 2015, but after that adverse demographics will increase the government deficit for many years – unless action is taken. Monetary Review - 4th Quarter 2010

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If we in Denmark are to avoid government debt growing to unmanage- able proportions in the long term, we will need to increase taxes, adding to the already heavy tax burden, and put a much tighter rein on public spending than ever before. In addition, we need labour market reforms to boost the supply of labour substantially. The sooner we start implementing such reforms, the better. This will give us more room for manoeuvre. Danmarks Nationalbank eagerly awaits the forthcoming plan that will chart Denmark's economic policy course until 2020. Confidence in the Danish economy will be strengthened, if broad agreement can at least be reached on the scope of the challenge. * * * The financial system is recovering. If the Danish economy develops in line with our expectations, the banks will generally be resilient to the coming losses. But in view of uncertainty concerning the economic outlook , several banks would be wise to build up further buffers. * * * Now that the Danish banks are emerging from the crisis, it is also time to consider how we can prepare ourselves better for future financial crises. At the end of September the general government guarantee covering the banks' unsecured creditors expired. Happily for us all, this took place without major problems. But the sector is not yet standing on its own two feet. The government has injected kr. 46 billion in subordinated capital and given guarantee commitments for a further kr. 364 billion. As these schemes expire, they must be replaced by market-based solutions. At the same time, the banks must prepare for tighter regulation and supervision in future. The challenge is to ensure a robust financial system that can survive without government assistance next time a crisis occurs. Credit will be more expensive and harder to come by. Banks, companies and households will all have to accept a higher equity share when operating a business or purchasing a home. This is not a purely Danish challenge. Many international forums are working hard to define common standards for the financial system to make it more robust and self-contained. However, the future international standards may not be sufficient to ensure a robust and self- contained Danish financial system in due time. Or perhaps they will not take Danish experience into account to a sufficient degree. Let me mention a few areas that will be important to consider in a Danish context. The Basel Committee's proposals for new liquidity rules and the status of mortgage bonds when calculating the new liquidity buffer have for Monetary Review - 4th Quarter 2010

133 good reason been prominent in the Danish debate. Efforts are still underway to amend key elements of the rules. But I think the sector will have to face the fact that self issued bonds cannot be included in the calculations. And after all, if you want a sound liquidity buffer, it does actually make sense that the value of this buffer is – as far as possible – independent of your own situation. The stable financing requirement has been postponed until 2018. The debate on the consequences for adjustable-rate loans has died down. On several occasions, Danmarks Nationalbank has expressed its concern about the refinancing risk on these very popular loans. The idea behind the stable financing requirement has indeed been to reduce this type of refinancing risk. Although the proposal has been postponed, this risk is very real in Denmark. Some banks spread out their auctions over the year, while others have, unfortunately, not come that far with existing loans. Spreading out the auctions is a good principle, but not sufficient to solve the basic problem. A solution needs to be found before 2018. The global financial crisis has evolved differently from country to country. But there have been common traits – such as property market developments. Rapidly rising property prices, very strong housing and property investments and high lending growth for financing such investments have all contributed to the financial crisis. That has also been the case in Denmark. The Danish banks that have succumbed to the crisis or have been close to the brink have all been characterised by very high lending growth and an almost aggressive exposure to the property sector. These factors contributed heavily to the build-up of systemic risk in the years leading up to the crisis. The Basel Committee has proposed that the financial institutions not only hold an extra capital buffer on a permanent basis, but also hold a countercyclical capital buffer. In good times, when lending growth is high, restrictions may be imposed on disbursement of dividend if the accumulated reserves are insufficient. This will dampen strong cyclical upswings. When the tide turns, the additional reserves are released. It is still uncertain whether this model will be sufficient to address the role of the property market and its financing in relation to financial stability in Denmark. Several countries have tightened or are thinking of tightening the conditions for mortgaging real property or the capital requirements imposed on the lender. Such instruments come in many shapes and can be linked to cyclical developments. It will be a challenge to develop efficient economic instruments in a world with free flows of capital – not least within the EU. This openness Monetary Review - 4th Quarter 2010

134 is a great advantage to Denmark, but as Danmarks Nationalbank sees it, we need to consider whether we can introduce instruments in this area that will support financial stability. Preferably such instruments should be a kind of automatic stabilisers. If not – they should be available to the Danish Financial Supervisory Authority and Danmarks Nationalbank. * * * The financial crisis led to a very important piece of legislation in Den- mark. The general government guarantee has been replaced by a winding-up scheme for banks – known as Bank Rescue Package III – that provides for orderly winding-up of banks that cannot continue as going concerns under their existing ownership. From society's point of view it is, as I have previously underscored, not important whether the individual bank survives, but whether sound activities can continue without interruption. People must be able to access their accounts, use their debit cards, pay their bills on time, etc. Unfortunately, the current legislation does not make it mandatory for banks to join the scheme, but merely to decide at a general meeting whether they want to join the scheme now. If they say no, this generates uncertainty as to whether they will join if the need arises. During its recent visit, the IMF took a positive approach to the Danish winding-up scheme and recommended that banks which do not join beforehand are subjected to additional capital requirements. I hope we find a voluntary solution, and today I will merely encourage banks to join the scheme at their forthcoming general meetings. With this well-intentioned advice I would like to express my appreciation to the Danish Bankers Association and its members for our cooperation over the past year.

Thank you for your attention. Monetary Review - 4th Quarter 2010

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Press Releases

14. OCTOBER 2010: INTEREST RATE INCREASE

Effective from 15 October 2010, Danmarks Nationalbank's rate of interest for certificates of deposit is increased by 0.10 percentage point to 0.60 per cent and the current account rate is increased by 0.10 percentage point to 0.50 per cent. The lending rate is maintained at 1.05 per cent, and the discount rate is maintained at 0.75 per cent. The interest rate increase is due to a raise in the short European market rates compared to the equivalent Danish market rates. This development has weakened the krone, and Danmarks Nationalbank has intervened in the foreign exchange market to support the krone. Effective from the above date, Danmarks Nationalbank's interest rates are: Lending rate: 1.05 per cent Rate of interest on certificates of deposit: 0.60 per cent Current account rate: 0.50 per cent Discount rate: 0.75 per cent

28 OCTOBER 2010: INTEREST RATE INCREASE

Effective from 29 October 2010, Danmarks Nationalbank's rate of interest for certificates of deposit is increased by 0.10 percentage point to 0.70 per cent and the current account rate is increased by 0.10 percentage point to 0.60 per cent. The lending rate is maintained at 1.05 per cent, and the discount rate is maintained at 0.75 per cent. The interest rate increase is due to a rise in the short-term European market rates compared to the equivalent Danish market rates. Effective from the above date, Danmarks Nationalbank's interest rates are: Lending rate: 1.05 per cent Rate of interest on certificates of deposit: 0.70 per cent Current account rate: 0.60 per cent Discount rate: 0.75 per cent Monetary Review - 4th Quarter 2010

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1 NOVEMBER 2010: THE IMF ARTICLE IV CONSULTATION ON THE DANISH ECONOMY

The International Monetary Fund (IMF) regularly carries out Article IV Consultations on the state of the economy in individual member countries and, at the same time, presents recommendations on the country’s economic policy. As far as Denmark is concerned, the Article IV Consulta- tions are carried out every other year. Today, at a press meeting at Danmarks Nationalbank, a delegation from the IMF presented conclusions and recommendations from their Article IV Consultation on the Danish economy in 2010. Governor Nils Bernstein, Danmarks Nationalbank, comments on the Consultation: "Basically, Danmarks Nationalbank shares the IMF's view of the current economic situation in Denmark, and we agree with the IMF in their recommendations on Danish fiscal policy. To ensure the credibility of the Danish fixed-exchange-rate policy and other aspects of economic policy, it is essential to stay focused on the planned consolidation of public sector finances starting next year in order to gradually eliminate the government budget deficit. Danmarks Nationalbank also agrees with the IMF that it will require tight spending policies and ongoing labour market reforms to ensure the sustainability of long-term fiscal policy. This will be a long haul, and a new 2020 plan for the Danish economy can be a useful tool when it comes to keeping developments on track." The IMF also assessed the latest trends for the Danish financial sector. Governor Nils Bernstein says: "The IMF believes that the stability of the Danish financial system is recovering, but that the banking sector will be faced with significant challenges over the coming years. Danmarks Nationalbank agrees with this assessment. The upcoming regulation presents a challenge. The IMF states that, in its current form, the Basel Committee's proposal for new liquidity ratios will have implications for the Danish mortgage market as well as the market for government securities. Danmarks Nationalbank appreciates the IMF's recognition of Danish mortgage bonds as liquid assets. On previous occasions, Danmarks Nationalbank has pointed to the need for closer integration between Danmarks Nationalbank and the Danish Financial Supervisory Authority. This is in line with the IMF's considerations concerning increased cooperation between the two institutions," the Governor says.

26 NOVEMBER 2010: NEW SHIP COIN WITH KAYAK-UMIAK

On 29 November 2010 Danmarks Nationalbank issues a new 20-krone coin. This is the eighth coin in the thematic series with ships. Monetary Review - 4th Quarter 2010

137

The motif for the new ship coin with a Kayak-Umiak is designed by the Greenland sculptor Niels Motzfeldt, who also designed the motifs on the tower coin "Three Brothers" and the polar coin "Polar Bear". The obverse of the coin carries a portrait of the Queen in profile. This is a new portrait of the Queen made for the commemorative coin to mark the 70th birthday of Her Majesty Queen Margrethe II on April 2010. As from 29 November the coin can be purchased from certain banks and Danmarks Nationalbank. The coin can also be acquired from The Royal Danish Mint's website, www.royalmint.dk. Pictures of the coin can be downloaded from www.nationalbanken.dk – Press room - photogallery or from www.royalmint.dk. Monetary Review - 4th Quarter 2010

Monetary Review - 4th Quarter 2010

Tables

Interest rates and share-price index ...... 1

Selected items from Danmarks Nationalbank's balance sheet ...... 2

Factors affecting the banks' and the mortgage-credit institutes' net position with Danmarks Nationalbank ...... 3

Selected items from the consolidated balance sheet of the MFI sector 4

Money stock ...... 5

Selected items from the balance sheet of the banks ...... 6

Selected items from the balance sheet of the mortgage-credit institutes ...... 7

Lending to residents by the banks and the mortgage-credit institutes . 8

The mortgage-credit institutes' lending broken down by type ...... 9

The banks' effective interest rates ...... 10

Selected items from the balance sheet of the investment funds ...... 11

Securities issued by residents by owner's home country ...... 12

Households' financial assets and liabilities ...... 13

Companies' financial assets and liabilities ...... 14

Current account of the balance of payments ...... 15

Financial account of the balance of payments ...... 16

Portfolio investments of the balance of payments ...... 17

Denmark's external assets and liabilities ...... 18

GDP by type of expenditure ...... 19

EU-harmonized index of consumer prices (HICP) and underlying inflation (IMI) ...... 20

Selected monthly economic indicators ...... 21

Selected quarterly economic indicators ...... 22

Exchange rates ...... 23

Effective krone rate ...... 24

Danmarks Nationalbank's Statistical Publications

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Symbols and Sources

0 Magnitude nil or less than one half of unit employed. … Data not available or of negligible interest.

Some of the most recent statistics may be provisional. Due to rounding- off there may be small differences between the sum of the individual figures and the totals stated.

