2002 Monetary Review - Danmarks Nationalbank€¦ · Monetary Review 02 Danmarks Nationalbank...

2002

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Danmarks Nationalbank

Monetary Review 1st Quarter

Danmarks Nationalbank Havnegade 5 DK-1093 Copenhagen K

Telephone +45 33 63 63 63 Fax +45 33 63 71 25

www.nationalbanken.dk E-mail: [email protected]

D A N M A R K S

N A T I O N A L

B A N K 2 0 0 2

1

1-kvartal-2002-uk.pmd 13-02-2002, 14:571

Fejl! Ukendt argument for parameter. Antal sider: Fejl! Ukendt argument for

parameter. Rev. nr. Fejl! Ukendt argument for parameter. titel Oprettet af Palle

Lorentzen

DanmarksNationalbank Monetary Review 1st Quarter 2002

Fejl! Ukendt argument for parameter. Antal sider: Fejl! Ukendt argument for

parameter. Rev. nr. Fejl! Ukendt argument for parameter. kolofon Oprettet af

Alice Colombo

The Monetary Review is published by Danmarks Nationalbank and is issued quarterly.

Managing Editor: Jens Thomsen

Editor: Anders Møller Christensen

The Monetary Review can be ordered from:

Danmarks Nationalbank, Information Desk, Havnegade 5, DK-1093 Copenhagen K.

Telephone +45 33 63 70 00 (direct) or +45 33 63 63 63.

E-mail: [email protected]

www.nationalbanken.dk

Scanprint as, Viby J

ISSN 0011-6149

(Online) ISSN 1398-3865

02-04-2002 15:59 Antal sider: 2 Rev. nr. 5 G:\accidens\TEKST\ORDRENR\25\0001\1 kvt

2002\1-kvartal-UK-2002\12640-Indholdsfortegnelse-en.doc Oprettet af Alice Colombo

Contents

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

Euro 2002 ............................................................................................... 19 Niels Bartholdy, International Relations, and Governor Jens Thomsen

The introduction of euro banknotes and coins is tangible proof of the achieve-

ment of EMU in 12 EU member states. In the light of previous unsuccessful at-

tempts, a number of reasons are presented for the successful introduction of the

euro.

Counterfeit Banknotes.......................................................................... 33

Ulrik Bie and Johan Sebastian Gabel, Secretariat The extent of counterfeiting in Denmark is limited. Nevertheless, it is on the in-

crease in the light of the rapid technological development and the general pub-

lic's widespread access to reproduction equipment. Like other central banks,

Danmarks Nationalbank seeks to prevent counterfeiting by improving the secur-

ity features of the banknotes and by increased information measures.

Danmarks Nationalbank's New Payment System, Kronos.................. 43

Thomas Angelius and Astrid Henneberg Pedersen, Payment Systems

Danmarks Nationalbank has launched a new payment system for kroner and

euro. This system, Kronos, meets all requirements of modern payment systems

and e.g. includes a number of functions to facilitate the liquidity management of

financial institutions.

Taxation of Asset Income and the Financial Markets ........................ 51 Kristian Kjeldsen, Financial Markets, and Erik Haller Pedersen,

Economics

The taxation of asset income has changed considerably over the last 20 years, al-

though there are still a large number of different rates and asymmetries. Pension

savings are still subject to tax subsidies compared to free savings. The taxation of

investment associations and income from shares outside pension savings schemes

requires simplification.


2002\1-kvartal-UK-2002\12640-Indholdsfortegnelse-en.doc Oprettet af Alice Colombo

Market Dynamics at Low Interest Rates............................................... 69 Louise Mogensen, Financial Markets

In periods with low interest rates, options built into e.g. mortgage-credit bonds

will lead to self-reinforcing effects, increasing the volatility of the interest rates.

Speech by Bodil Nyboe Andersen at the Annual Meeting of the Danish Bankers Association on 5 December 2001 ................................................................................... 77

Tables and Graphs Section

Vol. XXXXI, No. 1

02-04-2002 16:05 Antal sider:18 Rev. nr.8 12640-Seneste tendenser aban-en Oprettet af

Alice Colombo

1

Recent Economic and Monetary Trends

This review covers the period from the middle of November 2001 to the middle of February 2002

INTERNATIONAL ECONOMIC DEVELOPMENT

After the global economic downturn in 2001 incipient, but not unam- biguous signs of a recovery are most apparent in the USA, but are also seen in Europe. The yen depreciated by 10 per cent against the dollar, while the euro weakened by 2-3 per cent. The USA has been in recession since March, according to the NBER1, after 10 years of economic expansion, the longest in the NBER's review period of more than 140 years. The background to the NBER's dating of the recession is described in further detail in Box 1.

Recessions in the US economy are typically of relatively short duration. According to the NBER, the recessions since 1945 have lasted 11 months on average. Several indicators suggest that the current recession will be short-lived too. Manufactured output continued to decrease in January, but not as strongly as in the preceding months, cf. Chart 1. The decline in employment diminished in December and January. Retail sales fell in November, but remained unchanged in December and January, and are still well above the level in the same period of 2000. In addition, the consumer confidence index, and especially the ISM2 business confidence index, rose in December and January, albeit from low levels.

The recession is apparent from the national accounts for the 3rd quar-ter of 2001, which show a decrease of 0.3 per cent in GDP from the 2nd quarter. The decline was strongest for investments, including inventories, while private consumption continued to increase at a moderate rate. In the 4th quarter GDP rose by 0.1 per cent, concealing a continued decline in investments and very strong growth in public consumption.

Fiscal policy has been eased considerably in response to the cyclical course. In addition to the tax cuts adopted in the summer and the cost increases in the aftermath of the terrorist attacks, the government has

1 National Bureau of Economic Research.

2 Institute of Supply Management, previously NAPM.


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proposed further relaxations amounting to 60-100 billion dollars. How-ever, Congress has not reached agreement on the composition of the measures, and their magnitude is also uncertain, not least in view of the tentative signs of a recovery.

On 11 December the Federal Reserve cut interest rates for the eleventh time in 2001. The fed funds target rate was reduced by 0.25 per cent to

RECESSION ACCORDING TO THE NBER Box 1

The term recession is often used without further specification. The NBER defines a re-

cession as a considerable decline in activity throughout the economy for more than

just a few months, where this decline is apparent from manufactured output, real in-

come, employment, and wholesale and retail trade. The NBER states employment to

be particularly important, and that other information may also be applied to the

assessment of the cyclical position.

The Chart shows the background to the NBER's timing of the current recession. Espe-

cially employment began to recede in March. Manufactured output already levelled off

in the autumn of 2000, while private real income especially, but also wholesale and re-

tail sales, seemed to be less affected by the current recession, compared to previous re-

cessions.

NBER CYCLICAL INDICATORS

Note: The month indications apply to the current recession. The deviation in months from the peak applies to

the average of the last six recessions. Source: www.nber.org

The NBER definition is far from the frequently cited common definition of recession as

negative GDP growth in two consecutive quarters. According to this definition, the

USA is not in recession.

0.92

0.94

0.96

0.98

1.00

1.02

1.04

Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep

Personal income less transfers Average of last 6 recessions

Level compared to peak

0.92

0.94

0.96

0.98

1.00

1.02

1.04


Employment Average of last 6 recessions


0.92

0.94

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1.02

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Wholesale and retail sales Average of last 6 recessions


0.92

0.94

0.96

0.98

1.00

1.02

1.04


Manufactured output Average of last 6 recessions



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1.75 per cent, which is the lowest level for 40 years. At its meeting on 30 January, the Federal Open Market Committee decided to hold the fed funds target rate unchanged with reference to positive economic news, notwithstanding the uncertainty concerning the strength of the upturn and the still high risk of continued weak development.

After declining over the summer and in the autumn after the many in-terest-rate cuts the 10-year government bond yield bottomed out at the beginning of November and has since risen by approximately 75 basis points to 5 per cent, cf. Chart 2. The background to this increase includes the preceding strong decline in yields in the 10-year segment after the US Treasury announced on 31 October that 30-year US government bonds would no longer be issued.

The fiscal-policy relaxation and the economic downturn entail a consid-erable deterioration of the general government budget balance. Com-pared to 2.4 per cent of GDP in 2000, the balance is expected to be 1.3 per cent of GDP in 2001, and -0.2 per cent of GDP in 2002.1 The decline in the government savings surplus coincides with a reduction of the private sav-ings deficit, which otherwise has been increasing since the early 1990s. Overall, there is a slight improvement of the balance of payments, which nevertheless still shows a significant deficit of approximately 3.7 per cent of GDP.

1 Congressional Budget Office, January 2002.

MANUFACTURED OUTPUT AND BUSINESS CONFIDENCE IN THE USA Chart 1

Note: Source:

Institute of Supply Management's business confidence index. A neutral trend corresponds to an index value of 50. EcoWin.

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42

46

50

54

58

62

-8

-6

-4

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2

4

6

8

Manufactured output (right-hand axis) Business confidence

Index Per cent, year/year

1998 1999 2000 2001


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The consensus forecasts1 point to a reversal of the cyclical trend during 2002, although the exact timing of the recovery is subject to great un-certainty. Capacity pressure is subsiding, and rising unemployment may dampen growth in private consumption and delay the upswing. The considerable private savings deficit may also hamper growth. On the other hand, the economic-policy stance is strongly expansionary, inventories have been reduced, and oil prices are still rather low at 18-22 dol-lars per barrel after declining in the autumn. The course of the 10-year government-bond yield may indicate stronger inflation expectations in connection with an imminent recovery.

Despite the general brightening of the macroeconomic outlook the US stock market took a negative course after New Year. The Dow Jones fell by approximately 6 per cent and the Nasdaq by around 12 per cent. This development was affected by such factors as the bankruptcy of several large enterprises, including K-mart and Enron. The Enron case in particu-lar gave rise to uncertainty concerning US accounting practices, since Enron's accounts excluded a number of liabilities, but were nonetheless endorsed by its auditors.

After a decade of low growth Japan is now moving into a deeper re-cession. GDP fell by 0.5 per cent in the 3rd quarter, and seasonally- adjusted unemployment rose from 5.0 per cent in August to 5.6 per cent in December. This is the highest rate of seasonally-adjusted unemploy-

1 Consensus Forecast published by Consensus Economics Inc.

INTEREST RATES IN THE USA Chart 2

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2

3

4

5

6

7

10-year government-bond yield Fed funds target rate

Per cent p.a.

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


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CONFIDENCE INDICATORS Box 2

Many market participants expect an imminent turnaround in the US economy. These

assessments are based on such factors as increases in business and consumer confid-

ence indicators. The indicators are based on responses to questionnaires concerning

business enterprises' views of the current situation, e.g. output, inventories and future

expectations. Consumers are asked about the current situation and their expectations

of the country's and their own financial situation, and the indicators are published a

few days later. Confidence indicators are good measures of business enterprises' and

consumers' own assessments here and now of the current situation and of their ex-

pectations, but their value in the prediction of a business cycle is questionable. Such

prediction requires correlation with relevant macroeconomic measures.

Chart 1 in the main text shows that the business confidence indicator of the Insti-

tute of Supply Management, ISM, correlates with US manufactured output. The corre-

lation is also high for longer time series. Chart 1 also shows that the indicators may

reflect reality incompletely. According to the ISM, values below 50 correspond to con-

traction of manufacturing industry, but in 1998 the indicator was below 50, while

output continued to increase.

On the consumption side, the historical correlation between the consumer confid-

ence indicator – here measured in terms of the Conference Board indicator – and sim-

ple monthly changes in consumption has been lower. However, it is possible to find a

stronger correlation with trend-adjusted consumption, cf. the Chart below. Subject to

the right interpretation, the indicator may be used as the basis for assessment. The

Chart also reveals that the two series may differ in certain subperiods. The correlation

is less apparent in the 2nd half of the 1990s. The correlation must be stable to provide

a basis for immediate forecasts. The Chart contains no indication either of how to

close the current gap between confidence and consumption. Confidence indicators

are a useful cyclical forecasting tool but cannot stand alone.

CONSUMPTION AND CONSUMER CONFIDENCE

40

60

80

100

120

140

160

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002

-6

-4

-2

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Consumer confidence (left-hand axis) Trend-adjusted private consumption (right-hand axis)

Index Per cent deviation from trend

Note: Source:

Conference Board consumer confidence indicator. The consumption series consists of the residuals from regression of the logarithm for consumption excluding durable consumer goods on a constant and a time trend. EcoWin.


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ment since 1960, when its compilation began. Manufactured output is very low, and the consumer and business confidence indicators fell strongly during the autumn. All economic key figures point to further negative development, so that an upswing seems precluded in the short run. This is confirmed by the consensus forecasts of growth at -0.3 per cent in 2001 and -1.1 per cent in 2002.

As a consequence of the recession, consumer prices in Japan have fallen by 1.2 per cent since December 2000. The Bank of Japan raised the target for the banks' deposits with the central bank in December in or-der to counter deflation and ensure continued ample liquidity. Since November the yen has weakened by more than 10 per cent against the dollar, cf. Chart 5. Continued depreciation will contribute directly to checking deflation via higher import prices.

In the euro area the downturn is milder than in the USA. Total GDP growth was marginally positive in the 2nd and 3rd quarters, but there was a clear dampening in the 3rd quarter when exports declined further after levelling off at the beginning of 2001. Investments and stock ad-justments made a negative contribution to growth. Together with a marked decline in imports this paints a picture of a weaker domestic economy.

The downturn has not yet affected overall employment, which contin-ues to rise, although at a slower pace. As unemployment continued to take a stable course throughout 2001, the lower GDP growth had an impact on productivity growth which fell after peaking at more than 2 per cent in 2000 to almost zero in the 3rd quarter of 2001. This may re-flect that the downturn in the economy is expected to be short-lived, as confirmed by the consensus forecast of quarterly GDP growth in the five largest euro-area member states which indicates that the downturn bot-tomed out in the 4th quarter.

A negative consumer response is the most immediate risk, in view of the low level of consumer confidence. If the recovery in the USA is de-layed, and euro-area unemployment begins to rise, the slowdown in the euro area may prove to be of longer duration. The year-on-year growth in manufactured output has decreased strongly since the summer, and has been negative since September, cf. Chart 3. The level of business confidence is also rather low, although it increased in December and January.

According to the OECD's autumn forecast the government budget deficit is expected to be -1.2 per cent and -1.3 per cent of GDP in 2001 and 2002 respectively. This is a considerable deterioration from the small surplus in 2000, which was partly attributable to revenue from the sale


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of UMTS licences. The deterioration in the government budget deficit is not only related to the tax reductions implemented in a number of member states, but also to the automatic stabilisers, i.e. the tendency for diminishing tax revenue and increasing government spending when economic growth decelerates.

Inflation measured as the increase in the Harmonised Index of Con-sumer Prices, HICP, fell during the autumn to 2.1 per cent in December, but rose to 2.5 per cent in January, according to preliminary data. The increase is due to such factors as indirect taxes and higher prices for fruit and vegetables. Inflation thus moved away – probably only temporarily – from the ECB's targeted upper limit of 2 per cent for the year-on-year increase in HICP in the medium term. The increase in January is roughly equivalent to the increase in non-euro area member states, the UK and Denmark. It seems that the rounding off of new retail prices in euro did not lead to a general price increase as feared. However, the coming months' HICP development needs close monitoring before definite con-clusions can be drawn.

Growth in the monetary aggregate, M3, reached 8.0 per cent in November and December, and thus considerably exceeds the ECB's reference value of 4.5 per cent growth in the medium term. The ECB refers to increasing demand for liquid funds in the light of pronounced financial and economic uncertainty as an important contributing factor,

MANUFACTURED OUTPUT AND BUSINESS CONFIDENCE IN THE EURO AREA Chart 3

Note: Source:

Manufactured output excluding construction. Business confidence calculated by the European Commission. EcoWin.

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-5

0

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Manufactured output (right-hand axis) Business confidence

1998 200120001999

Index Per cent, year/year


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just as growth in M3 is not accompanied by a significant rise in credit to the private sector. The ECB has not adjusted interest rates since 8 November 2001.

The pattern of implicit forward rates in the euro area shows a significant change since November in the money market's expectations of fu-ture ECB interest rates, cf. Chart 4. The curves for the beginning of November and December show that at these times the money market expected short-term interest rates to decrease 7-8 months ahead. At the beginning of February the pattern has changed, as the market now ex-pects almost unchanged short-term interest rates 6 months ahead, and rising short-term interest rates 6-12 months ahead. This indicates a gen-eral improvement in economic prospects.

On 1 January euro coins and banknotes were put into circulation, marking the start of the largest money conversion in history. The intro-duction of euro banknotes and coins proceeded according to plan. After 3 weeks the euro was used in around 95 per cent of all cash transactions, and euro banknotes accounted for approximately 60 per cent of the value of total banknotes in circulation. On 4 and 10 January the ECB extraordinarily provided liquidity for 25 and 40 billion euro, respectively, in order to ensure ample liquidity in connection with the changeover.

IMPLICIT 1-MONTH FORWARD INTEREST RATES IN THE EURO MONEY MARKET Chart 4

Note: Source:

Implicit forward rates are derived from the uncollateralised money-market interest rates with a maturity of up to 12 months. The implicit forward rate indicates the market's expectations of the future short-term money-market interest rate. In normal circumstances the short-term money-market rate closely matches the ECB's official interest rate. EcoWin.

3.0

3.2

3.4

3.6

3.8

4.0

4.2

1 2 3 4 5 6 7 8 9 10 11 12

1 Nov. 2001 3 Dec. 2001 2 Jan. 2002 1 Feb. 2002

Months from calculation date

Per cent


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The euro/dollar rate was relatively stable from October to the middle of January, after which the euro weakened to below 0.86 dollar per euro, cf. Chart 5. Since then, the euro has recovered a little ground.

Among the large euro-area member states Germany appears to be most severely affected by the international downturn, since the damp-ening follows several years of moderate growth, with the exception of 2000, when growth was 3 per cent. GDP growth was a modest 0.6 per cent in 2001, according to preliminary data. The growth rate was -0.1 per cent in the 3rd quarter. Domestic demand fell for all segments, while export growth was surprisingly sound.

However, tax cuts and the cyclical slowdown led to a considerable in-crease in the government deficit, which was around 2.6 per cent of GDP in 2001, or 1.1 per cent higher than estimated at the beginning of the year. This is the largest deficit among the euro-area member states. If growth continues to be low, Germany may exceed the limit of 3 per cent of GDP for the government deficit stipulated in the Stability and Growth Pact. Portugal also risks coming close to the 3 per cent limit. Against this background the European Commission took steps for the EU ministers of economic affairs and finance, the Ecofin Council, to issue an early warn-ing to Germany and Portugal. After Germany and Portugal declared that the limit would not be exceeded, and that they intended to achieve budget balance in 2004, the ministers refrained from issuing early warn-ings.

EXCHANGE RATES Chart 5

0.70

0.75

0.80

0.85

0.90

0.95

1.00

Dollars per euro Dollars per 100 yen

Aug Sep Oct Nov Dec Jan

Exchange rate

Feb


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The UK differs from the other major EU member states by continuing to achieve sound growth. GDP growth was 0.5 per cent and 0.2 per cent in the 3rd and 4th quarters respectively. In the 3rd quarter resilient private consumption in particular contributed to activity, while investments fell. However, several indicators suggest that also the UK is about to be af-fected by the global downturn. Unemployment rose in Octo-ber/November after an otherwise stable course in 2001, and the confi-dence indicators for the service, industrial and manufacturing sectors are now rather low. The degree of spill-over to private consumption will be decisive for whether the UK economy will be able to sustain growth, just as the timing of the recovery in the USA will be of importance.

Inflation measured as the annual rate of increase in the RPIX index was 2.6 per cent in January. This is an upturn of 0.7 per cent from December, and is just above the inflation target of 2.5 per cent. Sterling is relatively stable at a high level vis-à-vis both the dollar and the euro.

Sweden is also affected by the economic slowdown. GDP growth was marginally positive in the 2nd and 3rd quarters, although this conceals decreasing domestic demand, primarily related to a decline in invest-ments and a significant drop in imports, indicating a weak domestic economy. Sveriges Riksbank's preferred inflation target, consumer prices excluding interest costs and indirect taxes, was 3.4 per cent in December, which is higher than Sveriges Riksbank's target zone of 2 per cent +/- 1 per cent in the medium term. Inflation is expected to diminish during the spring as the effects of previous price increases for e.g. foodstuffs, electricity and telecom services subside.

Three years of sustained recession in Argentina reached a culmination in December when the de la Rua government stepped down after rioting and plundering in the streets.1 In the following two chaotic weeks four presidents came and went. The development up to the middle of Febru-ary is described below.

In December, Argentina suspended payments on its private external debt. On 6 January Argentina abandoned the fixed-exchange-rate policy pursued since 1991 which had kept the peso at a 1:1 parity vis-à-vis the US dollar via a currency board. The government introduced a dual ex-change-rate system instead. A new fixed exchange rate of 1.4 pesos per dollar was applied to the central government's external transactions, as well as to exporters and importers, while individual citizens' transactions were subject to a floating exchange rate. The dual exchange-rate system

1 Argentina's turbulent economic history is described in Morten Roed Sørensen, Argentina's Crises,

Danmarks Nationalbank, Monetary Review, 4th Quarter 2001.


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was abandoned at the beginning of February, since it gave a strong in-centive for fraud, and the foreign-exchange market reopened on 11 February. The peso is now in principle a freely floating currency, but various restrictions on foreign-exchange trading and intervention by Argentina's central bank indicate that Argentina is seeking to set a bot-tom limit for the peso rate. In mid-February the exchange rate was 1.95 pesos per dollar, corresponding to devaluation by 49 per cent from the previous parity.

The Argentine government has announced a number of initiatives to protect the population from the worst consequences of the devaluation. Among other things, these imply that private dollar-denominated debt to the banks must be converted into pesos at a 1:1 exchange rate, while dollar-denominated deposits are converted into pesos at an exchange rate of 1.4 pesos per dollar. These initiatives partly cushion the enor-mous losses the devaluation would otherwise impose on the private sector, whose earnings are predominantly denominated in pesos, while most of the private sector's debt is denominated in dollars. Instead, the banks, which are predominantly foreign-owned, will have to bear the losses.

The change of monetary-policy regime is accompanied by various fis-cal-policy measures such as a tax on oil exports, and a cut in wages and pensions by 13 per cent. Furthermore, a ceiling has been placed on prices for electricity, gas and telephony, in order to counter any infla-tionary pressure. Constitutional reforms have also been proposed.

It is uncertain whether the new government has the political support necessary to implement the proposed reforms, and whether the reforms are sufficient to rescue Argentina's economy. The economy is relatively closed, so the activity-boosting effect of the devaluation will probably be limited, just as the scope of fiscal policy is limited. The decisive factor will be whether Argentina can establish a credible economic policy in an internationally competitive environment.

DOMESTIC ACTIVITY AND THE BALANCE OF PAYMENTS

Denmark is also affected by the international cyclical downturn, but so far to a lesser degree than other countries such as Germany. In addition, high capacity utilisation, low unemployment, low inflation and sound surpluses on the current account and public finances together give Denmark a robust starting point to meet any temporary slowdown.

Unemployment still fell a little from October to December, and is now 5.0 per cent of the labour force. Employment calculated on the basis of payments to ATP (the Danish Labour Market Supplementary Pension


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Fund) fell by 9,000 in the 3rd quarter. The manufacturing sector ac-counted for most of the decline, while public-sector employment rose by 5,000. The construction sector still reports a shortage of labour, albeit less pronounced. Overall, the labour market is still relatively tight, but nevertheless has eased a little.

The national accounts for the 3rd quarter showed GDP growth of 0.5 per cent from the 2nd quarter. Domestic demand stagnated, reflecting a decrease in investments and private consumption and a continued in-crease in public consumption. Imports fell more than exports. Overall, the national accounts confirm the impression of rather weak domestic demand in an economy close to its capacity limit.

Investments fell from a high level, reflecting normalisation after the extraordinary repairs following on the hurricane in December 1999, cf. Chart 6. The Chart also shows that the development in total private con-sumption has been by and large constant since 1998. However, this con-ceals a decline in car sales in 1999 and 2000. For private consumption excluding cars the growth rate was moderate from 1998 to the begin-ning of 2001, after which it was virtually constant. Consumer confidence rose in December and January and became slightly positive once more. Especially Denmark's economic situation was assessed more positively.

The confidence indicator for building and construction also rose in December and January, but remained negative. Industrial confidence was stable at a low level in the autumn, but rose in January to an almost

PRIVATE CONSUMPTION AND GROSS FIXED CAPITAL FORMATION Chart 6

Note: Source:

Seasonally-adjusted, 1995 prices. Statistics Denmark.

118

123

128

133

138

59

61.5

64

66.5

69

Private consumption Private consumption, excluding cars

Gross fixed capital formation (right-hand axis)

1998 1999 2000 2001

Kr. billion Kr. billion


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neutral level. Output expectations rose in particular. Turnover in the manufacturing industry was constant throughout 2001, after a sound increase in 2000. Taken together, the confidence indicators show a mixed pattern, but the major downward adjustments of expectations seem to be over.

Housing prices continue to take a stable course, underpinned by low interest rates. According to the statistics of the Association of Danish Mortgage Banks, prices for one-family and terraced houses rose by 0.7 per cent from the 3rd to the 4th quarters. Greater Copenhagen still accounted for the strongest increases, while housing prices fell in sev-eral major provincial centres.

After strong growth in 2000, seasonally-adjusted exports were virtually stable in 2001, cf. Chart 7. The dampening of the domestic economy is reflected in seasonally-adjusted imports, which fell from June to Octo-ber. Imports for consumption declined in particular, but imports to the business sector also fell. The background is the decline in investments, which have a considerable import element. In the period up to Decem-ber, imports again rose a little.

The current account of the balance of payments continues to show a sound surplus, although the surplus was smaller in the 4th quarter of 2001 than one year before, due mainly to substantial imports of aircraft. For 2001 as a whole, the surplus was kr. 33.7 billion, against kr. 20.6 bil-

EXPORTS, IMPORTS AND THE CURRENT ACCOUNT OF THE BALANCE OF PAYMENTS Chart 7

Note: Source:

Seasonally-adjusted exports and imports of goods, excluding ships and aircraft. Statistics Denmark.