The Tables section of this publication is closed on 2 December 2010.

Danmarks Nationalbank is the source for Tables 1-14, 16-18 and 23-24, while the NASDAQ OMX Copenhagen is the source for series of bond yields and the share-price index in Table 1. Statistics Denmark is the source for Tables 15 and 19-22. The calculations in Tables 20 and 24 have been made by Danmarks Nationalbank on the basis of data from Statis- tics Denmark and OECD.

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INTEREST RATES AND SHARE-PRICE INDEX Table 1

The Danmarks ECB's Nationalbank's interest interest rates rate Bond yields

Main re- Inter- financ- bank ing interest 10-year 30-year Share- opera- rate, central- mort- price Certifi- tions, 3-months govern- gage- index Discount cates of fixed uncollat- ment credit OMXC20 rate Lending deposit rate1 eralized bond bond (prev.KFX) Effective end-of-year/ End of pe- 3.7.89 from Per cent per annum riod Per cent per annum =100

2005 ...... 2.25 2.40 2.40 2.25 2005 ...... 2.46 3.30 4.39 393.52 2006 ...... 3.50 3.75 3.75 3.50 2006 ...... 3.81 3.95 5.24 441.48 2007 ...... 4.00 4.25 4.25 4.00 2007 ...... 4.65 4.48 5.61 464.14 2008 ...... 3.50 3.75 3.75 2.50 2008 ...... 4.20 3.31 6.21 247.72 2009 ...... 1.00 1.20 0.95 1.00 2009 ...... 0.85 3.62 5.19 336.69 2009 25 Sep 1.00 1.25 1.15 1.00 Nov 09 .... 1.05 3.53 5.21 327.20 29 Sep 1.00 1.25 1.00 1.00 Dec 09 .... 0.85 3.62 5.19 336.69 11 Dec 1.00 1.20 0.95 1.00 Jan 10 .... 0.80 3.54 5.10 354.85 Feb 10 .... 0.85 3.42 5.03 354.77 2010 8 Jan 1.00 1.15 0.90 1.00 Mar 10 .... 0.70 3.37 5.01 383.04 15 Jan 0.75 1.05 0.80 1.00 Apr 10 .... 0.70 3.21 4.98 411.50 26 Mar 0.75 1.05 0.70 1.00 May 10 .... 0.50 2.69 4.81 388.69 20 May 0.75 1.05 0.60 1.00 27 May 0.75 1.05 0.50 1.00 Jun 10 .... 0.50 2.68 4.80 393.02 15 Oct 0.75 1.05 0.60 1.00 Jul 10 ....0.55 2.76 4.79 410.83 29 Oct 0.75 1.05 0.70 1.00 Aug 10 .... 0.62 2.16 4.09 396.38 Sep 10 .... 0.55 2.35 4.15 416.96 Oct 10 .... 0.90 2.61 4.31 424.20 2 Dec 0.75 1.05 0.70 1.00 Nov 10 .... 0.80 2.82 4.47 424.77

1 Until 7 October 2008 minimum bid rate.

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SELECTED ITEMS FROM DANMARKS NATIONALBANK'S BALANCE SHEET Table 2

The The banks' and the mortgage-credit central institutes' net position with govern- Danmarks Nationalbank ment's The account foreign- Notes and with exchange coin in Danmarks Certifi- Deposits reserve circula- National- cates of (current Total net (net) tion bank deposit account) Loans position

End of period Kr. billion

2005 ...... 212.3 56.2 56.4 207.6 12.8 135.3 85.1 2006 ...... 171.7 59.8 73.8 163.2 8.8 153.7 18.2 2007 ...... 168.8 61.6 89.9 200.5 9.4 216.8 -6.9 2008 ...... 211.7 61.3 262.8 118.5 9.7 240.9 -112.7 2009 ...... 394.5 60.8 212.4 166.2 22.1 104.2 84.1 Oct 09 ...... 376.1 58.4 195.6 167.4 10.2 92.8 84.8 Nov 09 ...... 383.4 58.6 185.2 142.0 15.0 53.3 103.7 Dec 09 ...... 389.1 60.8 210.9 166.2 22.1 104.2 84.1 Jan 10 ...... 415.4 58.1 196.0 131.2 11.3 26.4 116.2 Feb 10 ...... 416.1 58.3 202.0 113.8 12.3 15.5 110.6 Mar 10 ...... 417.2 59.4 203.5 116.1 19.2 23.3 112.0 Apr 10 ...... 404.1 60.5 190.3 96.9 16.3 3.1 110.1 May 10 ...... 440.5 61.3 199.8 120.3 16.8 0.5 136.6 Jun 10 ...... 438.3 61.4 220.7 142.1 23.5 47.2 118.4 Jul 10 ...... 428.6 61.2 191.5 121.0 16.0 0.1 136.9 Aug 10 ...... 429.1 60.9 216.8 95.3 16.0 0.1 111.3 Sep 10 ...... 431.3 60.7 218.5 108.2 12.6 9.9 110.9 Oct 10 ...... 421.7 61.1 206.3 99.9 16.1 0.1 115.9

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FACTORS AFFECTING THE BANKS' AND THE MORTGAGE-CREDIT INSTITUTES' NET POSITION WITH DANMARKS NATIONALBANK Table 3

The banks' and the mortgage- credit institutes' net position Net purchase of with Central-government foreign exchange by Danmarks finance Danmarks Nationalbank Nationalbank Net Sales of pur- do- chase Do- mestic of mestic central- Interven- bonds gross govern- tions to by financ- ment purchase Dan- ing securi- Liquid- foreign marks Change require- ties, ity exchange, Nation- Other in net End of ment etc. effect net Other Total albank factors position period

Kr. billion

2005 ...... 39.5 30.9 8.6 -18.4 3.0 -15.4 -2.2 -0.5 -9.5 85.1 2006 ...... -14.5 16.2 -30.6 -34.3 4.3 -30.0 -4.9 -1.2 -66.7 18.2 2007 ...... -26.1 2.9 -29.1 -1.7 7.2 5.5 -0.4 -1.4 -25.3 -6.9 2008 ...... -11.9 99.6 -111.5 -19.9 0.1 -19.8 0.6 24.9 -105.8 -112.7 2009 ...... 178.6 123.8 54.8 153.6 17.1 170.7 6.5 -35.3 196.8 84.1 Oct 09 ...... 17.3 20.5 -3.2 0.0 -0.1 -0.1 0.5 -1.2 -3.9 84.8 Nov 09 ...... 28.9 19.6 9.3 8.7 -0.2 8.5 -0.2 1.2 18.9 103.7 Dec 09 ...... -12.4 13.8 -26.2 7.9 -1.7 6.2 -0.4 0.7 -19.6 84.1 Jan 10 ...... 27.2 13.5 13.7 18.7 3.5 22.2 -3.7 -0.2 32.1 116.2 Feb 10 ...... 8.6 16.0 -7.4 0.0 2.1 2.1 1.3 -1.6 -5.5 110.6 Mar 10 ...... 19.5 22.0 -2.5 3.1 -0.9 2.2 1.2 0.4 1.3 112.0 Apr 10 ...... 17.8 17.9 -0.1 0.0 0.3 0.3 0.9 -2.8 -1.8 110.1 May 10 ...... 4.4 15.1 -10.7 38.5 -0.7 37.8 1.0 -1.6 26.5 136.6 Jun 10 ...... 4.2 26.2 -22.0 0.0 -1.0 -1.0 0.2 4.7 -18.1 118.4 Jul 10 ...... 36.5 8.5 28.0 -8.4 0.0 -8.4 0.0 -1.2 18.5 136.9 Aug 10 ...... -15.6 10.1 -25.7 0.0 0.9 0.9 -0.2 -0.7 -25.6 111.3 Sep 10 ...... 7.8 10.7 -2.9 3.4 0.1 3.5 -0.5 -0.5 -0.4 110.9 Oct 10 ...... 14.2 4.3 9.9 -7.3 0.1 -7.2 -0.2 2.5 5.0 115.9

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SELECTED ITEMS FROM THE CONSOLIDATED BALANCE SHEET OF THE MFI SECTOR Table 4

Assets Liabilities

Domestic Domestic lending securities

Bonds, Foreign Total Public Private Bonds, Shares, Domestic etc. assets, balance sector sector etc. etc. deposits issued net 1