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Exports Imports Balance of payments, 12-month sum (right-hand axis)

Kr. billion Kr. billion

20001993 1994 1995 1996 1997 1998 1999 2001


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lion in 2000. The improvement can be attributed to balances for services and marine transport, while the balances for wage incomes and trans-fers to the EU deteriorated slightly.

The new government has stated that it "… intends to pursue a tight fiscal policy and continue the stability policy which has been conducted since 1982, based on the fixed krone rate".1 The 2002 Finance Act implies a redistribution of public spending and a continued sound surplus on public finances. The general fiscal effect is in line with the proposals of the previous government. The overall fiscal-policy stance is appropriate in view of Denmark's current economic situation and future challenges.

DEVELOPMENT IN INTEREST AND EXCHANGE RATES IN DENMARK

Since mid-May 2001 the krone has been a little stronger than its central rate of kr. 7.46038 per euro in ERM II. Since mid-1997 the day-to-day fluctuations in the krone rate have been moderate, cf. Chart 8. Since November the krone has shown an underlying tendency to strengthen, from a level of approximately kr. 7.45 per euro to just under kr. 7.43 per euro in mid-February. This is the strongest level since the introduction of the euro on 1 January 1999, but is still close to the krone's central parity, cf. Chart 9. From November to January Danmarks Nationalbank's net purchases of foreign exchange amounted to kr. 16.6 billion. In view of the large purchases of foreign exchange in January and the krone's strength and stability, on 1 February Danmarks Nationalbank lowered the lending rate and the rate of interest for certificates of deposit by 0.05 per cent, thereby narrowing the differential to the ECB's minimum bid rate to 0.30 per cent.

The 3-month money-market interest rate has remained constant at around 3.6 per cent since mid-November, cf. Chart 10. During the same period the differential to the euro area was 25-35 basis points. The 10-year government-bond yield mirrored the corresponding euro-area yield, and rose by approximately 70 basis points from the beginning of November to the New Year, but then took a more stable course. After a falling trend in September and October the 10-year yield differential to Germany has been relatively stable since November at approximately 15-25 basis points. On 23 November the minimum coupon rate was low-ered extraordinarily to 3 per cent, but was then raised again to 4 per cent at New Year. 3-per-cent securities for almost kr. 8 billion were issued, and Danish Ship Finance accounted for almost 75 per cent of these issues.

1 The Prime Minister's Opening Speech to the Folketing (Parliament) on 4 December 2001.


Alice Colombo

15

In December, the mortgage-credit institutes held their annual bond auc-tions in connection with the refinancing of adjustable-rate loans. The auctions proceeded according to plan. Homeowners with mortgage- credit loans subject to annual interest-rate adjustment must pay interest at approximately 3.95 per cent in 2002, compared to approximately 5.6 per cent in 2001. In 2002 the rate of interest for adjustable-rate loans

KRONER VIA-À-VIS EURO Chart 9

VOLATILITY OF THE KRONE RATE VIA-À-VIS THE EURO Chart 8

Note: The volatility is the 60-day moving standard deviation. Before 1 January 1999 the D-mark exchange rate is used.

0

0.5

1

1.5

2

2.5

3

3.5

1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

Volatility

Per cent

7.20

7.25

7.30

7.35

7.40

7.45

7.50

7.55

7.60

7.65

7.70

Kr. per euro Central parity Upper intervention limit Lower intervention limit

Aug Sep Oct Nov Dec Jan

Kr. per euro

Feb


Alice Colombo

16

denominated in euro was 45-50 basis points lower than the rate for a corresponding loan denominated in kroner, excluding conversion costs, etc.

The mortgage-credit institutes' auctions, as well as other factors, meant that the amount to be settled in the Danish money market on 2 January was record-high. The payments were related to the refinancing of loans denominated in kroner for approximately kr. 92 billion, extraordinary redemptions for approximately kr. 80 billion, and interest and redemption payments for approximately kr. 15 billion. Payments for settlement on 2 January in addition to normal settlements totalled kr. 187 billion. Dan-marks Nationalbank remained open for purchase and sale of certificates of deposit to prevent any problems arising in connection with the distri-bution of liquidity among the individual banks and mortgage-credit insti-tutes. The market participants were thus assured of access to liquidity at the rate of interest for certificates of deposit plus 5 basis points on selling certificates of deposit to Danmarks Nationalbank.1 The settlement of transactions presented no problems.

The market and Danmarks Nationalbank knew in advance that liquidity would be ample due to large central-government disbursements on 2 January. In other words, the money market's need to place liquidity (buy certificates of deposit) would be greater than the need to raise liquidity (sell certificates of deposit). The market participants had an incentive to

1 Danmarks Nationalbank's normal premium is 5 basis points on purchase of certificates of deposit.

MONEY-MARKET INTEREST RATES AND BOND YIELDS Chart 10

Note: The 30-year construction-bond yield is the weighted yield of the Association of Danish Mortgage Banks.

3.0

3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

3-month CIBOR 10-year government-bond yield 30-year construction-bond yield

Per cent p.a.

May Jun Jul Aug Sep Oct Nov Dec Jan Feb


Alice Colombo

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trade among themselves: those wishing to place liquidity could only ob-tain the rate of interest for certificates of deposit if they bought certifi-cates of deposit from Danmarks Nationalbank, while those wishing to raise liquidity had to pay the rate of interest for certificates of deposit plus 5 basis points, if they sold certificates of deposit to Danmarks Nation-albank. The two parties could therefore meet each other half-way and share the 5 basis points. Nevertheless, the market resorted to Danmarks Nationalbank as counterparty on a considerable scale during the day, since placements for kr. 32 billion were made, and liquidity for kr. 29 bil-lion was raised.

Growth in total domestic lending by the banks and mortgage-credit institutes has increased in recent months to a little more than 7 per cent year-on-year at the end of 2001. This is slightly below the level at end-2000. Lending by the mortgage-credit institutes accounted for the strongest increase. Business lending increased less than lending to households, reflecting the dampening of investments.

PRICES AND WAGES

According to the statistics of the Danish Employers' Confederation wages rose by 4.4 per cent in the 3rd and 4th quarters. The rate of growth has thus slowed down from the level of 4.9 per cent in the 2nd

CONSUMER-PRICE INDEX AND DOMESTICALLY-DETERMINED MARKET PRICES Chart 11

Note: Source:

Seasonally-adjusted. Statistics Denmark and Table 10 of the Tables and Graphs Section.

98

100

102

104

106

108

110

112

114

Consumer-price index Domestically-determined market prices

1997 1998 1999 2000 2001

Index, Jan. 1997 = 100


Alice Colombo

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quarter, which was inflated by the inclusion of extra days of holiday leave as from 1 May. The rate of wage increase is still higher than in the euro area, confirming the tightness of the Danish labour market. The extension of the maternity leave entitlement puts more pressure on the labour market, particularly within certain groups, e.g. nurses.

The Harmonised Index of Consumer Prices, HICP, rose by 2.5 per cent year-on-year in January, compared to 1.7 per cent in November and 2.1 per cent in December. Approximately one per mille of the November increase can be attributed to a shortfall in reporting changes in district heating prices to Statistics Denmark since February 2000. Almost two years' increases in district heating prices were thus included in the con-sumer-price index at one time in December 2001. The remainder of the increase is due mainly to higher foodstuffs prices.

Domestic market-determined inflation, IMI, has risen by more than the general index in the 2nd half of 2001, cf. Chart 11. This should be viewed primarily as a normalisation, since the increasing import and energy prices in especially 2000 were not passed on immediately to con-sumer prices, but caused domestic market-determined inflation to level out. The development is consistent with the interpretation that the ris-ing import and energy prices in 2000 were perceived as a temporary phenomenon.


2002\1-kvartal-UK-2002\word\12640-Euroen 2002-en.doc Oprettet af Alice Colombo

19

Euro 2002

Niels Bartholdy, International Relations, and Governor Jens Thomsen

INTRODUCTION

Euro banknotes and coins were put into circulation in 12 EU member states1 on 1 January 2002, and the legacy currencies are by now virtually withdrawn from circulation. This marks the 12 member states' full achievement of the final stage of Economic and Monetary Union, EMU. Although the euro, the European System of Central Banks and the single monetary policy have existed since 1999, the launch of euro banknotes and coins and the discontinued use of the legacy currencies for pay-ments or pricing have made EMU tangible to the general public.

The idea of an economic and monetary union in the European Community first gained momentum more than 30 years ago, and led to the preparation of the Werner plan, which subsequently stranded. This was also the case for the outline EMU plans which were part of the agreement on the establishment of the European Monetary System, EMS, in 1979. This article reviews the old plans now that EMU has become a reality, and seeks to explain why these plans stranded, as well as why EMU has now been successfully implemented.

The euro has not yet gained the same status as the dollar in the inter-national foreign-exchange markets. Nevertheless, the euro is the cur-rency of more than 300 million Europeans, making it a tangible symbol of European cooperation. The 12 euro-area member states now have one interest rate, one system of central banks, and one single currency.

In view of Denmark's fixed-exchange-rate policy and substantial trade with the euro area, the euro is clearly its most important foreign cur-rency.

THE WERNER PLAN

At the European Council in The Hague, the Netherlands, in December 1969, at the initiative of German Chancellor Willy Brandt a decision was taken to prepare a plan for the establishment of an economic and

1 Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands,

Portugal and Spain.



20

monetary union in the European Community. At that time, the Euro-pean Community consisted of Belgium, France, the Netherlands, Italy, Luxembourg and Germany. This summit also created the basis for the enlargement negotiations which were to lead Denmark, Ireland and the UK into the EC as from 1973.

Willy Brandt's EMU initiative can be seen as an attempt to actively embrace closer cooperation within the Community as a type of compen-sation to meet the concerns of other EC member states, especially France, at the perspectives of Willy Brandt's new dialogue with East Germany ("Ostpolitik").

The economic background to the initiative was the high degree of stability, with low unemployment and inflation, mainly current-account surpluses, and stable foreign-exchange markets, enjoyed by the EC mem-ber states during the 1960s. Exchange rates were kept stable within the Bretton Woods system whereby each currency was pegged to the US dollar, subject to a fluctuation band of +/- 1 per cent. The European countries had imposed a slightly narrower fluctuation band of +/- 0.75 per cent on themselves, and in practice the exchange rates were kept even more stable. Under this system, an exchange rate would only be adjusted in the event of fundamental balance-of-payments imbalances. No EC currencies were realigned from 1962 to 1968.

This calm pattern of stability was broken in 1969 when the French franc came under strong pressure and finally had to be devalued, while the D-mark was revalued.

Also during the 1960s, the European Community had made consider-able progress in the implementation of the common agricultural policy with common prices for agricultural products, the establishment of a system for own resources, and, in 1968, full achievement of the customs union as an important step towards the establishment of the common market.

The decision at the summit in The Hague led to the appointment of a working group headed by Pierre Werner, Luxembourg's Premier, with the remit to prepare a plan for the establishment of EMU. The Werner group submitted its report in October 1970 outlining the "indispensable structures and mechanisms" of a final EMU. These included irrevocably- fixed exchange rates, full liberalisation of capital flows, and transfer of considerable economic and political competence from the national to the Community level. The report called for the establishment of a com-mon "centre for economic-policy decisions" (including decisions on the national public budgets), as well as a common central bank.

The report proposed a transition to EMU in stages, but did not clearly define the stages. The first stage, which would last until the end of 1973,



21

would feature the gradual narrowing of the fluctuation bands of the EC currencies in the Bretton Woods system – and thereby a narrowing of the fluctuation bands between the EC currencies. Furthermore, the co-ordination of the member states' economic policies would be intensi-fied. The report did not consider such issues as how to establish the new institutions and the legal requirements for implementing the plan.

This lack of specific obligations also characterised the resolution adopted by the EC Council of Ministers in February 1971 on the imple-mentation of the Werner plan (after consultation of the 4 candidate countries, including Norway). France in particular was opposed to a commitment to transfer competence to the EC.

These vaguely sketched institutional commitments stand in sharp con-trast to the specifications of today's EMU in the Delors Report and par-ticularly the Maastricht Treaty, where the institutional basis for EMU is specified in great detail, cf. below.

In March 1971, the EC central-bank governors, as the first step towards the implementation of the first stage of the Werner plan, decided to narrow the fluctuation bands between the EC currencies in the Bretton Woods system from 1.5 per cent to 1.2 per cent.1 However, before this decision could be executed, the Bretton Woods system collapsed, and the most serious monetary crisis since World War II broke out. The crisis caused the dollar to weaken and the D-mark to strengthen, and subse-quently led to the abandonment of the system of pegging currencies to the dollar.

The ensuing years saw the first oil crisis, more and more capital restric-tions and an unsuccessful attempt to establish a fixed-exchange-rate system between all EC member states. The Werner plan stranded. In the fixed-exchange-rate system, called "the Snake" (from 1972, with a fluc-tuation band of +/-2.25 per cent), the participation of all EC member states soon had to be abandoned. The UK and Ireland left the band in June 1972, and the system became a D-mark zone consisting of the Benelux countries, Denmark and Germany. Furthermore, Sweden and Norway participated in the snake from outside the EC. During its life-time from 1972 to 1978 the snake was characterised by frequent ex-change-rate adjustments, as well as the coming (in the case of France) and going of various member states.