End of period Kr. billion

2005 ...... 4,221.9 107.8 2,584.2 75.9 53.5 971.3 1,318.2 -172.9 2006 ...... 4,656.2 116.8 2,956.0 51.8 60.3 1,077.0 1,433.4 -223.0 2007 ...... 5,446.3 117.5 3,356.1 43.3 63.5 1,219.7 1,505.2 -304.5 2008 ...... 6,286.4 129.1 3,724.3 40.6 56.7 1,487.5 1,508.4 -407.9 2009 ...... 5,970.1 135.9 3,647.9 78.2 65.5 1,427.9 1,650.9 -417.6 Oct 09 ...... 5,945.4 131.7 3,642.0 74.1 63.0 1,413.9 1,630.1 -382.9 Nov 09 ...... 6,025.3 130.5 3,648.3 74.8 63.2 1,392.3 1,644.3 -417.3 Dec 09 ...... 5,970.1 135.9 3,647.9 78.2 65.5 1,427.9 1,650.9 -417.6 Jan 10 ...... 6,091.2 133.7 3,660.0 80.1 68.0 1,430.4 1,684.5 -399.5 Feb 10 ...... 6,150.8 132.1 3,652.2 72.2 68.6 1,421.9 1,690.3 -403.9 Mar 10 ...... 6,143.5 135.3 3,660.2 77.1 69.2 1,419.4 1,713.2 -396.7 Apr 10 ...... 6,137.6 136.1 3,651.7 74.9 69.5 1,421.8 1,685.5 -396.3 May 10 ...... 6,435.3 136.8 3,679.3 66.3 70.3 1,428.2 1,718.9 -389.5 Jun 10 ...... 6,394.5 140.7 3,719.6 54.1 79.5 1,432.8 1,718.2 -396.4 Jul 10 ...... 6,398.7 143.7 3,694.1 46.5 80.9 1,443.1 1,719.9 -359.6 Aug 10 ...... 6,614.0 138.9 3,716.7 64.5 81.3 1,471.3 1,763.6 -332.5 Sep 10 ...... 6,511.8 143.1 3,713.9 66.2 74.3 1,430.8 1,792.8 -337.4 Oct 10 ...... 6,346.3 141.5 3,704.5 56.1 77.3 1,446.4 1,765.6 -309.3 Change compared with previous year, per cent 2005 ...... 10.6 15.0 -24.7 15.4 14.4 7.9 ... 2006 ...... 8.3 14.4 -31.8 12.8 10.9 8.7 ... 2007 ...... 0.6 13.5 -16.4 5.2 13.3 5.0 ... 2008 ...... 9.8 11.0 -6.2 -10.7 22.0 0.2 ... 2009 ...... 5.3 -2.1 92.4 15.5 -4.0 9.4 ... Oct 09 ...... 5.0 0.2 80.1 11.3 4.5 10.8 ... Nov 09 ...... 4.1 -1.1 60.7 11.7 -5.2 13.7 ... Dec 09 ...... 5.3 -2.1 92.4 15.5 -4.0 9.4 ... Jan 10 ...... 3.4 -1.8 111.1 19.0 -3.3 12.1 ... Feb 10 ...... 3.9 -1.4 60.7 22.5 -2.8 11.9 ... Mar 10 ...... 5.4 -1.8 54.3 26.1 -0.7 9.7 ... Apr 10 ...... 5.2 -1.5 33.6 23.2 -1.2 7.4 ... May 10 ...... 6.5 0.2 11.1 21.6 -0.3 8.8 ... Jun 10 ...... 5.4 0.2 -10.4 34.0 1.9 6.0 ... Jul 10 ...... 5.9 0.5 -26.8 38.5 -0.1 5.9 ... Aug 10 ...... 6.5 1.7 -4.1 38.0 3.4 9.1 ... Sep 10 ...... 9.2 1.2 -8.5 20.6 1.6 7.5 ... Oct 10 ...... 7.5 1.7 -24.4 22.7 2.3 8.3 ...

Note: The MFI sector includes Danish monetary financial institutions, i.e. banks and mortgage-credit institutes, other credit institutions, money-market funds and Danmarks Nationalbank. 1 The net foreign assets of the MFI sector has been compiled as the difference between all assets and liabilities vis-a-vis non-residents.

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MONEY STOCK Table 5

Bonds, Time Deposits etc. Bank- deposits at notice issued notes with with with and original original Repur- original coin in Deposits maturity maturity chase maturity circula- on =<2 =< 3 agree- =< 2 tion1 demand M1 years months M2 ments years M3

End of period Kr. billion

2005 ...... 47.3 596.3 643.5 114.1 18.4 776.0 14.2 8.4 798.7 2006 ...... 50.7 648.6 699.3 143.0 17.9 860.2 8.0 21.3 889.5 2007 ...... 51.9 703.2 755.1 199.7 18.0 972.8 6.2 61.5 1,040.6 2008 ...... 50.4 704.8 755.2 286.4 18.4 1,060.0 4.0 57.0 1,121.1 2009 ...... 48.5 772.0 820.5 183.2 19.6 1,023.3 10.9 143.0 1,177.3 Oct 09 ...... 49.7 781.0 830.6 201.3 18.0 1,050.0 2.9 165.8 1,218.7 Nov 09 ...... 48.1 785.6 833.7 186.9 17.7 1,038.3 3.1 160.1 1,200.6 Dec 09 ...... 48.5 772.0 820.5 183.2 19.6 1,023.3 10.9 143.0 1,177.3 Jan 10 ...... 47.4 792.9 840.4 185.5 17.2 1,043.0 6.9 172.3 1,222.2 Feb 10 ...... 47.5 791.3 838.8 174.6 17.3 1,030.7 6.5 162.3 1,199.6 Mar 10 ...... 50.7 788.4 839.1 156.9 17.5 1,013.4 19.9 187.3 1,220.8 Apr 10 ...... 51.1 806.4 857.5 157.4 16.2 1,031.1 17.2 177.0 1,225.5 May 10 ...... 51.3 811.8 863.1 161.3 16.6 1,041.0 4.4 201.1 1,246.7 Jun 10 ...... 51.4 800.1 851.5 144.3 17.2 1,013.1 15.3 210.5 1,239.0 Jul 10 ...... 51.5 814.6 866.1 154.4 17.2 1,037.8 31.8 245.6 1,315.3 Aug 10 ...... 51.1 811.8 862.9 151.3 17.2 1,031.3 40.6 254.2 1,326.2 Sep 10 ...... 51.2 789.8 840.9 128.8 16.6 986.3 43.2 236.4 1,266.0 Oct 10 ...... 51.8 797.0 848.8 156.3 17.9 1,023.0 33.8 231.8 1,288.6

Change compared with previous year, per cent 2005 ...... 19.9 ...... 14.7 ...... 14.3 2006 ...... 8.7 ...... 10.8 ...... 11.4 2007 ...... 8.0 ...... 13.1 ...... 17.0 2008 ...... 0.0 ...... 9.0 ...... 7.7 2009 ...... 8.6 ...... -3.5 ...... 5.0 Oct 09 ...... 9.5 ...... -1.5 ...... 4.4 Nov 09 ...... 9.4 ...... -2.4 ...... 3.6 Dec 09 ...... 8.6 ...... -3.5 ...... 5.0 Jan 10 ...... 9.1 ...... -3.7 ...... 2.9 Feb 10 ...... 7.8 ...... -4.4 ...... 0.4 Mar 10 ...... 9.1 ...... -4.0 ...... 3.1 Apr 10 ...... 9.1 ...... -2.5 ...... 3.0 May 10 ...... 7.9 ...... -2.8 ...... 2.9 Jun 10 ...... 6.4 ...... -3.1 ...... 3.8 Jul 10 ...... 6.7 ...... -2.7 ...... 6.5 Aug 10 ...... 3.7 ...... -3.5 ...... 8.6 Sep 10 ...... 4.6 ...... -4.4 ...... 4.0 Oct 10 ...... 2.2 ...... -2.6 ...... 5.7

1 Notes and coin in circulation, excluding the banks' holdings.

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SELECTED ITEMS FROM THE BALANCE SHEET OF THE BANKS Table 6

Assets Liabilities

Domestic lending

of which:

Non- House- financial Holdings Loans Total Lending holds, compa- of from balance to MFIs Total etc. nies securities MFIs Deposits

End of period Kr. billion

2005 ...... 2,860.9 652.0 920.1 396.6 370.0 862.1 975.7 1,065.6 2006 ...... 3,216.1 715.0 1,124.3 475.0 458.0 889.6 1,133.4 1,148.3 2007 ...... 3,940.0 924.3 1,333.6 557.4 551.8 1,065.8 1,441.8 1,345.6 2008 ...... 4,568.5 974.6 1,546.3 586.8 603.3 1,092.1 1,444.2 1,424.2 2009 ...... 4,147.6 876.1 1,359.1 575.7 529.7 1,203.5 1,186.0 1,410.2 Oct 09 ...... 4,103.1 784.2 1,357.3 562.5 517.7 1,236.3 1,074.3 1,440.4 Nov 09 ...... 4,170.2 861.8 1,355.7 560.6 529.3 1,204.9 1,154.9 1,428.6 Dec 09 ...... 4,147.6 876.1 1,359.1 575.7 529.7 1,203.5 1,186.0 1,410.2 Jan 10 ...... 4,263.3 950.4 1,361.4 565.4 523.6 1,200.6 1,257.2 1,427.2 Feb 10 ...... 4,287.3 969.2 1,344.9 560.9 534.6 1,180.7 1,258.2 1,415.9 Mar 10 ...... 4,293.0 949.6 1,347.2 566.5 532.3 1,241.8 1,264.5 1,417.4 Apr 10 ...... 4,226.3 916.4 1,333.6 560.0 528.0 1,189.8 1,149.0 1,440.4 May 10 ...... 4,485.0 958.3 1,352.7 558.9 527.0 1,216.5 1,180.2 1,456.0 Jun 10 ...... 4,485.9 917.9 1,388.3 569.5 531.6 1,275.3 1,204.8 1,421.3 Jul 10 ...... 4,437.4 935.8 1,361.4 563.1 510.8 1,243.5 1,152.5 1,490.6 Aug 10 ...... 4,611.5 965.2 1,370.5 563.3 518.5 1,221.8 1,165.3 1,540.0 Sep 10 ...... 4,537.0 910.0 1,362.2 571.9 503.9 1,223.7 1,297.3 1,463.6 Oct 10 ...... 4,347.1 921.8 1,348.3 564.9 495.0 1,154.1 1,174.2 1,513.3

Change compared with previous year, per cent 2005 ...... 31.7 21.9 22.1 19.5 10.5 18.5 17.3 2006 ...... 9.7 22.2 19.8 23.8 3.2 16.2 7.8 2007 ...... 29.3 18.6 17.4 20.5 19.8 27.2 17.2 2008 ...... 5.4 15.9 5.3 9.3 2.5 0.2 5.8 2009 ...... -10.1 -12.1 -1.9 -12.2 10.2 -17.9 -1.0 Oct 09 ...... -23.4 -7.8 -4.3 -11.2 6.0 -31.7 -0.3 Nov 09 ...... -19.7 -10.2 -3.9 -11.7 0.3 -30.9 -1.2 Dec 09 ...... -10.1 -12.1 -1.9 -12.2 10.2 -17.9 -1.0 Jan 10 ...... 0.8 -11.3 -2.3 -10.6 3.7 -12.2 -1.8 Feb 10 ...... 6.9 -10.2 -2.0 -7.2 0.1 -9.2 -0.6 Mar 10 ...... 0.8 -10.6 -2.0 -7.2 4.7 -11.0 1.1 Apr 10 ...... -5.5 -9.5 -1.6 -7.0 -2.1 -20.9 1.7 May 10 ...... 9.2 -5.4 -0.8 -4.3 -8.6 -14.3 0.8 Jun 10 ...... 9.9 -5.0 -0.1 -4.4 -4.8 -12.9 1.2 Jul 10 ...... 12.9 -4.1 0.5 -4.7 -3.8 -6.8 3.8 Aug 10 ...... 20.3 -0.6 1.2 -2.3 -5.0 3.5 6.0 Sep 10 ...... 15.8 -2.1 0.6 -3.5 -1.3 13.4 5.0 Oct 10 ...... 17.5 -0.7 0.4 -4.4 -6.7 9.3 5.1

Note: Excluding Danish banks' units abroad.