It can be concluded that the Werner plan was unsuccessful due to the dismal global economic outlook at that time, but perhaps even more importantly, due to a high level of ambition for the surrender of na-

1 Each EC currency was subject to a fluctuation band of +/-0.75 per cent against the dollar. This in

reality implied a fluctuation band between the EC currencies of +/-1.50 per cent. A fluctuation band between the EC currencies of +/-1.2 per cent thus represented a narrowing.



22

tional competence combined with a lack of specification of the plan's practical implementation. The economic crisis and the EC member states' response to it clearly showed that the member states were not yet ready for more formal cooperation. It also indicated that the member states were still far from reaching consensus on the most appropriate eco-nomic policy. The Werner plan was prepared in an economic-policy con-text which subsequently changed dramatically, and in an environment where the member states had not yet found their bearings.

EMS: STABLE EXCHANGE RATES WITHOUT A MONETARY UNION

Whereas the period up to the launch of the Werner plan in 1970 was pre-dominantly characterised by economic and monetary stability, the follow-ing decade was chaotic. In the mid-1970s any notions of increased economic-policy coordination and formalised cooperation were over-whelmed by short-term national economic policies in an attempt to tackle the sudden substantial economic imbalances in most European countries (and in the USA). Recession, high inflation, strongly rising unemployment, balance-of-payments problems and substantial government-budget defi-cits were the order of the day.

In the midst of this turbulent time when EMU and a single currency were but distant notions, the EC took a decision which at that time must have seemed primarily technical, but since turned out to have wide im-plications. After the collapse of the Bretton Woods system the existing unit of account used for certain payments within the EC system had be-come obsolete, so in 1975 a new unit of account, the EUA (European Unit of Account) was introduced and gradually implemented in the European Community. The value of 1 EUA was initially fixed at 1 SDR (Special Drawing Rights of the IMF). The exchange rate of the EUA, which was re-named the ECU in 1979, was determined by the develop-ment in a weighted basket of EC member states' currencies. Many years later, the exchange rate of the ECU against other currencies, such as the dollar, would determine the exchange rate of the euro. On the introduc-tion of the euro in 1999 its exchange rate vis-à-vis the ECU was fixed at 1:1.

The issue of EMU was put back on the agenda in the autumn of 1977 when the President of the European Commission, Roy Jenkins, made a speech in favour of breathing new life into plans for EMU. The speech was met by the public with great scepticism, but in retrospect Jenkins' thoughts were quite visionary. They were apparently his personal ideas, and not the result of a recommendation from within the Com-mission. One of the visionary aspects of Jenkins' speech was his argu-



23

ment that – contrary to the notion in the Werner plan – it was possible to establish EMU without significantly centralising the fiscal policy of the member states. Roy Jenkins argued that "a monetary union might be viable with expenditure of the order of 5-7 per cent of the gross national product".1 The ideas in Jenkins' speech were thwarted by the EC member states' ministers of economic affairs and finance in November 1977. At the EC summit in December there was support for the EMU idea, although nothing was concluded, except to continue along these lines.

In the meantime, the international monetary situation had become even more turbulent. Germany's prominent role in the global economy was becoming more and more apparent, which was not wholly unprob-lematic from a German point of view. In the period 1977-78 alone, the dollar weakened by 30 per cent against the D-mark, which naturally led to considerable tension in the currency snake. At the same time, growth prospects were gloomy for all countries, including Germany.

In this environment Germany's Chancellor, Helmut Schmidt, in the spring of 1978 launched the idea of a European Monetary System. In the first instance, Schmidt had only discussed the idea with the French President, Giscard d'Estaing, but it was submitted to the other heads of state and of government of the EC member states at the European Council in Copenhagen in April 1978 under the Presidency of Danish Prime Minister Anker Jørgensen.

The circumstances behind Helmut Schmidt's initiative were similar in many ways to Willy Brandt's initiative in 1969. The proposal was submit-ted out of the blue. It was a personal initiative that had not been dis-cussed with e.g. the German finance minister or the Bundesbank. Fur-thermore, the initiative broke with previous German positions.

In the Werner plan negotiations, Germany was the leading supporter of the argument that closer monetary cooperation would require closer integration of other economic policy. The EMS initiative presents a dif-ferent view and suggests closer monetary cooperation without making any outright requirements of other economic policy.

Although generally ambitious, the EMS proposal was less extensive than Roy Jenkins' EMU notions. At the end of 1978 agreement was reached on a version of EMS whereby the European Currency Unit, the ECU, would be at the centre of the system, and the degree of tension in the EMS would be measured by a divergence indicator, although this never gained any practical significance. At the same time, a central parity against all other currencies in the system was fixed for each currency, called the parity grid.

1 Roy Jenkins, The First Jean Monnet Lecture, Florence, 27 October 1977.



24

The fluctuation band for each currency was +/-2.25 per cent, and certain rules were applied to financing intervention1. A declaration of intent was also adopted, whereby the considerations would continue and a "final system", including a European monetary fund, would be established within 2 years. This could be interpreted in various ways, from the pooling of a small proportion of the member states' foreign-exchange reserves to the establishment of an actual European central bank. However, it was never quite clear what this entailed, since the plans were quietly shelved during the first turbulent years with the EMS.

The first 4 years of the EMS were characterised by frequent exchange- rate alignments, with no indication that greater exchange-rate stability had been achieved. In practice, the EMS represented a continuation of the snake without any changes, except that it had a slightly larger group of participants. For example, during this period France's fiscal policy was strongly expansionary, which contributed to tension in the EMS. How-ever, the system stabilised as from 1983, when the national economic policies of a number of countries (including France and Denmark) be-came stability-oriented to the degree necessary to maintain a stable exchange rate against the D-mark. For instance, inflation2 in Denmark and France was reduced by half, from 12-14 per cent to 6-7 per cent, in the period 1979-1983. Even Italy's inflation rate, at more than 20 per cent in 1979, had been reduced to 6 per cent in 1985. At no point during this period did Germany's inflation exceed 6 per cent. Ironically, the French arguments in the negotiations on the Werner plan – to start with the monetary union, and then the rest would slot into place – turned out to be most valid. The EMS was stable right up to 1992, with no re-alignments at all from January 1987, except one case of realignment of the lira.

Up to the beginning of 1988 the ambitions to establish a monetary union were subdued. During that period the focus was on ensuring the optimum functioning of EMS. From time to time the EMS was subject to minor adjustments which did not require institutional changes. Never-theless, this period planted the seed of a new EMU initiative. For a num-ber of member states the period of stable exchange rates as from 1983 illustrated the advantages of de facto relinquishment of monetary sov-ereignty by matching the Bundesbank's interest-rate adjustments and maintaining a stable exchange rate. This was in sharp contrast to the preceding turbulent decade which clearly demonstrated the problems of

1 The Bundesbank had concluded an informal agreement with the German government to ensure that

the Bundesbank was not expected to intervene if Germany's monetary stability was considered by the Bundesbank to be at risk.

2 Inflation measured in terms of the year-on-year rate of increase in the consumer-price index, cf.

Statistics Denmark's "Statistisk Tiårsoversigt".



25

uncoordinated national approaches to the economic problems by means of measures such as devaluations and capital restrictions.

At the same time there was growing dissatisfaction, particularly on the part of France and Italy, with the asymmetry of the EMS. This entailed that it was always the currency "at the bottom of the system" which became the target for economic-policy adjustments. The "top" currency (the D-mark) would never be required to adjust to other currencies, e.g. by means of a lowering of interest rates to weaken the D-mark.

In the mid-1980s the adoption of the Single Act and thus the basis for establishing the Single Market also lent the strongest new momentum to the EC integration process since the establishment of the customs union in 1968, and following the standstill in the 1970s. This, together with the new winds that were blowing in the Soviet Union and eastern Europe, soon to lead to German reunification, formed the background to a new EMU initiative. The initiative was again quite unexpectedly presented by Germany; in the first instance by Foreign Minister Hans- Dietrich Genscher in February 1988 during Germany's EU Presidency1. Mr. Genscher proposed to work to establish a European currency area and a European central bank based on the same principles of independence as applied to the Bundesbank. He also proposed the establishment of en expert group at the next EC summit in Hanover in June 1988. Within one year the group was to prepare a report with proposals for the estab-lishment of EMU, including statutes for a European central bank. Pro-moted by Jacques Delors, President of the European Commission, this proposal, in slightly modified form, was adopted at the Hanover summit. As a result, the Delors Committee was established, consisting of Jaques Delors, the central-bank governors of the 12 EC member states (with a "personal mandate"), a member of the European Commission, and 3 independent experts.

Immediately before the Hanover summit the Ecofin Council had adopted the full liberalisation of capital flows as from 1 July 1990 in most EC member states. Germany had stipulated this as a condition for proceeding with the plans for EMU.

THE DELORS REPORT AND THE MAASTRICHT TREATY

The Delors Committee submitted its report in April 1989. The report was adopted unanimously by the committee members (including most nota-bly the Governor of Deutsche Bundesbank, Karl Otto Pöhl, and the Gov-ernor of the Bank of England, Robert (Robin) Leigh-Pemberton). Jacques

1 Proposals were submitted simultaneously by France (Balladur) and Italy (Amato) on the further

development of cooperation towards a European central bank.



26

Delors had thus ensured "ownership" by the central-bank governors of the plan so that they could not begin to oppose it at a later stage.

The final Maastricht Treaty and the third stage of EMU now achieved accord to a great extent with the proposals outlined in the Delors Report. This applies to the establishment of the European System of Central Banks, ESCB, and its structure, tasks and independence. The re-port recommended application of the principle of subsidiarity to other economic policy. The Council of Ministers only sets out the framework, which would later become the "Broad Economic-Policy Guidelines" ac-cording to Article 99 of the Treaty. However, binding rules and proce-dures for budget policy are recommended, such as upper limits for budget deficits, and rules for the financing of budget deficits. These rules were later incorporated in Articles 101-104 of the Treaty.

With regard to the process towards the last stage of EMU, the Delors Report sets out a number of principles, especially the need for parallel progress in the monetary and other economic integration processes.

In this respect the actual development in the EU member states throughout the 1990s exceeded all expectations. This was due to the sig-nificant fiscal consolidation and economic convergence in all member states, but just as much to the emergence of a common political under-standing of economic policy issues. This common understanding included suitable measures to solve the balance problems, such as increased focus on the role of structural policy. There was also a further change of atti-tudes towards political acceptance of the advantages of minimum re-quirements of public finances, as a natural consequence of the awareness that had dawned when the EMS stabilised in the mid-1980s. For example, early in 1991 most member states were still clearly opposed to setting an upper limit for government-budget deficits. The limit was later accepted as a central element of the common rules. Several of the member states which had traditionally experienced substantial government-budget defi-cits now believed that EMU could contribute to general public awareness of the need to reduce the deficits.

In many respects the Delors Report was only an outline with few spe-cific details. This for instance applies to the description of the "second stage" where e.g. the subsequent collapse of the EMS in 1992-1993 was naturally not foreseen. The report mentions the need for gradual reduc-tion of the ERM fluctuation band up to the fixing of the exchange rates. On the other hand, this requirement was in tune with the de facto de-velopment in the EMS from the end of 1993, with considerable stability and minor fluctuations. Furthermore, the report had not foreseen the need for legal instruments concerning the single currency (the subse-quent "euro legislation") in the transition period. Naturally, the report



27

had not foreseen either that the ECU would become the euro, the change of name not being adopted until 1995. In all other areas the proposals in the Delors Report have turned out to "hold water".

The Delors Report recommended that no fixed time schedule be adopted for the transition to the third stage. But it did recommend that the first stage commence by no later than 1 July 1990 (to coincide with the liberalisation of capital flows in 8 member states). The report en-couraged a flexible degree of participation by the individual member states, with correlation between the degree of influence and the degree of participation, however.

On the basis of the Delors Report, the European Council in Madrid in June 1989 adopted the commencement of the first stage on 1 July 1990, and the European Council in Strasbourg in December 1989 convened an inter-governmental conference in 1990 to determine the subsequent stages of EMU.

The statute for the ESCB was prepared by the EC Committee of Central Bank Governors in 1990 and was considered at the inter-governmental conference which commenced on 15 December that year. The final stat-ute, which is annexed as a protocol to the Treaty, is very close to the proposal of the Committee of Central Bank Governors.

The plans for an inter-governmental conference were subsequently ex-tended to include a second part, the achievement of a political union.

The negotiations were crowned by the signing of the Maastricht Treaty in December 1991. The Maastricht Treaty contained very detailed institutional provisions concerning the establishment of EMU in 3 stages, as well as convergence criteria, a European central bank, and a provision stipulating that the third and final stage would commence by no later than 1 January 1999, irrespective of the number of member states ready to participate at that time.

German reunification commenced after the fall of the Berlin wall in 1989, and was fully achieved in October 1990. This was no doubt a de-termining factor for the agreement between France and Germany on the central decisions concerning the EMU process in this period, cf. Hoffmeyer (2000).