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SELECTED ITEMS FROM THE BALANCE SHEET OF THE MORTGAGE-CREDIT INSTITUTES Table 7

Assets Liabilities

Domestic lending

of which:

Non- House- financial Holdings Loans Bonds, Total Lending holds, compa- of from etc. balance to MFIs Total etc. nies securities MFIs issued

End of period Kr. billion

2005 ...... 2,519.9 101.4 1,664.4 1,281.5 334.2 645.0 151.7 2,237.0 2006 ...... 2,699.9 245.1 1,834.8 1,420.2 358.2 574.1 226.5 2,297.9 2007 ...... 3,088.2 362.8 2,015.5 1,549.2 404.0 649.2 344.2 2,495.2 2008 ...... 3,322.7 428.5 2,164.6 1,629.6 466.7 633.5 474.4 2,582.3 2009 ...... 3,827.1 512.2 2,278.8 1,712.2 501.0 927.6 539.3 3,048.3 Oct 09 ...... 3,127.3 410.7 2,271.1 1,698.7 503.7 343.9 457.5 2,450.8 Nov 09 ...... 3,236.9 420.0 2,278.9 1,704.9 504.2 426.6 456.0 2,557.0 Dec 09 ...... 3,827.1 512.2 2,278.8 1,712.2 501.0 927.6 539.3 3,048.3 Jan 10 ...... 3,074.5 429.2 2,283.2 1,714.0 504.2 278.4 484.6 2,418.2 Feb 10 ...... 3,120.7 438.3 2,288.9 1,716.5 506.6 290.8 495.5 2,444.5 Mar 10 ...... 3,235.7 500.4 2,293.2 1,718.4 507.4 344.5 502.9 2,540.3 Apr 10 ...... 3,122.4 424.8 2,298.2 1,718.0 512.8 286.9 477.7 2,453.6 May 10 ...... 3,171.6 460.2 2,305.5 1,723.4 517.3 289.5 496.8 2,491.3 Jun 10 ...... 3,263.7 523.3 2,315.2 1,730.0 518.3 315.6 529.3 2,538.8 Jul 10 ...... 3,229.2 477.8 2,320.4 1,734.5 519.5 315.9 515.7 2,516.5 Aug 10 ...... 3,288.0 502.8 2,328.9 1,742.0 519.8 332.4 534.2 2,561.6 Sep 10 ...... 3,398.8 583.7 2,336.6 1,743.5 524.8 361.9 530.4 2,648.3 Oct 10 ...... 3,277.5 498.8 2,340.0 1,747.4 525.6 337.2 520.3 2,564.0

Change compared with previous year, per cent 2005 ...... 11.1 11.7 12.3 8.5 34.0 481.5 14.6 2006 ...... 141.7 10.2 10.8 7.2 -11.0 49.3 2.7 2007 ...... 48.0 9.9 9.1 12.8 13.1 52.0 8.6 2008 ...... 18.1 7.4 5.2 15.5 -2.4 37.8 3.5 2009 ...... 19.5 5.3 5.1 7.4 46.4 13.7 18.0 Oct 09 ...... 7.0 5.8 4.7 10.2 65.8 28.7 13.9 Nov 09 ...... 16.6 5.6 4.6 9.2 54.8 24.3 14.0 Dec 09 ...... 19.5 5.3 5.1 7.4 46.4 13.7 18.0 Jan 10 ...... 27.4 4.9 4.7 6.4 -6.9 18.2 6.7 Feb 10 ...... 30.7 4.6 4.4 6.4 18.5 21.9 9.6 Mar 10 ...... 36.1 4.1 3.9 5.8 32.1 20.4 11.2 Apr 10 ...... 12.5 3.7 3.4 5.7 19.7 12.3 6.9 May 10 ...... 18.0 3.6 3.2 6.2 21.7 17.8 7.3 Jun 10 ...... 16.5 3.5 3.2 5.8 20.1 20.0 6.8 Jul 10 ...... 22.3 3.2 3.0 5.2 18.9 20.7 6.2 Aug 10 ...... 25.0 3.1 3.0 4.2 10.7 19.3 6.1 Sep 10 ...... 31.2 3.1 2.9 4.6 9.6 20.9 6.8 Oct 10 ...... 21.4 3.0 2.9 4.4 -2.0 13.7 4.6

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LENDING TO RESIDENTS BY THE BANKS AND THE MORTGAGE-CREDIT INSTITUTES Table 8

The mortgage-credit Total lending The banks' lending institutes' lending

House- House- House- holds, holds, holds, Total etc. Business Total etc. Business Total etc. Business

End of period Kr. billion

2005 ...... 2,614.5 1,678.0 852.2 950.2 396.6 510.4 1,664.4 1,281.5 341.7 2006 ...... 3,000.8 1,895.2 1,002.6 1,166.0 475.0 636.9 1,834.8 1,420.2 365.7 2007 ...... 3,387.8 2,106.7 1,173.0 1,372.3 557.4 760.5 2,015.5 1,549.2 412.4 2008 ...... 3,787.5 2,216.4 1,456.4 1,622.9 586.8 978.3 2,164.6 1,629.6 478.1 2009 ...... 3,682.4 2,287.9 1,283.8 1,403.6 575.7 770.0 2,278.8 1,712.2 513.8 Oct 09 ...... 3,672.9 2,261.2 1,303.3 1,401.9 562.5 784.8 2,271.1 1,698.7 518.5 Nov 09 ...... 3,679.1 2,265.5 1,305.7 1,400.2 560.6 785.6 2,278.9 1,704.9 520.2 Dec 09 ...... 3,682.4 2,287.9 1,283.8 1,403.6 575.7 770.0 2,278.8 1,712.2 513.8 Jan 10 ...... 3,684.5 2,279.4 1,297.1 1,401.3 565.4 780.3 2,283.2 1,714.0 516.9 Feb 10 ...... 3,673.7 2,277.4 1,291.9 1,384.8 560.9 772.6 2,288.9 1,716.5 519.3 Mar 10 ...... 3,680.4 2,285.0 1,289.5 1,387.1 566.5 769.6 2,293.2 1,718.4 519.9 Apr 10 ...... 3,661.2 2,278.0 1,276.6 1,363.0 560.0 751.7 2,298.2 1,718.0 524.9 May 10 ...... 3,687.6 2,282.3 1,300.0 1,382.1 558.9 771.0 2,305.5 1,723.4 529.0 Jun 10 ...... 3,732.9 2,299.5 1,324.5 1,417.7 569.5 794.8 2,315.2 1,730.0 529.7 Jul 10 ...... 3,701.4 2,297.6 1,292.8 1,381.1 563.1 761.8 2,320.4 1,734.5 531.1 Aug 10 ...... 3,719.0 2,305.3 1,307.4 1,390.1 563.3 776.1 2,328.9 1,742.0 531.3 Sep 10 ...... 3,718.4 2,315.4 1,293.6 1,381.8 571.9 757.8 2,336.6 1,743.5 535.8 Oct 10 ...... 3,707.9 2,312.3 1,291.1 1,367.9 564.9 754.4 2,340.0 1,747.4 536.6 Change compared with previous year, per cent

2005 ...... 14.9 14.5 15.0 20.9 22.1 19.6 11.7 12.3 8.8 2006 ...... 14.8 12.9 17.7 22.7 19.8 24.8 10.2 10.8 7.0 2007 ...... 12.9 11.2 17.0 17.7 17.4 19.4 9.9 9.1 12.8 2008 ...... 11.8 5.2 24.2 18.3 5.3 28.6 7.4 5.2 15.9 2009 ...... -2.8 3.2 -11.9 -13.5 -1.9 -21.3 5.3 5.1 7.5 Oct 09 ...... -0.6 2.3 -4.8 -9.5 -4.3 -12.9 5.8 4.7 10.7 Nov 09 ...... -1.8 2.4 -8.1 -11.8 -3.9 -17.1 5.6 4.6 9.9 Dec 09 ...... -2.8 3.2 -11.9 -13.5 -1.9 -21.3 5.3 5.1 7.5 Jan 10 ...... -2.1 2.9 -9.4 -11.6 -2.3 -17.6 4.9 4.7 6.8 Feb 10 ...... -1.7 2.7 -8.2 -10.5 -2.0 -16.0 4.6 4.4 6.6 Mar 10 ...... -2.1 2.4 -8.9 -10.9 -2.0 -16.7 4.1 3.9 5.8 Apr 10 ...... -2.3 2.1 -9.1 -10.9 -1.6 -17.0 3.7 3.4 5.1 May 10 ...... -0.7 2.2 -5.1 -7.0 -0.8 -11.2 3.6 3.2 5.6 Jun 10 ...... -0.6 2.4 -5.0 -6.6 -0.1 -10.7 3.5 3.2 5.0 Jul 10 ...... -0.3 2.4 -4.5 -5.7 0.5 -9.9 3.2 3.0 4.4 Aug 10 ...... 1.0 2.6 -1.6 -2.4 1.2 -4.7 3.1 3.0 3.5 Sep 10 ...... 0.4 2.4 -2.8 -3.8 0.6 -7.0 3.1 2.9 3.7 Oct 10 ...... 1.0 2.3 -0.9 -2.4 0.4 -3.9 3.0 2.9 3.5

Note: Including lending in Danish banks' units abroad.