The following 2 years up to the final ratification of the Treaty by all member states in November 1993 were extremely turbulent. The refer-endum in Denmark in June 1992 resulted in a small majority against the Treaty, and the referendum in France in September 1992 returned a small majority in favour. With the 4 opt-outs for Denmark agreed by the European Council in Edinburgh in December 1992, the Treaty was en-dorsed by a new referendum in Denmark in May 1993. In the meantime, the EMS boat had begun to rock, however, and the UK and Italy left the



28

EMS in the autumn of 1992. In August 1993 the EMS was partly sus-pended when the fluctuation limits were extended considerably.

This began to resemble the pattern at the beginning of the 1970s with currency crises and stranded EMU plans. However, it was possible to weather the storm thanks to the very strong and specific legal provisions of the new Treaty.

As prescribed by the Treaty, the second stage of EMU had commenced at the beginning of 1994 with the establishment of the European Mone-tary Institute, EMI, which was to undertake the establishment of the European Central Bank, ECB. During 1995 it became increasingly clear that it would not be possible to commence the third stage of EMU be-fore the deadline stipulated in the Treaty, i.e. 1 January 1999. On the basis of performance in 1995, for example, only Denmark, which had declared its intention to opt out of the third stage, and Luxembourg and Ireland, met the convergence criterion of a government-budget deficit not exceeding 3 per cent of GDP.

A principal task for the EMI was to prepare the following stages of the EMU process. Together with the Commission's proposal in a Green Book in the spring of 1995 on the practical aspects of the introduction of the single currency, this lent new momentum to the EMU process. The Madrid European Council in 1995 adopted a number of key specifica-tions of the further process. The name of the future single currency was changed from the ECU to the euro. On the basis of an EMI proposal a plan was prepared for the introduction of the single currency in stages. The time schedule was close to the schedule that was finally realised, stipulating the selection of participating member states and establish-ment of the ECB in 1998, the introduction of the euro as "account money" in 1999, and the final introduction of euro banknotes and coins in 2002, with the withdrawal of national banknotes and coins during the 1st half of 2002 (subsequently reduced to 2 months).

This new momentum turned out to be self-reinforcing. Even in 1996 not many would have guessed that the public finances of 11 member states would meet the convergence criteria by 1998 when the member states were selected. Yet the widespread confidence in this process con-tributed to significant decreases in interest rates in member states with large interest-rate differentials to Germany, which in itself led to signifi-cant budget consolidation until 1997. This was sufficient for all the member states that wished to participate from the start in 1999 (except Greece) to meet the convergence criteria1.

1 The convergence criteria relate to the government budget and government debt, as well as inflation,

interest rates and exchange rates.



29

WHY SUCCESSFUL THIS TIME?

The successful execution of this last EMU initiative, unlike e.g. the Werner plan, can be attributed to a number of factors.

A decisive factor was the stipulation of fixed dates, first for the com-mencement of the inter-governmental conference and the revision of the Treaty, then for the final date for commencement of the third stage of EMU, including the introduction of the euro. Furthermore, it was ac-cepted that not all member states had to participate. The UK and Den-mark were subject to opt-out clauses, and the convergence criteria im-plied that there could be member states that did not qualify. This was based on the experience from the currency snake and later the EMS, where it was increasingly accepted that not all member states would participate, in contrast to the experience in other parts of the EC system.

Moreover, until the late 1980s and throughout the 1990s the member states had undergone a "mental" convergence process concerning economic-policy priorities. This convergence was first evident among the central banks. They came to realise that the Bundesbank's focus on con-taining inflation was the best strategy, which they did well to follow. In the first instance, this was ensured via the fixed-exchange-rate policy vis-à-vis the D-mark, but the currency crisis in 1992-1993 had shown that the EMS was not a permanent solution. The convergence subsequently became evident among the governments, with growing consensus on the advantages of a stability-oriented economic policy based on such elements as a responsible fiscal policy.

The Maastricht Treaty's specific guidelines for the implementation of the first stages of the transition process and the establishment of the new European Central Bank undoubtedly also played a significant role. Especially the establishment of the EMI lent momentum to the process. Compared to previous initiatives the Delors Report’s more realistic ap-proach did not require centralisation of fiscal policy and a strongly in-creased EC budget. The central banks of the EMS member states, except the Bundesbank, had de facto surrendered their sovereignty, so from their point of view, the introduction of the single currency would first and foremost ensure them more influence.

A final factor was the self-reinforcing momentum of the harmonised approach, emphasised by the adoption in 1995 of a detailed and exhaust- ive scenario for achievement of economic and monetary union which en-hanced the confidence in the plans for EMU.

In retrospect, the guidelines of the Maastricht Treaty have turned out to be amazingly durable. As regards the actual process of implementing EMU, the specifications in the Madrid conclusions of 1995 proved to be



30

adequate. No adjustments have yet been required concerning the monetary aspect. In 1997, at Germany's request, the Treaty provisions on general economic policy were supplemented with the Stability and Growth Pact, which dampened the resistance to the project from within Germany and supported the growing confidence in the project. How-ever, this did not entail amendment of the Treaty's provisions, but only a number of specifications of the provisions concerning public finances, and the addition of some not legally binding criteria regarding the government-budget balance in the medium term.

Moreover, the informal Eurogroup consisting of the Ecofin ministers of the euro-area member states was established in 1998. This primarily re-flects that the Treaty is not entirely clear as regards the interaction be-tween euro-area and non-euro-area member states. All formal decisions, except certain euro-related decisions, are therefore still taken by the Ecofin Council of ministers of all member states.



31

REFERENCES

Danmarks Nationalbank, various Annual Reports and Monetary Reviews. Delors Report, Committee for the study of economic and monetary union (1989), Report on the economic and monetary union in the European Community, Office for Official Publications of the European Communities, Luxembourg. Gros, Daniel and Niels Thygesen (1998), European Monetary Integration, 2nd edition, Addison Wesley Longman Limited: Essex. Hoffmeyer, Erik (2000), Decisionmaking for European Economic and Monetary Union, Occasional Paper 62, Group of Thirty: Washington, DC. Kristensen, Jens P., Thomas A. Christensen and Gitte W. Pedersen (1998), European Monetary Cooperation – from EMS to EMU (in Danish), Handelshøjskolens forlag: Copenhagen. Ludlow, Peter (1982), The Making of the European Monetary System, Butterworths European Studies, Butterworths: Kent. Mikkelsen, Richard (1993), Danish Monetary History 1960-1990 (in Danish), Danmarks Nationalbank. Thomsen, Jens (1990), European Monetary Cooperation (in Danish), Handelshøjskolens forlag, Copenhagen. Tsoukalis, Loukas (1977), The Politics and Economics of European Monetary Integration, St. Catherine's College: Oxford. Ungerer, Horst (1997), A concise history of European monetary integra-tion: From EPU to EMU, Quorum Books: Westport, CT. The Werner Report, Report to the Council and the Commission on the realisation by stages of Economic and Monetary Union in the Community: "Werner Report", Supplement to Bulletin 11 – 1970 of the European Communities, Luxembourg.


2002\1-kvartal-UK-2002\12640-Falske sedler-en.doc Oprettet af Alice Colombo

33

Counterfeit Banknotes

Ulrik Bie and Johan Sebastian Gabel, Secretariat

INTRODUCTION

As the central bank of Denmark, Danmarks Nationalbank holds the ex-clusive right to issue banknotes. Unfortunately there are people who do not respect this monopoly. For unsuspecting individuals or companies that receive or pass on a counterfeit banknote the matter is unpleasant and may result in a financial loss. For society at large, counterfeiting is, however, still a very limited problem in Denmark.

When the first banknotes were introduced in Denmark in 1713, the sig-nature was the most important authentication feature. Since then a num-ber of security features have been added to the banknotes. Even though today's banknotes are better secured against copying than ever before, relatively deceptive imitations can be produced using modern technology. The counterfeit banknotes found in Denmark so far have, however, been easily identifiable by their lack of well-known security features.

A stable currency system has always been seen as a basis for a well-functioning society. The maximum penalty for counterfeiting is 12 years, one of the most severe under the Danish penal code. Many people are surprised to find that production of a few banknotes can result in an unmitigated sentence of imprisonment.

INCIDENCE OF COUNTERFEITING IN DENMARK

Up through the 1990s the extent of counterfeiting rose significantly in Denmark. All the same, the number of counterfeit banknotes in Denmark is modest – both in comparison with other countries and in terms of the overall effect on the economy. Since the extent of counterfeiting is so low, only few Danes check the authenticity of the banknotes they receive.

The number of counterfeit banknotes annually found in circulation1 has risen from approximately 100 in the early 1990s to around 700, cf. Chart 1.

1 On compiling counterfeiting statistics a distinction is made between banknotes found in circulation

and confiscated banknotes. All counterfeit banknotes put into circulation are found – if not before, then when they are machine-checked at Danmarks Nationalbank in connection with the general screening to maintain the quality of banknotes. Confiscated banknotes are typically found by the police in their investigation of cases of suspected counterfeiting. They have therefore not yet been put into circulation.



34

The increase during the 1990s can be explained by the more widespread access to new reproduction technology during the past decade. The new technology has made it easier and cheaper to produce counterfeit banknotes.

In many countries, including Denmark, new methods to prevent coun-terfeiting were introduced in the 1990s. A new series of Danish bank-notes with enhanced security features was introduced in 1997-1999.

The most frequently counterfeited Danish banknote is the 500-krone note. While the average number of counterfeit banknotes found per million in circulation was 5.4 in 2001, 20.5 counterfeit 500-krone bank-notes were found per million 500-krone banknotes in circulation. The

POLICE REGISTRATION OF COUNTERFEIT BANKNOTES Box 1

Every case of counterfeiting reported is registered separately, but when unravelling

the cases the police try to establish a connection between related reports. An initial

measure is to compare the serial numbers of counterfeit banknotes received to see

whether the same original has been used.

In addition to counterfeit banknotes found in circulation the police from time to

time seize large or small quantities of counterfeit banknotes in connection with their

work. In the last decade there have only been few major seizures, which supports the

conclusion that the incidence of professional counterfeiting is limited in Denmark.

NUMBER OF COUNTERFEIT BANKNOTES FOUND IN CIRCULATION Chart 1

Source: The police.

0

100

200

300

400

500

600

700

800

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Number

50-krone banknote 100-krone banknote 200-krone banknote

500-krone banknote 1,000-krone banknote



35

500-krone banknote is the denomination preferred by counterfeiters, presumably because it is used in relatively many everyday transactions, but is also sufficiently valuable to make it attractive to counterfeit. Correspondingly the number of counterfeit 50-krone banknotes is very low.

International comparison In Denmark's neighbouring countries there is great variation in both the level of and the trend for the number of counterfeit banknotes found in circulation as a ratio of banknotes in circulation. In Norway and Sweden, where there have been significant increases in recent years, the ratios

THE PROFILE OF COUNTERFEITING IN DENMARK Box 2

Counterfeiting differs from most other serious crimes in that only few of those

charged come from a criminal environment. Relative to the population, most inci-

dents are reported in and around Copenhagen, which is in line with the general crime

pattern in Denmark.

GEOGRAPHICAL DISTRIBUTION OF REPORTED COUNTERFEITING INCIDENTS

Note: Source:

The figures are averages for the period 1995-2000. The police and Statistics Denmark.

The typical profile of a counterfeiter is a young man from Copenhagen or a large

town. The age distribution is worth noting, in that more than half of those convicted

are between 15 and 20 years of age. In most cases they have produced a small number

of banknotes which they attempt to put into circulation within a limited geographical

area.

0 50 100 150 200 250 300

Greater Copenhagen

County of Frederiksborg

County of Roskilde

County of West Zealand

County of Storstrøm

County of Bornholm

County of Funen

County of Southern Jutland

County of Ribe

County of Vejle

County of Ringkøbing

County of Aarhus

County of Viborg

County of Northern Jutland

Number per million inhabitants



36

have been considerably higher than in Denmark, Finland and Germany, cf. Chart 21.

In Norway and Sweden, counterfeiting has been concentrated on a few denominations. In 2000, the two most frequently counterfeited banknotes (the 100- and 500-krona notes in Sweden and the 200- and 1,000-krone notes in Norway) accounted for more than 90 per cent of the counterfeited banknotes found2. The high concentration of espe-cially the 200-krone banknote in Norway meant that 102 counterfeit 200-krone banknotes were found per million 200-krone banknotes in circulation in 2000. The central banks in Norway and Sweden have sought to counteract the relatively high incidence of counterfeiting by adding new security features to their banknotes. In Norway, a number of security-enhancing features were introduced in 1999-2001, while the Swedish 100- and 500-krona banknotes were upgraded in 2001. Prelim- inary Norwegian figures for 2001 indicate that the incidence of counter-feiting declined in that year.

Germany has seen a declining trend in recent years, and the incidence of counterfeiting has generally been relatively low. This is particularly remarkable, considering that the D-mark was in widespread use beyond

1 The 2001 figures for these countries are not yet available. However, Germany has registered a 42 per

cent increase in the number of counterfeit banknotes from 2000 to 2001. 2 The corresponding figure for Denmark in 2001 was 76 per cent (for the 500- and 1,000-krone notes).

COUNTERFEIT BANKNOTES FOUND IN CIRCULATION, INTERNATIONAL COMPARISON Chart 2

Source: National central banks.