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THE MORTGAGE-CREDIT INSTITUTES' LENDING BROKEN DOWN BY TYPE Table 9

Adjustable-rate lending of which:

Index- Fixed- Lending Instal- linked rate of which in foreign ment-free lending lending Total =<1 year Total currency lending 1

End of period Kr. billion

2005 ...... 88.6 720.3 853.9 616.0 1,662.8 80.5 315.5 2006 ...... 83.5 797.5 951.7 720.5 1,832.7 85.7 432.2 2007 ...... 77.9 889.2 1,045.6 796.6 2,012.7 123.8 547.3 2008 ...... 72.4 903.9 1,189.1 900.3 2,165.4 155.3 626.4 2009 ...... 68.3 740.2 1,472.7 1,106.6 2,281.2 211.4 695.1 Oct 09 ...... 71.2 776.3 1,423.1 1,097.8 2,270.7 199.6 682.4 Nov 09 ...... 70.7 769.0 1,437.9 1,103.4 2,277.6 201.3 688.0 Dec 09 ...... 68.3 740.2 1,472.7 1,106.6 2,281.2 211.4 695.1 Jan 10 ...... 68.5 729.5 1,487.3 1,092.9 2,285.3 214.2 697.5 Feb 10 ...... 68.7 719.2 1,504.0 1,103.6 2,291.9 216.1 702.5 Mar 10 ...... 68.8 697.5 1,529.8 1,137.4 2,296.1 220.3 703.2 Apr 10 ...... 69.0 684.4 1,548.1 1,147.9 2,301.5 221.8 706.2 May 10 ...... 68.8 680.3 1,560.0 1,155.3 2,309.0 224.3 710.0 Jun 10 ...... 66.7 666.2 1,585.6 1,170.7 2,318.4 228.1 716.4 Jul 10 ...... 66.7 661.5 1,595.4 1,175.4 2,323.5 228.9 719.6 Aug 10 ...... 66.6 664.5 1,600.5 1,176.7 2,331.6 229.5 722.9 Sep 10 ...... 66.6 658.2 1,614.1 1,182.7 2,338.9 231.0 727.2 Oct 10 ...... 66.5 655.6 1,619.8 1,177.3 2,341.8 231.3 731.8

Note: The Table includes the mortgage-credit lending to residents only, whereas Tables 7 and 8 include the institutes' total lending to residents. 1 The mortgage-credit institutes' instalment-free lending to owner-occupied dwellings.

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THE BANKS' EFFECTIVE INTEREST RATES Table 10

Lending Deposits

Non- Non- House- financial Financial House- financial Financial All holds, compa- compa- All holds, compa- compa- sectors etc. nies nies sectors etc. nies nies

Per cent, per annum

Q1 05 ...... 5.1 6.7 4.8 2.8 1.7 1.3 1.7 2.1 Q2 05 ...... 4.9 6.5 4.6 2.7 1.7 1.3 1.7 2.1 Q3 05 ...... 4.8 6.3 4.5 2.6 1.7 1.3 1.7 2.2 Q4 05 ...... 4.7 6.2 4.4 2.6 1.7 1.3 1.8 2.2 Q1 06 ...... 4.8 6.2 4.5 2.8 1.9 1.5 2.0 2.4 Q2 06 ...... 5.0 6.4 4.7 3.1 2.1 1.8 2.3 2.6 Q3 06 ...... 5.2 6.6 5.0 3.3 2.4 2.1 2.5 2.8 Q4 06 ...... 5.4 6.8 5.2 3.5 2.7 2.4 2.9 3.2 Q1 07 ...... 5.7 7.1 5.5 3.6 3.1 2.8 3.2 3.4 Q2 07 ...... 5.9 7.2 5.7 4.0 3.4 3.1 3.4 3.8 Q3 07 ...... 6.1 7.4 6.0 4.1 3.6 3.3 3.6 4.0 Q4 07 ...... 6.2 7.4 6.1 4.3 3.7 3.4 3.7 4.1 Q1 08 ...... 6.2 7.5 6.1 4.5 3.7 3.5 3.8 4.2 Q2 08 ...... 6.5 7.7 6.3 4.6 3.8 3.6 3.9 4.2 Q3 08 ...... 6.6 7.8 6.5 4.9 4.0 3.6 4.1 4.5 Q4 08 ...... 7.0 8.4 7.1 5.2 4.4 3.9 4.5 5.0 Q1 09 ...... 6.0 7.4 6.3 4.0 3.3 2.8 3.2 4.1 Q2 09 ...... 5.1 6.4 5.4 2.7 2.2 2.0 2.0 2.6 Q3 09 ...... 4.5 6.0 5.0 2.1 1.7 1.7 1.5 1.9 Q4 09 ...... 4.1 5.6 4.6 1.7 1.4 1.5 1.1 1.5 Q1 10 ...... 3.9 5.5 4.4 1.5 1.2 1.4 0.9 1.3 Q2 10 ...... 3.6 5.3 4.2 1.3 1.0 1.2 0.7 1.0 Q3 10 ...... 3.5 5.1 4.1 1.2 0.9 1.1 0.6 0.8 Q4 10 ...... Oct 09 ...... 4.3 5.7 4.7 1.9 1.5 1.5 1.2 1.6 Nov 09 ...... 4.1 5.7 4.6 1.6 1.4 1.5 1.1 1.5 Dec 09 ...... 3.9 5.6 4.5 1.5 1.3 1.5 1.1 1.4 Jan 10 ...... 3.9 5.6 4.4 1.5 1.3 1.4 1.0 1.4 Feb 10 ...... 3.9 5.4 4.4 1.5 1.2 1.3 0.9 1.3 Mar 10 ...... 3.8 5.4 4.4 1.4 1.2 1.3 0.9 1.3 Apr 10 ...... 3.7 5.4 4.3 1.3 1.1 1.3 0.8 1.1 May 10 ...... 3.7 5.4 4.3 1.3 1.0 1.2 0.8 0.9 Jun 10 ...... 3.5 5.1 4.1 1.2 0.9 1.1 0.6 0.9 Jul 10 ...... 3.5 5.2 4.1 1.1 0.9 1.1 0.6 0.8 Aug 10 ...... 3.5 5.1 4.1 1.2 0.9 1.1 0.6 0.8 Sep 10 ...... 3.5 5.1 4.1 1.2 0.9 1.1 0.6 0.8 Oct 10 ...... 3.5 5.2 4.2 1.1 0.9 1.1 0.6 0.8

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SELECTED ITEMS FROM THE BALANCE SHEET OF INVESTMENT FUNDS Table 11

Assets Liabilities

Holdings of Investment fund shares/units broken securities down by sector

Insurance companies and Total Bonds, Shares, House- pension balance etc. etc. holds funds Other Abroad

End of period Kr. billion

2005 ...... 794.7 412.1 286.4 265.7 236.5 263.0 24.4 2006 ...... 924.7 431.8 385.4 294.3 289.6 305.1 28.8 2007 ...... 1,020.7 477.9 411.6 295.2 336.8 322.1 29.2 2008 ...... 773.2 425.3 222.5 211.4 266.9 238.1 14.6 2009 ...... 865.5 487.5 301.4 252.7 357.8 185.1 22.7 Jan 10 ...... 895.0 515.5 290.8 253.6 366.5 191.0 22.5 Feb 10 ...... 906.5 522.4 299.5 256.3 368.5 190.7 26.0 Mar 10 ...... 934.3 525.4 316.9 265.8 388.8 198.3 27.3 Apr 10 ...... 955.9 535.2 332.6 269.9 398.6 204.8 27.3 May 10 ...... 967.1 554.7 313.5 268.2 412.7 198.7 27.0 Jun 10 ...... 992.0 586.0 311.0 271.3 447.2 196.4 27.2 Jul 10 ...... 1,010.0 591.9 322.0 276.2 454.9 200.9 27.0 Aug 10 ...... 1,031.8 625.1 307.2 276.8 472.6 204.3 27.4 Sep 10 ...... 1,117.9 676.1 319.7 283.3 539.5 211.0 26.7 Oct 10 ...... 1,167.7 711.8 335.4 287.9 578.0 216.2 26.7

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SECURITIES ISSUED BY RESIDENTS BY OWNER'S HOME COUNTRY Table 12

Bonds, etc.

of which:

Central-government Mortgage-credit Total securities bonds Shares

Denmark Abroad Denmark Abroad Denmark Abroad Denmark Abroad

End of period Market value, kr. billion

2005 ...... 2,559.7 461.2 434.9 205.1 2,002.9 252.5 845.2 300.5 2006 ...... 2,541.3 464.7 380.1 172.6 2,034.9 285.9 989.4 361.8 2007 ...... 2,701.2 475.8 301.9 176.2 2,247.1 287.7 996.1 445.4 2008 ...... 2,981.5 405.0 363.1 158.5 2,419.2 227.4 529.9 244.4 2009 ...... 3,415.2 431.4 394.2 159.8 2,803.0 251.7 641.0 347.5 Oct 09 ...... 2,913.0 454.4 406.1 162.9 2,296.7 272.2 620.1 332.2 Nov 09 ...... 3,039.0 451.2 398.4 162.5 2,433.9 269.1 619.8 337.1 Dec 09 ...... 3,415.2 431.4 394.2 159.8 2,803.0 251.7 641.0 347.5 Jan 10 ...... 2,744.7 455.3 414.1 156.4 2,123.6 280.5 677.6 367.0 Feb 10 ...... 2,770.4 471.0 418.1 168.7 2,146.3 282.3 673.3 374.0 Mar 10 ...... 2,894.4 465.2 432.9 170.5 2,251.6 274.8 705.7 407.5 Apr 10 ...... 2,767.4 507.3 440.2 181.1 2,117.4 307.1 739.2 435.8 May 10 ...... 2,849.6 505.2 473.7 177.9 2,159.9 308.5 666.3 445.0 Jun 10 ...... 2,973.4 499.2 486.2 191.1 2,257.5 286.4 670.5 463.9 Jul 10 ...... 2,929.8 528.3 483.3 193.9 2,186.8 313.5 688.3 475.6 Aug 10 ...... 2,991.8 547.5 500.2 213.4 2,233.3 311.5 652.7 460.3 Sep 10 ...... 3,060.3 547.3 494.7 207.4 2,334.0 314.1 682.9 491.9 Oct 10 ...... 2,928.1 556.8 483.8 195.8 2,213.7 334.9 718.9 518.5

Note: Comprise quoted and unquoted securities registered with the VP Securities Services (VP).