0

5

10

15

20

25

30

35

40

1997 1998 1999 2000

Finland Denmark Germany Sweden Norway

Counterfeit banknotes per million notes in circulation



37

Germany, especially in central and eastern Europe, and was therefore more susceptible to counterfeiting. The low incidence is a result of suc-cessful preventive measures – such as the addition of new security fea-tures to the most frequently counterfeited banknotes (the 50-, 100- and 200-mark notes) in 1997. Yet it should be noted that while the incidence of counterfeiting has declined for the upgraded denominations, and on an overall basis, it has risen for the denominations that have not been upgraded.

Several euro-area member states, including Germany, experienced an increase in counterfeiting in 2001. This is attributed to criminals at-tempting to dispose of their stocks of counterfeit banknotes in the na-tional currencies before the introduction of euro banknotes and coins from 1 January 2002. The incidence of counterfeiting in Germany in 2001 was thus the highest since 1993.

TECHNOLOGICAL DISPERSION – INCREASED COUNTERFEITING

The single most important factor behind the increase in counterfeiting in Denmark, as elsewhere, is the development of new technology. The reproduction quality achievable at a given price has been enhanced sig-nificantly, and equipment reserved for experts a few years ago has now become accessible to a large proportion of the population.

New methods Production of counterfeit banknotes requires equipment to scan a genu-ine copy and to reproduce the scanned image as a colour print. Techno-logical advances within the last decade mean that modern standard scanners can distinguish colours in a high resolution. Moreover, an ordinary printer can now produce high-resolution colour prints. High- resolution colour prints are therefore available at a moderate cost to-day, whereas copies of an equivalent quality would have been relatively expensive to produce only a few years ago.

Dispersion Technological advances within reproduction equipment have not only enhanced the quality of the reproductions available at a given cost. They have also made this technology available to a very large group of people who previously would not have had access to equipment which might be used for counterfeiting. Such equipment includes colour copiers, scan-ners and colour printers.

Today a colour printer is standard equipment, often sold with a PC. In 1994, 33 per cent of all Danish families owned a PC. In 2000 the figure



38

was 65 per cent. Many of these families also own a colour printer, and moreover a large proportion of the population have access to PCs and printers at work or via educational institutions and libraries.

The dispersion of reproduction equipment means that potentially more people can produce counterfeit banknotes. While only 10-15 years ago a typical counterfeiter would be a specialist, with access to specialist equipment, professional skills are not essential qualifications for today's counterfeiters.

The primary counterfeiting technologies In the early 1990s photocopying was the primary technology used for counterfeiting banknotes. The counterfeit banknotes were not of par-ticularly good quality, and few people had access to colour copiers. The colour copiers sold today have technology installed which leaves an identification mark on the copy so that it is traceable to the place of production.

In the mid-1990s photocopying was replaced by the use of colour printers, which account for most of today's counterfeit banknotes. In the USA the proportion of counterfeit banknotes produced using colour printers rose from 0.5 per cent in 1995 to 43 per cent in 1998. In Norway and Denmark, too, most counterfeit banknotes in recent years have been produced using colour printers. The increase in colour printers in private homes generally coincides with the greater prevalence of coun-terfeiting in Denmark.

COMBATING COUNTERFEITING

Banknote producers have always had to reckon with counterfeiting. On early banknotes, the hand-written signature was proof of authenticity. Over time a number of methods – e.g. watermarks – have been used to protect banknotes against counterfeiting as inter alia new printing methods have been developed. Relatively few years ago the most important protection against counterfeiting was high-quality workman-ship: the banknotes were printed on high-quality paper using high-quality inks, and the impression itself was very finely drawn, which made it difficult to imitate.

Modern Danish banknotes are still of a high quality, but technological advances have made it easier to produce counterfeits printed in a qual-ity that is good enough for the print not to differ significantly from the genuine article. In recent years it has therefore been necessary to intro-duce new methods to protect banknotes in circulation: i.e. a number of new security features. This applies in Denmark as in other countries.



39

New methods to protect banknotes are being developed on an ongoing basis to prevent the greater prevalence of new technology from resulting in an upward trend in counterfeiting. Work is being done in this field in Denmark, and new methods will be implemented. The ongoing development of new methods will ensure that in future all counterfeit banknotes will still be easily recognisable by anyone who wishes to check the money they receive.

As counterfeiting has gone from being a highly specialised form of crime to not requiring any particular professional skills, the focus of the preventive measures taken by central banks has shifted. Previously, they tended mainly to focus on technology, but today there is an increasing realisation that information is also important. Technology ensures that counterfeit banknotes are easy to detect. Information about security features helps to discourage potential counterfeiters and increase awareness of security, e.g. in connection with the introduction of up-graded banknote series.

Security features By far the majority of western countries have improved the quality of their banknotes during the 1990s in direct response to the technological advances within reproduction equipment.

A number of different features have been introduced to make bank-notes more difficult to imitate, e.g.: • Window thread with colour shift • Holograms/patches with changing patterns and colours • Plastic banknotes with a transparent window • Fluorescent effect visible under ultraviolet light

A common characteristic of all these security features is that they are not immediately reproducible via simple copying techniques. Window threads and patches, where the colours and patterns change, can only be copied in one colour or with one pattern, which makes it easy to see that a banknote is not genuine.

Some security features are immediately recognisable, e.g. window threads, patches and holograms, while others require a closer examina-tion, e.g. the fluorescent effect visible under ultraviolet light. The vari-ous features reflect different considerations. It is important to protect the public from counterfeit banknotes by including easily recognisable features, but it is also essential to be able to detect any sophisticated counterfeits which are not immediately distinguishable from genuine banknotes. The various features do not exclude each other – adding several features enhances security.



40

All other things being equal, the introduction of a new, upgraded banknote will lead to a reduction in the number of counterfeit bank-notes. The rate of decline depends on the technology and the general public's awareness of the appearance of banknotes.

Information In addition to their continued measures to improve the security of banknotes, central banks can help to reduce the incidence of counter-feiting by informing the general public about the banknotes' security features and increasing the general awareness of counterfeit banknotes. A three-pronged strategy is applied: regular information about bank-notes in circulation, a targeted strategy when banknotes are replaced, and information about the consequences of counterfeiting.

The ongoing measures include informing the public about how to easily recognise genuine banknotes. Danmarks Nationalbank's website, www.nationalbanken.dk, includes detailed information on the security features of Danish banknotes. Should large-scale counterfeiting occur, public awareness can be raised via an enhanced effort to point out the primary security features which distinguish the genuine banknotes from the counterfeit notes. So far all counterfeits found in Denmark could be detected by checking the well-known security features. A high degree of passive preparedness increases the odds against coun-terfeiters, as it becomes more difficult to distribute counterfeit bank-notes.

When a new series of banknotes is introduced, the incidence of coun-terfeiting may rise. Counterfeiters may exploit the fact that the general public is not yet familiar with the new banknotes. To reduce uncertainty, the replacement of banknotes is normally followed up by targeted in-formation measures aimed at the general public. As people become more familiar with the banknotes, the risk that counterfeiters can suc-cessfully distribute their output declines. Therefore the information measures are aimed at quickly enhancing familiarity with the new bank-notes. For instance, Danmarks Nationalbank conducted a campaign in connection with the replacement of the former banknote series in 1997-1999. In the euro area an extensive information campaign was launched on 30 August 2001 to increase awareness of the appearance and security features of the new euro banknotes and coins in order to ease the transition and reduce insecurity. It is particularly important for citizens of euro-area member states with a low incidence of counterfeit-ing (e.g. Finland) to be attentive.

To the extent that counterfeiting reflects ignorance of the law, includ-ing the high maximum penalty, more information about the potential



41

consequences of counterfeiting may help to reduce the number of people who are tempted to try their luck. This is in the interests of society.

CONCLUSION

Up through the 1990s the incidence of counterfeiting has risen in Den-mark. To a large extent this has been a result of the technological de-velopment over the same period: on the one hand technological ad-vances have made it possible to make high-quality reproductions at low cost, on the other hand equipment which used to be accessible to ex-perts only has now become available to a large part of the population. This means that counterfeiting has changed from being a specialist form of crime to a crime which anyone can commit.

Despite the increase, the level of counterfeiting is still modest in Den-mark – both in comparison with other countries and in terms of the overall effect on the economy. Nevertheless, Danmarks Nationalbank faces a challenge which it cannot ignore. Most western countries have indeed upgraded their banknotes by adding new security features dur-ing the 1990s.

As the nature of counterfeiting has changed, the focus of preventive efforts on the part of the central banks has shifted. Previously they con-centrated mainly on the technology, but today central banks have adopted a more balanced approach, stressing the importance of infor-mation on e.g. security features.

New technology can be expected to be developed at the same rapid pace. Central banks will monitor the situation carefully to be ready to strike back against the new technologies – in the form of new security features, as well as information. Security features are particularly effective if they are accompanied by information measures to ensure that any citizen in doubt can quickly verify whether a banknote is genuine. The counterfeit banknotes found in Denmark so far have all been immedi-ately distinguishable by their lack of security features. Counterfeiting can never be defeated completely, but it is important for society to re-duce it to the lowest possible level.


2002\1-kvartal-UK-2002\12640-KRONOS- ahp-engelsk.doc Oprettet af Alice Colombo

43

Danmarks Nationalbank's New Payment System, Kronos

Thomas Angelius and Astrid Henneberg Pedersen, Payment Systems

INTRODUCTION

Danmarks Nationalbank's new payment system for kroner and euro, Kronos, was launched on 19 November 2001. Kronos has been designed in close cooperation with current-account holders, taking into account the requirements of modern payment systems. For instance, the system includes a number of features to facilitate financial institutions' liquidity management. Kronos replaced the DN Inquiry and Transfer System as the krone payment system, as well as the DEBES euro payment system.

This article first outlines the background to the development of Kronos. After a description of the characteristics of modern RTGS systems the structure and functionality of Kronos are described.

FROM DN INQUIRY AND TRANSFER SYSTEM TO KRONOS

For 20 years, Danmarks Nationalbank's current-account holders have been able to access their accounts via the DN Inquiry and Transfer System. When the system was introduced back in 1981, it was one of the world's first real-time gross settlement (RTGS) systems.

In RTGS systems, transactions are settled individually, instantly and finally to the participants' accounts. Consequently, RTGS systems offer a very high degree of security that payments can be settled in due time.1 RTGS systems are used by financial institutions for exchanging large, time-critical payments such as money-market transactions and other inter-bank settlements.

The DN Inquiry and Transfer System thus gave Danmarks Nationalbank's account holders a "home banking system" whereby they could access their accounts directly. Initially the DN Inquiry and Transfer System was

1 For a discussion of efficiency and security, etc. in relation to payment systems, see Tobias Thygesen,

International Standards for Payment Systems, Danmarks Nationalbank, Monetary Review, 1st Quarter 2001.



44

used for transactions related to inter-bank settlements, but later it also became possible for account holders to transfer liquidity1 to their settlement accounts for the Danish clearing and settlement operations.

Danmarks Nationalbank's account holders have increasingly required mechanisms that can reduce their liquidity requirements and facilitate their liquidity management, as the clearing and settlement operations have become more complex over the years2. The forthcoming introduction of the international currency settlement system, CLS3, will further increase account holders' focus on liquidity management.

Even though the DN Inquiry and Transfer System had been subject to ongoing development, it could not meet the requirements resulting from developments in the financial sector. Danmarks Nationalbank therefore decided to develop a new RTGS system, Kronos, for both kroner and euro. In 1999, Danmarks Nationalbank began to analyse how the requirements of a modern RTGS system could be met. Kronos was developed in close cooperation with Danmarks Nationalbank's account holders. The new system was launched on 19 November 2001 and replaced both the DN Inquiry and Transfer System and the DEBES euro payment system as the home banking system of Danmarks Nationalbank's approximately 130 current-account holders. Participation in Kronos is mandatory for current-account holders.

The section below outlines the characteristics of modern RTGS systems, and the following section outlines the features of Kronos. CHARACTERISTICS OF MODERN RTGS SYSTEMS

Modern RTGS systems offer participants features to support their liquid-ity management, and may also include liquidity-saving mechanisms.4

The desire for instant and secure settlement of payments has increased focus on the networks used to send payment messages. RTGS systems increasingly use the international financial network, SWIFT, to exchange payment messages with participants. SWIFT offers a standardised

1 In this connection, liquidity is taken to mean electronic deposits to current accounts at Danmarks

Nationalbank. For a discussion of the concept of liquidity, see Pengepolitik i Danmark, Danmarks Nationalbank, June 1999 (in Danish).

2 For a detailed description of the settlement concept and account structure at Danmarks

Nationalbank, see Financial Institutions' Accounts at and Pledging of Collateral to Danmarks Nationalbank, Danmarks Nationalbank, Monetary Review, 4th Quarter 2001. For an in-depth description of existing settlement operations, see the report Konsekvenser for dansk betalingsformidling af en eventuel indførelse af euroen i Danmark, Danmarks Nationalbank, August 2000 (in Danish).

3 CLS = Continuous Linked Settlement. For a detailed description, see Danmarks Nationalbank, Report

and Accounts 1998, p. 79 and Danmarks Nationalbank's website under About us, transaction of payments.

4 For a comparison of the characteristics of modern payment systems, see James McAndrews and John

Trundle, New Payment System Designs: Causes and Consequences, Financial Stability Review, December 2001.



45

messaging format, fast handling of messages and a very high degree of security against unauthorised persons gaining access to the messages in the network.

Today, many RTGS-system participants have their own automated payment systems which transmit payments to and receive payments from other financial institutions via SWIFT. The systems are designed to settle payments with as little manual interference as possible. This fully-automated processing is called STP (Straight Through Processing). A modern RTGS system must be able to support participants' STP.

Technological advances require RTGS systems to offer a state-of-the-art interface which must be user-friendly, graphical and interactive, as seen in standard software such as Windows.

In view of the ongoing technological development, an RTGS system is also required to be easy to upgrade. A modular structure makes it easier to add new systems or features, or to alter existing components.

Finally, a shared characteristic of modern RTGS systems is that they are financed by participants as a general rule. In most cases the systems are developed and operated by central banks, whose costs are reimbursed by the participants. However, there are examples of participants joining forces to develop and operate a system.

FEATURES IN KRONOS

The structure of Kronos is based on current-account holders' requirement for e.g. liquidity-management features, and emphasis is on ensuring that Kronos includes the features account holders would expect to find in a modern RTGS system. It has also been important to ensure that Kronos meets the requirements of both large and smaller account holders. Kronos thus operates with two networks aimed at different groups of account holders, and the account holders may choose business modules with various features.

The following section outlines the key features of Kronos, with focus on the liquidity-management options.

Liquidity management in Kronos Kronos is designed to facilitate account holders' liquidity management, and inter alia offers queuing facilities which account holders can monitor and manage via their Kronos terminals.

Liquidity queue Each account holder has a liquidity queue in which payments awaiting cover on the account are placed. There are separate queues for



46

payments in kroner and in euro. In principle, Kronos settles payments on a first-come-first-served basis. However, account holders can, via the Kronos terminal, change the order of payments in the liquidity queue, or delete payments. Kronos always settles payments in the order in which they are listed in each account holder's liquidity queue.

On settling payments in the liquidity queue Kronos in principle attempts to settle the first payment in the queue first using the first-in-first-out principle. If there are insufficient funds to settle the first payment, the subsequent payments in the queue will not be settled either. Account holders can, however, choose for Kronos to attempt settlement of the next payment in the queue if the preceding one cannot be settled.

Payments in the liquidity queue are released for settlement if the amount available changes sufficiently, i.e. if the current-account is credited with sufficient liquidity, or if additional securities are pledged as collateral for overdrafts. In addition, a change in the order of the queue, or deletion of a payment may also lead to settlement of payments in the liquidity queue.

Gridlock resolution Kronos enables ongoing monitoring of liquidity queues to detect any gridlocks, i.e. situations where several participants' payments are mutu-ally awaiting each other's settlement1. In Kronos, gridlocks can be resolved and the payments involved settled, without deviating from the individual account holders' requested settlement order. Gridlocks are resolved by settling a group of payments simultaneously, whereby no account holder incurs an overdraft. Standing orders In Kronos, account holders may register preset amounts which on a daily basis are to be transferred from the account holders' current accounts to their settlement accounts at preset times that match the clearing and settlement operations. These standing orders facilitate the account holders' work to manage the transfers in the various clearing and settlement blocks.

Value date queue Kronos allows account holders with SWIFT to submit payments for settlement on a future value date. Forward-validated payments are

1 For a detailed description, see Morten Linnemann Bech and Kimmo Soramäki, Gridlock Resolution in

Payment Systems, Danmarks Nationalbank, Monetary Review, 4th Quarter 2001.



47

placed in the individual account holder's value date queue for kroner or euro, so that the account holder can see the outgoing payments. Account holders can delete payments in their value date queue.

Stop Sending queue Finally, Kronos has a Stop Sending queue for cross-border euro payments. This feature is used if a central bank in the European payment system, TARGET, cannot receive payments. The individual account holders' payments to banks in the country in question are placed in the account holder's Stop Sending queue. Account holders can delete payments in their Stop Sending queue. Kronos’ structure Box 1 illustrates the structure of Kronos. In the box, Kronos is divided into the current-account holders and their terminals, the two commun-ication networks, and the key system features. The description of Kronos' features below is based on this division.

At the technical level, Kronos is modular, meaning that in principle the individual functions are contained in individual source code modules. This structure makes it easier to upgrade the system, e.g. by adding new systems and facilities.

The modular structure offers the extra advantage that account holders can select business modules as required. All account holders must have a mandatory basic RTGS module enabling them to send krone payments either via SWIFT or via the Kronos terminal. Account holders with SWIFT can, as described below, select a module (Poseidon) which supports STP. Finally, account holders with SWIFT may select a module (TARGET Interlinking) enabling them to send and receive domestic and cross-border euro payments via TARGET.

The Kronos terminal Account holders have access to the Kronos terminal, which is a program running on one or several of the account holders' PCs in a web browser. The terminal has a graphic interactive user interface based on the principles used in standard software.

From the Kronos terminal account holders can submit payments to other account holders, transfer liquidity to their settlement accounts manually or as standing orders, view the entry lists, monitor clearing and settlement operations, use the queuing features, receive news and retrieve historical entry data.

In the Kronos terminal, account holders themselves create authorisations for users, accounts, etc.

Internet Protocolnetwork

SWIFT

Poseidon

BasicModule

TARGET Interlinking


Payments /Information


CLS TARGET


Payments

Payments

Payments

Payments

KRONOSterminal

Small bankwithout SWIFT

KRONOSterminal

Large bankwith SWIFT

1 Chart of the structure of Kronos. At the top two account holders, in the middle the two communicationnetworks (Internet Protocol and SWIFT), and at the bottom Danmarks Nationalbank with the threemodules. The small bank on the left does not have SWIFT and therefore subscribes to the basic moduleonly. It uses the Kronos terminal for payments, queuing facilities and for retrieving information aboutentries, news, etc. The large bank on the right has SWIFT and subscribes to all three modules. Thisbank uses SWIFT for payments and the terminal for queuing facilities and information.

KRONOS' STRUCTURE Box 1

Kronos IP network and SWIFTIn Kronos, account holders can submit payments via two differentnetworks, either manually via the Kronos terminal, which small accountholders generally prefer, or via SWIFT, which large account holdersgenerally prefer.

48



49

Communication between Danmarks Nationalbank and a current-account holder's Kronos terminal takes place via a newly-established network dedicated to Kronos. The network is based on the communication form – IP (Internet Protocol) – used on the Internet, which supports graphics and interactivity. However, traffic is not via the Internet, but via a closed encrypted network which connects the computer centres with Danmarks Nationalbank. The closed solution eliminates many of the risks associ-ated with the Internet.

Kronos supports the most common SWIFT payment messages. SWIFT payments can be used for payments to other current-account holders and for transfers to settlement accounts. In addition to the payments messages, a number of SWIFT service messages are supported. Support for fully-automated payment processing Kronos support a high degree of straight-through processing (STP) among participants. STP is typically used by large account holders who wish to send and receive all payments via SWIFT in order to fully automate the payment processing. Kronos includes a module, Poseidon, which "translates" between terminal payments and SWIFT payments. This allows account holders with SWIFT to send all payments via SWIFT, regardless of whether the recipient has SWIFT or only the Kronos terminal, and to receive all payments via SWIFT, regardless of whether they were sent via SWIFT or the Kronos terminal. Account holders with SWIFT can activate Poseidon themselves via a screen feature in the Kronos terminal. Kronos is financed by the users Kronos is user-financed in line with prevailing international practice. Account holders pay a connection fee and a fixed monthly fee, as well as for their actual use of the various transaction services. The development costs for Kronos total approximately kr. 18.5 million, and the total monthly operational costs are approximately kr. 765,000 in 2002. The transaction price of a domestic payment is 1 krone. Further information about prices in Kronos can be found at Danmarks Nationalbank's website, www.nationalbanken.dk.

The three modules in Kronos (Basic, Poseidon and Target Interlinking) are separately priced. Costs for the individual modules are distributed among the participants in each module.

The connection fee and the fixed monthly fee are distributed among the participants according to a distribution key based on adjusted working capital as a expression of the expected value of the system to the account holders. An equivalent distribution key is used by the members of the Danish Bankers Associations for the distribution of PBS costs.



50

KRONOS IN A LONG-TERM PERSPECTIVE

Kronos will be developed on an ongoing basis in cooperation with account holders. This is a natural consequence of the developments in the financial sector, as well as in the IT sector. Moreover, account holders' expectations of a modern RTGS system will naturally increase as other payment systems are upgraded with new features.

02-04-2002 17:34 Antal sider:18 Rev. nr.8 12640-EHP_artikel-en Oprettet af Alice

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Taxation of Asset Income and the Financial Markets

Kristian Kjeldsen, Financial Markets, and Erik Haller Pedersen, Economics INTRODUCTION

Virtually every type of tax influences the behaviour of companies and private citizens by affecting incentives to save, invest or work. In some cases such effects on behaviour are unintentional, while in others the tax is aimed specifically at influencing behaviour, e.g. environmental taxes and taxes on spirits and tobacco. Often interests are conflicting, and compromises must be made. In addition, external circumstances can change over time, so that a tax which once seemed appropriate has now become inappropriate, e.g. as a result of changing attitudes to what is fair and reasonable, internationalisation or other circumstances.

This articles focuses on taxation of asset income in relation to private individuals, i.e. taxation of interest and other returns on private savings and investments. The most important asset-income taxes and the tax revenue collected in 2001 are shown in Table 1. The total revenue was approximately kr. 43 billion, including corporation tax, equivalent to almost 7 per cent of the total income from direct and indirect taxes. This tax source also has many inexpedient side effects, cf. the Danish Economic Council (2001) among others. The following sections will focus on the distorting effects of the taxation of asset income on the financial markets. Not all aspects of taxation of asset income will be discussed, however. It is concluded that the Danish tax system, which has been subject to many changes over the last twenty years, has improved from the former situation, particularly in respect of taxation of asset income. Especially the latest amendments to pension taxation, where the real-interest tax was replaced by a general tax on pension yields with a uniform rate for all types of yields, has reduced the distorting effects on the financial markets. Nevertheless, there are still a number of inappropriate ele-ments, e.g. a high degree of variation in the taxation of asset income, cf. the Table in Appendix 1. This increases the scope for speculation in


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minimising tax payments, while reducing the transparency of the tax system.

The gap between the rate of tax on pension funds and free funds is wide. It is still worthwhile to borrow with a view to investment in a pen-sion scheme, although the advantages are not as significant as before. Pension returns are taxed at market value, with a low nominal rate with-out progression, whereas taxation of bond yields is asymmetrical and is determined by whether the taxpayer has positive or negative net capital income. The progressive taxation of bond yields means that for many tax-payers placement in risk-free assets gives a negative real return after tax. An exception is placement in index-linked bonds, where taxation is real and lower than for nominal bonds.

Income from shares which are not part of a pension scheme is taxed progressively, but – contrary to the situation for bond yields – this pro-gression is independent of the taxpayer's overall income and relates only to the size of the income from shares. Issues such as length of owner-ship, tax thresholds, and whether the shares are listed or unlisted, fur-ther complicate taxation.

For investment associations another complicating aspect is the wish for equivalence with the taxation of the underlying assets (the transparency principle). The taxation rules inhibit product development and external competition within this sector. TAXATION OF ASSET INCOME IN A HISTORICAL PERSPECTIVE

Until the tax reform which took effect in 1987, private individuals' asset income was taxed on a par with other income, e.g. wages and salaries. A system based on uniform taxation of all types of income is called a global income tax system. The Danish tax system was also progressive,

REVENUE FROM TAXATION OF ASSET INCOME Table 1

Kr. billion 2001

Tax on personal capital income .............................................. -101

Corporation tax and taxation of foundations ....................... 30.7 Tax on owner-occupied homes ............................................... 9.7 Tax on pension returns ............................................................ 5.22 Tax on income from shares ..................................................... 5.0 Business tax .............................................................................. 2.13

Total .......................................................................................... 42.7

Source: Statistics Denmark, Direct and Indirect Taxes, overview (in Danish) 2001. 1 Estimate. 2 This amount was extraordinarily low in 2001. For 2002 revenue of kr. 16 billion is expected. 3 Tax on account for savings under the business tax scheme.


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which meant that the tax value of the deductibility of private individuals' interest expenditure varied greatly, depending on the individual taxpayer's other fiscal circumstances. The combination of high inflation and the fiscal treatment of interest expenditure, of which the tax de-ductibility at one point was as high as 73 per cent, meant that for many people real interest after tax was negative for long periods from the 1960s up to the mid-1980s. The negative real interest after tax stimu-lated borrowing, large housing investments, and very low private sav-ings.

Even though private savings were modest, considerable funds were placed in capital pension schemes, life insurance policies and pension funds, often financed by loans. The reason was that returns on pension savings were tax exempt up to 1983. Taxation of capital pension savings was also moderate. The high tax value of the interest deduction enti-tlement made it extremely advantageous, especially for high-income groups, to borrow funds and gain an interest deduction entitlement, and simultaneously place the funds in wholly or partly tax-exempt pen-sion schemes.

There can be little doubt that inexpedient taxation of asset income combined with high inflation was a major reason for the imbalances characterising the Danish economy up through the 1970s and the first part of the 1980s. From a private financial point of view the system was to the great benefit of many people, however.