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HOUSEHOLDS' FINANCIAL ASSETS AND LIABILITIES Table 13

Assets Liabilities

Shares and certific- Life- ates insurance Currency issued by and and invest- pension- bank ment scheme Net deposits, Bonds, associa- savings, Loans, financial etc. etc. tions, etc. etc. Total etc. assets Total

End of period Kr. billion

2005 ...... 785 173 1,121 1,617 3,696 1,891 1,805 3,696 2006 ...... 839 181 1,560 1,681 4,260 2,075 2,185 4,260 2007 ...... 902 188 1,445 1,723 4,258 2,272 1,986 4,258 2008 ...... 905 178 793 1,785 3,660 2,442 1,219 3,660 2009 ...... 924 171 910 1,926 3,931 2,560 1,370 3,931 Q2 09 ...... 917 176 816 1,794 3,703 2,505 1,197 3,703 Q3 09 ...... 911 174 905 1,876 3,866 2,531 1,336 3,866 Q4 09 ...... 924 171 910 1,926 3,931 2,560 1,370 3,931 Q1 10 ...... 941 168 1,023 2,014 4,146 2,626 1,520 4,146 Q2 10 ...... 952 156 994 2,105 4,207 2,657 1,550 4,207

COMPANIES' FINANCIAL ASSETS AND LIABILITIES Table 14

Assets Liabilities

Debt Shares and Curren- certific- cy, bank ates deposits issued by and invest- granted ment Bonds, Shares, Net credits, Bonds, associa- Loans, etc. etc. financial etc. etc. tions, etc. Total etc. issued issued assets Total

End of period Kr. billion

2005 ...... 792 162 2,197 3,151 1,345 143 3,218 -1,554 3,151 2006 ...... 817 148 3,082 4,046 1,580 139 4,428 -2,101 4,046 2007 ...... 910 133 2,921 3,965 1,730 118 4,278 -2,160 3,965 2008 ...... 1,065 104 1,761 2,930 1,947 109 2,501 -1,627 2,930 2009 ...... 1,067 104 1,915 3,086 1,896 138 2,628 -1,576 3,086 Q2 09 ...... 1,072 113 1,820 3,005 1,950 119 2,475 -1,539 3,005 Q3 09 ...... 1,040 115 1,921 3,077 1,915 123 2,631 -1,592 3,077 Q4 09 ...... 1,067 104 1,915 3,086 1,896 138 2,628 -1,576 3,086 Q1 10 ...... 1,107 110 2,172 3,389 1,955 140 2,984 -1,690 3,389 Q2 10 ...... 1,139 105 2,107 3,352 1,977 129 2,919 -1,672 3,352

Note: Companies are defined as non-financial companies.

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CURRENT ACCOUNT OF THE BALANCE OF PAYMENTS (NET REVENUES) Table 15

Wages and Total Goods Goods and property Current current (fob) Services services income transfers account

Kr. billion

2005 ...... 43.9 38.3 82.2 9.9 -25.0 67.1 2006 ...... 18.2 42.0 60.2 16.8 -28.4 48.6 2007 ...... 2.1 40.3 42.5 9.7 -29.2 23.0 2008 ...... 4.2 51.6 55.8 18.2 -27.8 46.2 2009 ...... 42.7 23.6 66.4 21.0 -28.4 59.0 Oct 08 - Sep 09 ...... 29.1 32.1 61.2 22.4 -28.7 54.9 Oct 09 - Sep 10 ...... 51.3 40.5 91.7 17.1 -30.4 78.4 Sep 09 ...... 6.3 3.1 9.4 1.7 -1.8 9.3 Oct 09 ...... 1.9 2.0 3.9 1.9 -1.9 3.8 Nov 09 ...... 6.9 2.4 9.3 1.6 -2.0 8.9 Dec 09 ...... 3.4 1.7 5.1 1.6 -1.9 4.8 Jan 10 ...... 1.2 1.3 2.5 1.7 -4.0 0.2 Feb 10 ...... 4.7 2.2 6.9 1.7 -3.8 4.8 Mar 10 ...... 9.1 2.1 11.2 -1.5 -3.1 6.6 Apr 10 ...... 4.4 5.2 9.6 1.0 -2.3 8.3 May 10 ...... 1.9 3.7 5.5 3.1 -2.4 6.2 Jun 10 ...... 3.7 4.5 8.2 1.8 -2.2 7.8 Jul 10 ...... 7.3 4.1 11.4 1.1 -2.4 10.1 Aug 10 ...... 2.5 6.1 8.6 0.9 -2.3 7.3 Sep 10 ...... 4.4 5.2 9.6 2.1 -2.3 9.5

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FINANCIAL ACCOUNT OF THE BALANCE OF PAYMENTS (NET PAYMENTS FROM ABROAD) Table 16

Current Capital import account Danmarks and Direct National- capital investments bank's account, Portfolio Other transac- etc., Danish Foreign in invest- capital tions with total abroad Denmark ments 1 import Other 2 abroad3

Kr. billion

2005 ...... 70.0 -97.1 77.2 -68.8 23.2 -16.2 -11.8 2006 ...... 48.6 -50.2 16.1 -103.3 83.4 -33.0 -38.3 2007 ...... 23.3 -112.3 64.3 -32.0 56.5 -1.0 -1.2 2008 ...... 46.6 -72.1 11.4 53.0 -66.7 -43.5 -71.4 2009 ...... 58.8 -36.9 15.9 74.3 195.4 -19.4 288.0 Oct 08 - Sep 09 ...... 54.6 -29.5 10.0 228.8 15.5 -32.9 246.5 Oct 09 - Sep 10 ...... 79.1 -42.9 21.7 -144.7 207.2 -81.3 34.3 Sep 09 ...... 9.3 0.6 5.5 47.2 5.6 -39.3 28.9 Oct 09 ...... 3.9 -12.1 6.0 -33.3 -4.6 26.5 -13.6 Nov 09 ...... 9.0 -5.0 1.3 -29.2 62.2 -27.3 10.9 Dec 09 ...... 4.9 24.8 -13.1 -44.4 16.1 17.1 5.4 Jan 10 ...... 0.3 -7.0 6.3 -19.4 53.0 -13.1 20.0 Feb 10 ...... 4.8 -12.7 -11.5 16.3 8.1 -4.8 0.3 Mar 10 ...... 6.7 1.1 2.0 -39.5 33.1 -3.0 0.4 Apr 10 ...... 8.4 -8.3 5.4 44.4 -52.6 -11.1 -13.8 May 10 ...... 6.2 -2.3 14.1 4.7 23.6 -11.6 34.7 Jun 10 ...... 7.9 -4.9 -0.4 18.6 -22.1 -8.8 -9.7 Jul 10 ...... 10.1 -9.5 4.5 16.3 -2.7 -22.8 -6.0 Aug 10 ...... 7.4 1.5 2.7 -14.1 3.7 5.0 3.3 Sep 10 ...... 9.5 -8.5 4.5 -65.0 89.2 -27.5 2.3

1 This item may differ from the total of Table 17, as portfolio investments are published 1-2 weeks earlier than the rest of the balance of payments. 2 Including errors and omissions. 3 Including transactions on all Danmarks Nationalbank's accounts with abroad and not only transactions on accounts included by compilation of the foreign-exchange reserve. The latter is published by press release on the 2nd banking day of each month and included in Table 2 of this section.

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PORTFOLIO INVESTMENTS OF THE BALANCE OF PAYMENTS (NET PAYMENTS FROM ABROAD) Table 17

Danish securities Foreign securities Foreign Krone- currency denominated denominated bonds, bonds, Bonds, etc. etc. Shares etc. Shares Total1

Kr. billion

2005 ...... 20.8 122.5 -18.9 -108.2 -85.0 -68.8 2006 ...... 16.3 70.0 -34.4 -21.5 -133.8 -103.3 2007 ...... 26.2 73.1 15.0 -96.0 -49.8 -32.0 2008 ...... -59.1 141.2 11.4 -91.1 50.7 53.0 2009 ...... -5.6 162.6 43.1 -83.4 -42.4 74.3 Oct 09 ...... -0.8 -9.0 0.9 -15.5 -9.1 -33.3 Nov 09 ...... -13.7 -24.1 5.2 2.5 0.9 -29.2 Dec 09 ...... -13.5 -10.6 3.4 -18.5 -5.3 -44.4 Jan 10 ...... 0.2 16.9 1.2 -31.8 -5.9 -19.4 Feb 10 ...... 10.3 -10.2 5.3 2.3 8.5 16.3 Mar 10 ...... -6.8 5.4 5.3 -36.9 -6.4 -39.5 Apr 10 ...... 28.6 16.3 2.3 0.4 -3.3 44.4 May 10 ...... -13.4 -3.1 -1.2 23.2 -0.8 4.7 Jun 10 ...... 6.2 14.9 6.5 -7.3 -1.7 18.6 Jul 10 ...... 25.3 0.6 -3.3 0.2 -6.5 16.3 Aug 10 ...... 14.0 -37.2 1.0 5.2 2.9 -14.1 Sep 10 ...... 4.8 -89.1 2.5 14.6 2.1 -65.0 Oct 10 ...... 19.1 7.8 9.5 -17.7 -5.9 12.8

Note: A negative sign (-) indicates residents' net purchase of foreign securities, or non-residents' net sale of Danish securities. 1 This item may differ from "Portfolio investments" in Table 16, as the rest of the balance of payments is published 1-2 weeks later.

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DENMARK'S EXTERNAL ASSETS AND LIABILITIES Table 18

Direct Portfolio investments investments Other investments Finan- Inter- cial Dan- compa- deriva- Loans marks ny debt, Shares, Bonds, tives, Trade and Natio- Equity etc. etc. etc. net credits deposits Other nalbank Total

End of period Kr. billion

Assets 2005 ...... 566 254 558 685 85 37 720 19 217 3,141 2006 ...... 579 260 746 678 47 41 823 30 178 3,383 2007 ...... 651 287 794 733 0 47 1,035 32 176 3,755 2008 ...... 642 378 447 781 84 45 1,101 37 226 3,740 2009 ...... 718 375 607 924 23 38 927 32 400 4,044 Q2 09 ...... 728 364 492 880 40 44 994 36 336 3,913 Q3 09 ...... 721 370 566 889 33 41 956 33 400 4,008 Q4 09 ...... 718 375 607 924 23 38 927 32 400 4,044 Q1 10 ...... 779 388 652 1,014 41 43 987 34 423 4,361 Q2 10 ...... 823 405 648 1,031 70 46 968 32 483 4,506

Liabilities 2005 ...... 504 230 310 1,019 • 27 967 21 3 3,081 2006 ...... 482 270 356 1,066 • 32 1,142 35 4 3,386 2007 ...... 543 276 422 1,123 • 36 1,409 37 5 3,851 2008 ...... 508 295 242 1,198 • 42 1,398 40 121 3,845 2009 ...... 478 302 348 1,361 • 35 1,402 38 5 3,969 Q2 09 ...... 483 295 293 1,356 • 40 1,429 37 38 3,971 Q3 09 ...... 480 306 337 1,427 • 34 1,366 38 8 3,997 Q4 09 ...... 478 302 348 1,361 • 35 1,402 38 5 3,969 Q1 10 ...... 486 300 411 1,410 • 30 1,576 42 2 4,257 Q2 10 ...... 519 309 431 1,510 • 34 1,496 39 42 4,379 Net assets 2005 ...... 62 24 247 -333 85 11 -247 -2 214 61 2006 ...... 98 -11 390 -387 47 10 -319 -5 174 -3 2007 ...... 108 12 372 -390 0 11 -374 -5 171 -96 2008 ...... 134 83 205 -417 84 3 -298 -3 105 -104 2009 ...... 240 73 259 -437 23 3 -476 -6 395 74 Q2 09 ...... 246 69 199 -476 40 4 -434 -2 298 -57 Q3 09 ...... 241 63 229 -538 33 6 -410 -6 392 10 Q4 09 ...... 240 73 259 -437 23 3 -476 -6 395 74 Q1 10 ...... 292 88 242 -396 41 13 -589 -8 421 105 Q2 10 ...... 304 96 217 -478 70 12 -527 -7 441 128

Note: As a key principle, the market value has been used for the compilation.

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GDP BY TYPE OF EXPENDITURE Table 19

Final domestic demand

General- govern- Gross Exports Imports Private ment fixed Change in of goods of goods consump- consump- capital invent- and and GDP tion tion formation ories Total services services

Kr. billion

2005 ...... 1,545.3 745.1 402.5 303.9 17.9 1,469.5 757.0 681.2 2006 ...... 1,631.7 786.6 422.6 356.0 14.6 1,579.8 849.6 797.7 2007 ...... 1,695.3 820.4 440.0 371.4 24.8 1,656.5 885.2 846.5 2008 ...... 1,740.8 840.3 464.8 365.5 15.2 1,685.7 959.0 903.8 2009 ...... 1,656.1 813.6 496.3 303.4 -20.3 1,592.9 792.8 729.6 Q3 09 ...... 412.3 199.7 124.5 72.2 -4.9 391.5 200.7 179.9 Q4 09 ...... 429.3 212.9 129.2 75.8 -5.4 412.5 202.0 185.2 Q1 10 ...... 417.0 209.0 126.2 65.8 -3.4 397.6 198.8 179.4 Q2 10 ...... 439.1 210.4 129.7 74.1 2.7 416.9 219.2 197.0 Q3 10 ...... 437.4 209.4 128.8 69.9 0.8 408.9 229.3 200.8

Real growth compared with previous year, per cent 2005 ...... 2.4 3.8 1.3 4.7 ... 3.4 8.0 11.1 2006 ...... 3.4 3.6 2.8 14.2 ... 5.2 9.0 13.4 2007 ...... 1.6 3.0 1.3 0.4 ... 2.3 2.8 4.3 2008 ...... -1.1 -0.6 1.6 -3.2 ... -1.2 2.8 2.7 2009 ...... -5.2 -4.5 3.1 -14.3 ... -6.5 -9.7 -12.5 Q3 09 ...... -5.9 -4.1 3.3 -16.1 ... -6.7 -10.5 -12.4 Q4 09 ...... -3.3 -0.7 2.8 -14.5 ... -4.3 -8.7 -11.0 Q1 10 ...... -0.7 2.9 2.3 -16.4 ... -1.3 -2.8 -4.0 Q2 10 ...... 2.9 1.3 2.8 1.2 ... 3.9 2.5 4.5 Q3 10 ...... 3.0 2.0 1.2 -3.2 ... 2.5 4.6 3.5

Real growth compared with previous quarter (seasonally adjusted), per cent Q3 09 ...... 0.5 0.1 1.3 0.2 ... 1.4 0.0 1.7 Q4 09 ...... 0.5 0.4 0.2 -2.4 ... 0.1 -0.3 -1.0 Q1 10 ...... 0.6 1.8 0.5 -2.9 ... 0.0 1.2 -0.3 Q2 10 ...... 1.3 -0.9 0.8 6.6 ... 2.4 1.8 4.2 Q3 10 ...... 0.7 0.8 -0.3 -3.6 ... 0.0 1.9 0.4

24-01-2011 07:18:00 Antal sider: 26 Rev. nr. 18 H:\kvo\ENG\2010\4 qt\færdige\tabtill_4qtr_10.doc Oprettet af Palle Lorentzen Monetary Review - 4th Quarter 2010

EU-HARMONIZED INDEX OF CONSUMER PRICES (HICP) AND UNDERLYING INFLATION (IMI) Table 20

HICP Index of net retail prices1

Subcomponents:

Index of Administered net retail 4 prices Split into : HICP prices excl. excl. energy, energy, food food and and Core admini- admini- infla- Public stered stered Import Total Energy Food tion2 Rent services prices3 prices3 content5 IMI6

Weights, per cent

100 10.4 17.4 72.2 7.4 3.9 60.9 53.2 16.8 36.4

Year-on-year growth, per cent

2005 ...... 1.7 7.6 1.0 1.0 2.4 3.2 0.6 0.7 3.4 -0.6 2006 ...... 1.9 5.3 2.2 1.2 2.1 0.9 1.1 1.3 3.1 0.4 2007 ...... 1.7 0.3 3.7 1.3 2.1 0.6 1.2 1.4 1.4 1.4 2008 ...... 3.6 7.7 6.7 2.1 2.8 3.5 1.9 2.1 4.0 1.1 2009 ...... 1.1 -4.0 0.5 2.0 3.1 4.8 1.7 1.9 -4.3 5.1 Q1 08 ...... 3.2 7.5 6.0 1.7 2.2 2.4 1.6 2.0 3.6 1.2 Q2 08 ...... 3.7 9.7 7.4 1.7 2.6 4.0 1.4 1.8 4.2 0.6 Q3 08 ...... 4.6 10.4 8.6 2.5 3.9 3.7 2.2 2.2 5.0 0.9 Q4 08 ...... 3.0 3.1 5.0 2.4 2.4 3.8 2.3 2.3 3.2 1.8 Q1 09 ...... 1.7 -4.6 3.2 2.2 2.7 4.2 2.0 2.3 -1.9 4.4 Q2 09 ...... 1.1 -5.5 0.7 2.2 3.1 5.0 1.9 2.1 -4.2 5.2 Q3 09 ...... 0.6 -5.9 -0.5 2.0 3.5 5.1 1.6 1.9 -6.0 6.0 Q4 09 ...... 0.9 0.3 -1.5 1.6 2.9 4.9 1.2 1.6 -5.0 4.9 Q1 10 ...... 1.9 8.9 0.0 1.4 2.9 3.7 1.0 1.2 -1.3 2.3 Q2 10 ...... 2.0 10.1 0.8 1.1 2.8 3.9 0.7 0.7 1.0 0.6 Q3 10 ...... 2.3 8.8 3.2 1.1 2.5 4.0 0.8 0.9 3.2 -0.2

Note: The weights reflect the weighting basis as of January 2009. 1 Prices in the index of net retail prices are compiled excluding indirect taxes and subsidies. 2 Core inflation is defined as the increase in HICP excluding energy and food. 3 Goods and services excluding energy, food and administered prices constitute 60.9 per cent of HICP's weight basis and 53.2 per cent of the index of net retail prices. The difference reflects that the same goods and services do not count equally in the two indices, and does not express the indirect taxation content of the consumer prices. 4 The division of the index of net retail prices into import and IMI is based on Statistics Denmark's input-output table. 5 The indirect energy content is included in the import content. 6 IMI expresses the domestic market-determined inflation. For a detailed presentation of IMI, see Bo William Hansen and Dan Knudsen, Domestic Market-Determined Inflation, Danmarks Nationalbank, Monetary Review, 4th Quarter 2005.

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SELECTED MONTHLY ECONOMIC INDICATORS Table 21

Composite cyclical indicator Quantity index for

New Con- Unem- Forced passen- sumer Building ployment sales of ger car confi- Manu- and Manu- real registra- dence facturing construc- facturing Retail Per cent 1 property tions indicator industry tion Service industry trade of labour force 2005=100 2005=100 Number Balance per cent

2005 ...... 5.1 100.0 100.2 1,874 148,578 8.8 0 7 20 2006 ...... 3.9 105.7 103.5 1,231 156,719 10.5 9 21 24 2007 ...... 2.7 107.0 104.9 1,392 162,481 7.5 5 9 20 2008 ...... 1.9 106.7 101.7 2,840 150,663 -7.7 -7 -16 3 2009 ...... 3.6 88.2 97.0 4,140 112,249 -5.0 -17 -44 -13 Seasonally adjusted Nov 09 ...... 4.3 86.9 96.4 390 9,968 -3.4 -2 -44 -2 Dec 09 ...... 4.3 82.9 96.7 436 10,750 -1.6 -2 -39 -4 Jan 10 ...... 4.3 85.4 96.3 471 13,372 -0.6 3 -42 -1 Feb 10 ...... 4.3 87.3 96.1 459 10,542 2.9 3 -45 3 Mar 10 ...... 4.3 88.6 98.6 491 12,558 0.8 7 -40 0 Apr 10 ...... 4.2 86.7 93.9 376 11,731 2.4 6 -32 1 May 10 ...... 4.1 90.2 97.5 453 12,861 1.8 8 -32 6 Jun 10 ...... 4.2 94.8 95.8 445 12,639 -1.7 6 -33 7 Jul 10 ...... 4.1 94.6 96.1 440 12,213 3.6 5 -32 4 Aug 10 ...... 4.1 88.8 96.4 385 12,944 5.2 4 -32 3 Sep 10 ...... 4.2 91.0 96.1 423 13,129 2.2 5 -28 5 Oct 10 ...... 4.2 ... 96.1 450 13,672 1.4 1 -33 5 Nov 10 ...... 2.6 -3 -35 9

1 Excluding shipbuilding.

24-01-2011 07:18:00 Antal sider: 26 Rev. nr. 18 H:\kvo\ENG\2010\4 qt\færdige\tabtill_4qtr_10.doc Oprettet af Palle Lorentzen Monetary Review - 4th Quarter 2010

SELECTED QUARTERLY ECONOMIC INDICATORS Table 22

Employment Hourly earnings Property prices (purchase sum, one- family All sectors Manufac- Manufac- dwellings) in turing turing Denmark, industry industry As a per- Total Private total in Denmark abroad centage of property 1,000 persons 1996=100 value 2006

2005 ...... 2,767 1,924 141.4 141.7 130.7 82.5 2006 ...... 2,825 1,980 145.7 146.1 134.2 100.3 2007 ...... 2,903 2,061 151.4 152.1 138.4 104.8 2008 ...... 2,958 2,120 158.0 158.5 143.0 100.1 2009 ...... 2,866 2,016 162.9 163.1 145.7 88.1 Seasonally adjusted Q3 09 ...... 2,843 1,989 163.4 163.9 146.2 88.6 Q4 09 ...... 2,813 1,959 164.1 164.9 147.1 88.3 Q1 10 ...... 2,812 1,952 165.6 166.4 149.1 88.8 Q2 10 ...... 2,818 1,956 165.9 166.9 148.8 90.9 Q3 10 ...... 2,798 1,934 167.2 168.0 149.2 ... Change compared with previous year, per cent 2005 ...... 1.0 1.4 2.9 2.7 2.5 17.6 2006 ...... 2.1 2.9 3.1 3.1 2.7 21.6 2007 ...... 2.8 4.1 3.8 4.0 3.2 4.6 2008 ...... 1.9 2.9 4.4 4.2 3.3 -4.5 2009 ...... -3.1 -4.9 3.1 2.9 1.9 -12.0 Q3 09 ...... -3.9 -6.2 2.8 2.6 2.0 -12.2 Q4 09 ...... -5.1 -7.8 2.3 2.5 2.1 -5.1 Q1 10 ...... -3.9 -6.2 2.5 2.8 3.2 1.5 Q2 10 ...... -2.3 -3.9 2.2 2.6 2.5 3.4 Q3 10 ...... -1.6 -2.8 2.3 2.5 2.1 ...

24-01-2011 07:18:00 Antal sider: 26 Rev. nr. 18 H:\kvo\ENG\2010\4 qt\færdige\tabtill_4qtr_10.doc Oprettet af Palle Lorentzen Monetary Review - 4th Quarter 2010

EXCHANGE RATES Table 23

EUR USD GBP SEK NOK CHF JPY

Kroner per 100 units

Average

2005 ...... 745.19 600.34 1,090.02 80.29 93.11 481.30 5.4473 2006 ...... 745.91 594.70 1,094.32 80.62 92.71 474.22 5.1123 2007 ...... 745.06 544.56 1,089.81 80.57 92.99 453.66 4.6247 2008 ...... 745.60 509.86 939.73 77.73 91.02 469.90 4.9494 2009 ...... 744.63 535.51 836.26 70.18 85.39 493.17 5.7296 Nov 09 ...... 744.15 498.97 827.87 72.02 88.44 492.66 5.5974 Dec 09 ...... 744.18 508.69 826.69 71.46 88.43 494.93 5.6775 Jan 10 ...... 744.24 521.55 842.99 73.01 90.97 504.06 5.7128 Feb 10 ...... 744.40 543.98 849.77 74.83 91.94 507.39 6.0308 Mar 10 ...... 744.16 548.49 825.42 76.50 92.59 513.89 6.0496 Apr 10 ...... 744.27 555.17 851.40 77.05 93.83 518.83 5.9429 May 10 ...... 744.16 591.90 868.22 76.97 94.26 524.43 6.4246 Jun 10 ...... 744.09 609.55 899.03 77.74 94.12 540.65 6.7050 Jul 10 ...... 745.22 583.72 891.83 78.49 92.92 553.71 6.6710 Aug 10 ...... 744.95 577.90 904.51 79.07 93.91 555.68 6.7733 Sep 10 ...... 744.76 570.26 886.92 80.74 94.09 569.07 6.7591 Oct 10 ...... 745.67 536.57 850.91 80.36 91.93 554.34 6.5603 Nov 10 ...... 745.47 545.99 871.93 80.02 91.51 554.70 6.6164

24-01-2011 07:18:00 Antal sider: 26 Rev. nr. 18 H:\kvo\ENG\2010\4 qt\færdige\tabtill_4qtr_10.doc Oprettet af Palle Lorentzen Monetary Review - 4th Quarter 2010

EFFECTIVE KRONE RATE Table 24

Real Real Consumer-price indices effective effective Nominal krone rate krone rate Consumer- effective based on based on price index krone consumer hourly in the rate Denmark Abroad prices earnings euro area

Average 1980=100 2005=100

2005 ...... 101.6 241.7 228.5 107.5 109.6 100.0 2006 ...... 101.6 246.2 233.4 107.3 110.3 102.2 2007 ...... 103.2 250.5 238.7 108.3 112.7 104.4 2008 ...... 105.8 259.0 246.9 111.1 116.7 107.8 2009 ...... 107.8 262.4 247.3 114.9 120.7 108.1 Nov 09 ...... 108.4 263.3 248.3 115.1 ... 108.5 Dec 09 ...... 108.1 262.9 248.9 114.4 120.9 108.9 Jan 10 ...... 107.0 263.6 248.5 113.8 ... 108.1 Feb 10 ...... 105.7 266.6 249.5 113.4 ... 108.4 Mar 10 ...... 105.4 268.2 250.7 113.3 118.0 109.4 Apr 10 ...... 104.8 268.6 251.3 112.5 ... 109.9 May 10 ...... 103.3 268.6 251.6 111.3 ... 110.0 Jun 10 ...... 102.2 268.2 251.7 110.1 116.2 110.0 Jul 10 ...... 102.9 268.2 251.5 110.7 ... 109.7 Aug 10 ...... 102.8 269.0 251.7 110.6 ... 109.9 Sep 10 ...... 102.8 270.1 252.3 110.8 115.8 110.1 Oct 10 ...... 104.4 269.9 ...... 110.5 Nov 10 ...... 103.9 ......

Change compared with previous year, per cent 2005 ...... -0.6 1.8 2.0 -0.7 -0.2 2.2 2006 ...... 0.0 1.9 2.1 -0.1 0.6 2.2 2007 ...... 1.6 1.7 2.3 0.9 2.2 2.2 2008 ...... 2.5 3.4 3.4 2.6 3.5 3.3 2009 ...... 1.9 1.3 0.2 3.4 3.4 0.3 Nov 09 ...... 3.6 1.3 0.4 3.8 ... 0.5 Dec 09 ...... 0.7 1.4 1.1 0.6 2.6 0.9 Jan 10 ...... -0.3 2.0 1.3 0.0 ... 1.0 Feb 10 ...... -1.0 1.9 1.3 -0.7 ... 0.9 Mar 10 ...... -2.4 2.2 1.7 -2.2 -2.0 1.4 Apr 10 ...... -2.4 2.4 1.8 -2.1 ... 1.5 May 10 ...... -3.9 2.2 1.8 -3.2 ... 1.6 Jun 10 ...... -5.4 1.7 1.6 -4.5 -3.6 1.4 Jul 10 ...... -4.6 2.3 1.7 -3.7 ... 1.7 Aug 10 ...... -4.3 2.3 1.6 -3.2 ... 1.6 Sep 10 ...... -4.8 2.6 1.8 -3.6 -3.8 1.8 Oct 10 ...... -3.7 2.5 ...... 1.9 Nov 10 ...... -4.2 ......

Note: The nominal effective krone rate index is a geometric weighting of the development in the Danish krone rate against currencies of Denmark's 27 most important trading partners. However, only 25 countries are included in the calculation of consumer prices abroad and the real effective krone rate based on consumer prices and hourly earnings, respectively. As from April 2010 the weights are based on trade in manufactured goods in 2009 and earlier on trade in manufactured goods in 2002. An increase in the index reflects a nominal or a real appreciation of the krone.

24-01-2011 07:18:00 Antal sider: 26 Rev. nr. 18 H:\kvo\ENG\2010\4 qt\færdige\tabtill_4qtr_10.doc Oprettet af Palle Lorentzen Monetary Review - 4th Quarter 2010

Danmarks Nationalbank's Statistical Publications

Periodical electronic publications Danmarks Nationalbank releases new financial statistics to the public in electronic publications composed of 2 elements: • "Nyt" (News) describing the key development trends. • Tabeltillæg (Tables Supplement) containing tables with as detailed specifications as possible.

"Nyt" is available in Danish only, whereas the tables supplement and the corresponding sources and methodologies also are available in English.

Statistics databank The above publications are supplemented by a statistics database comprising all time series which are updated concurrent with a release. The time series include data as far back in time as possible. The statistical data from Danmarks Nationalbank are published through Statistics Denmark's "StatBank Denmark". Danmarks Nationalbank's part of the "StatBank Denmark" is available directly via: nationalbanken.statbank.dk

Special Reports Special Reports deal with statistics of a thematic character and are not prepared on a regular basis.

Release calendar A release calendar for the statistical publications, covering the current month and the following quarter, is available on: www.nationalbanken.dk (see Statistics > Release calendar).

24-01-2011 07:18:00 Antal sider: 26 Rev. nr. 18 H:\kvo\ENG\2010\4 qt\færdige\tabtill_4qtr_10.doc Oprettet af Palle Lorentzen