During the past twenty years the Danish tax system has undergone fundamental changes. Where taxation of asset income was previously based on Danish investors owning only Danish shares and bonds, the current system must take international placements into account too. However, the present Danish tax rules are still reminiscent of the former approach.

With the tax reform which took effect in 1987, a dual income-tax sys-tem was introduced by which asset income on the one hand and earned income and transfer income on the other are taxed separately. In 1994 a third category was introduced, namely share income. The taxation rate for negative net capital income, and thereby the tax value of the inter-est deduction entitlement, was reduced in several stages, so that now interest expenditure is deductible only from local-government tax, i.e. a typical deductible value of 32.5 per cent in 2001. Table 2 illustrates the historical development in tax rates. Progression has been maintained for positive net capital income, which is currently taxed at up to 58.5 per cent. Negative net capital income is thus taxed on a dual basis, while positive net capital income is taxed on a more or less global basis. Share income is also taxed progressively, but independently of other income.


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Especially the taxation of pension savings has changed radically over the last 20 years. Back in the early 1980s the pension sector invested mainly in Danish bonds. As bond yields were taxed from 1984, with the intro-duction of the real-interest tax, investments were increasingly moved to shares and index-linked bonds. In recent years the tax base has been extended to include these assets too. This means that the taxation of pension savings has generally been increased. However, pension savings are still fiscally subsidised, cf. the calculations in Appendix 2. Taxation in this area is now more in line with taxation of other capital income. Al-though in many cases it is still worthwhile for private individuals to take loans and place the funds in a pension scheme, the ad-vantages are generally less significant than previously. In addition, particularly after the abolition of the real-interest tax, taxation of pension savings is structured so as to have fewer negative side effects on the financial markets. For instance, shares have been included in the taxation of pensions, which was not the case under the real-interest tax up to 1998.

Exemption of shares from real-interest tax was partly related to a wish to provide inexpensive capital to Danish companies, and partly to the fact that companies were already subject to corporation tax. The free movement of capital makes it very difficult to use tax legislation to give Danish shares a preferential position vis-à-vis foreign shares.

As regards the taxation of capital income, it can be concluded that the tax system today is more appropriate than 20 years ago. As revealed below, there are nevertheless still a number of problems. TAXATION THEORY

There are several arguments in favour of taxing capital income more leniently than earned income. The higher the tax on capital income, the more advantageous it is to acquire debt, and the less favourable it is to

DEVELOPMENT IN SELECTED CAPITAL INCOME TAX RATES Table 2

Interest income Interest deduction Corporation tax rate Taxation of pensions1

1977 .............. 41.0 - 67.0 41.0 - 67.0 37.0 0 1987 .............. 51.0 - 57.0 51.0 50.0 56.0 1998 .............. 40.4 - 57.7 46.0 34.0 35.8 2002 .............. 37.5 - 58.5 32.5 30.0 15.0

Note: In addition to different tax rates, the tax base may vary considerably over time, e.g. in relation to the taxation of pensions. Although the tax rate has been lowered, the taxation of pensions has been increased.

Source: Statistics Denmark, Direct and Indirect Taxes (in Danish) various years. 1 Real-interest-tax rates for 1987 and 1998, the rate of taxation of pension yields for 2002.


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save. The disadvantages become more pronounced in periods of infla-tion. The combination of a nominal tax system and inflation means that in actual fact capital income is taxed more severely than earned income if the same rates are applied. This is because part of the yield merely compensates for price increases, and thus does not constitute real in-come to the investor. Finally, the international mobility of capital means that a rate of taxation which greatly exceeds that of other countries is not sustainable or requires extensive control measures, since it consti-tutes a major incentive to place income abroad, while interest expendi-ture is deductible in Denmark. Initiatives under EU auspices have been launched to improve tax collection internationally.

There are arguments both for and against progressive taxation of capital income. One argument against progression is that asymmetry leads to fiscal arbitrage, i.e. transactions undertaken to legally transfer highly-taxed income to income subject to lower taxation. Another ar-gument against progression relates to citizens achieving positive real interest on savings. Under the current interest and tax rules, the real yield after tax on e.g. an investment in bonds is moderately negative for an upper-bracket taxpayer with positive net capital income. The finan-cial incentive to save is thus in many cases eliminated for this taxpayer segment.

Arguments for progression include the principle of tax-paying ability and the fact that a low rate of tax on capital income is an incentive to attempt fiscal transformation of earned income into capital income, which can be a problem for sole proprietors in particular. The business taxation rules seek to solve this problem.

Overall, the requirement to optimise savings suggests that capital in-come should be taxed more leniently than earned income and transfer income. The asymmetry in the taxation of respectively negative and positive net capital income will often have a distorting effect, how-ever.

TAXATION OF PENSION SAVINGS

On assessing the advantages of pension savings, not only the taxation of current returns, but also the tax value of the deduction of contributions compared with the taxation of disbursements are of relevance. The lat-ter rate is not known for certain at the time of contribution. The calcula-tion should also take into account that certain public benefits are re-duced when income increases, which may influence the effective taxa-tion of the pension savings, particularly regular-premium pension schemes and annuities.


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If contributions are deductible, a savings scheme is subject to pension taxation. This applies to capital and regular-premium pension schemes, as well as annuities that include an insurance element. Other savings are subject to ordinary income tax.

The deductibility of contributions does not in itself entail preferential tax treatment. In terms of the yield on the pension savings it is in principle immaterial whether the contributions are deductible and the dis-bursements taxable, or the contributions fully taxable and the disburse-ments tax exempt, provided that the tax rate has not changed in the meantime. In Denmark, pension savings are taxed primarily at the time of disbursement. However, a labour-market contribution is always pay-able at the time that the pension contribution is made, whereas the disbursements are exempt from labour-market contribution. Deduct- ibility of contributions and taxation of disbursements do not necessarily benefit pension savers. If the marginal rate of tax increases over time, it would be more advantageous for savers not to have a deduction entitlement at the time of contribution, and not to be taxed at the time of disbursement.

The introduction of the Whitsun package of economic measures made a capital pension scheme less advantageous. Previously, contributions were deductible from income, i.e. at up to the upper tax rate, whereas disbursements were taxed at 40 per cent, which is still the case. After the reform, contributions to capital pension schemes have a maximum tax deductible value of 43.5 per cent, whereas regular-premium pension schemes have retained their full deductible value. The advantages of capital pensions vis-à-vis regular-premium pension schemes and annuities have thus been reduced. However, disbursements under capital- pension schemes generally have fewer effects on pensioners' eligibility for supplementary public benefits than pensions subject to current pay-ments.

The profitability of a pension scheme depends on the specific tax rates applying to the saver, cf. Table 3, which shows the isolated effect of variations in tax rates at the times of contribution and disbursement respectively. The essential aspect is that the benefits to savers vary con-siderably according to the savers' fiscal circumstances. Moreover, tax rates can change over time. The system has the drawback that the ef-fective interest on particularly regular-premium pension schemes and annuities is difficult to assess. It depends on the life-long income pro-file of the saver, as well as the development in the tax rates of the in-come tax system over time.

Although it is thus unclear whether the deductibility of contributions to pension schemes is an advantage to the saver, it is nevertheless ap-


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parent that it is important in a financial-market perspective. The Danish system of deducting contributions and taxing disbursements results in larger total registered pension capital than would have been the case had the contributions not been deductible. Part of the capital managed by pension funds and life assurance companies is thus in fact equivalent to deferred tax. On the other hand, the registered central-government debt is correspondingly greater.

Taxation at the time of disbursement may also involve losses to the Treasury if the pensioner takes up residence abroad. In this case, contri-butions can be deductible, but disbursements are not taxed. On assess-ing the advantages and drawbacks of the tax deductibility of contribu-tions, it should, however, be taken into account that a shift from one system to the other involves major problems of a practical nature.

The adoption of the Whitsun package of economic measures in 1998 brought extensive changes to the taxation of current yields on pension savings in Denmark. The compilation of the taxation basis was changed significantly. The real-interest tax basis of a realisation principle with mathematical revaluation was replaced by calculation at market value, i.e. the assets are stated at market value and any capital gains are taxed when they arise, regardless of whether they are realised or not. Capital losses are deductible. The shift from mathematical revaluation to the market-value principle is phased in over a 5-year period. Current taxation of yields stated at market value helps to ensure an efficient financial market, inter alia by counteracting tax arbitrage and prevent-ing lock-in effects, i.e. situations where fiscal considerations make it less profitable to sell certain bonds, resulting in price distortion. How-ever, the market-value principle can also give rise to problems of un-

DIFFERENCES IN MARGINAL TAX RATES AT TIME OF CONTRIBUTION AND DISBURSEMENT IN PRIVATE PENSION SCHEMES Table 3

Marginal tax rate at time of contribution

Lower bracket

37.5% Middle bracket

43.5% Upper bracket

58.5%

Marginal tax rate at time of disbursement Percentage points

Capital pension, 40%1 ................................... -2.5 3.5 3.5

Regular-premium pension and annuity Lower bracket 37.5% ................................ 0 6.0 21.0 Middle bracket 43.5% .............................. -6.0 0 15.0 Upper bracket 58.5% ................................ -21.0 -15.0 0

Note: Calculated on the basis of an average local-government tax rate of 32.5 per cent, excluding church tax. The figures show the different between the fiscal value of the contribution to a private pension scheme and the tax at the time of disbursement. This can be seen as an annual yield, provided that the time of retirement is only a year away.

1 25 per cent on savings from before 1980.


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derstanding in connection with general application, e.g. exchange-rate gains on debt, as well as the taxation of unrealised capital gains. This is one reason that it is not applied systematically in connection with taxa-tion of personal income.

The new tax on pension returns broadens the tax base so that share returns, newly-issued index-linked bonds and real property returns are generally subject to taxation, whereas the real-interest tax mainly ap-plied to nominal bonds. With the latest change, a uniform tax rate of 15 per cent has been introduced for all types of assets.

Whether the fiscal changes will cause pension savers to invest a larger or smaller proportion of their funds in shares is impossible to say at this stage. The higher taxation than before would, on an isolated basis, indi-cate a smaller proportion of shares, but this should be offset against the fact that the government now bears a larger share of the equity price risk, which points to a larger proportion of shares, cf. Møller, Parum and Sørensen (2001).

From the pension savers' point of view the current rules for share in-vestments related to pension schemes are both transparent and symmet-rical. The same rules apply to dividends and profits, regardless of length of ownership and ownership share, and of whether the shares are listed or unlisted. Losses are deductible from other returns in the pension scheme. This contrasts sharply with the fiscal treatment of free funds invested in shares, cf. below.

With regard to index-linked bonds, all series closed before 1 January 1999 are exempt from taxation of asset income. This means that in-dex-linked bonds issued after this date are priced on a par with ordinary bonds. At the same time, a reform of the financing of subsidised construction was adopted. Traditionally, this sector has been the main issuer of index-linked bonds. The reform gives access to financing via ordinary nominal mortgage-credit bonds.

Overall, the changes in the taxation of pensions are deemed to have a positive effect on the functioning of the financial market. With the shift to taxation at market value, the bond market avoids the lock-in effects which were a consequence of the real-interest tax. In other cases the opposite applied, i.e. tax-conditioned sale. The extension of the tax base to include shares and real property, as well as the uniform tax rate, help to prevent purely fiscally determined restructuring of pension portfolios with a view to investing in tax-exempt assets or assets that are taxed at low rates.

Appendix 2 outlines the effective taxation of a private investor's in-vestment opportunities. As can be seen, pension savings are taxed at a lower rate than other types of savings. The preferential fiscal treatment


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of pension savings lies in the taxation of current yields rather than in differences in tax rates at the time of contribution and disbursement.

A further benefit of the new pension tax is that it makes it possible for pension funds and life assurance companies to use derivatives such as futures and options more actively in the future. Derivatives are already taxed at market value, so there is now consistency between the taxation of the derivative and the underlying asset, e.g. a bond holding.

FREE SAVINGS

Bonds Taxation of the current yield (interest) on a bond investment depends on whether the taxpayer has positive or negative net capital income, cf. Box 1. If the net capital income is negative, the yield is subject to local- government tax, i.e. approximately 32.5 per cent. If it is positive, it is taxed progressively at up to 58.5 per cent, cf. Table 4. This also means that the tax value of the deductibility of interest payments on a loan can be as high as 58.5 per cent, provided that the total capital income re-mains positive. In actual figures, around 2.6 million Danish taxpayers have negative net capital income, while 1 million have positive net capital income, 170,000 of whom are in the upper income-tax bracket.

Turning to capital gains on bonds, private individuals are exempt from tax if the lower limit applying under the Capital Gains Act is ful-filled. If, at the time of issue, the asset has a coupon rate at least equiva-lent to the current minimum coupon rate, any capital gain is not taxed, and a loss is not deductible. This applies to virtually all krone-denominated bonds issued in Denmark. On the other hand, if the coupon is below the minimum coupon, private individuals' capital gains are taxed. A capital gain on premature redemption of a cash loan is al-ways taxed, however, provided that the loan was raised on 1 January 1996 or later. A gain is typically realised on a cash loan in connection with conversion to a higher interest rate and reduction of the out-

MARGINAL TAX RATES FOR POSITIVE AND NEGATIVE NET CAPITAL INCOME Table 4

Taxable income1 Positive

net capital income Negative

net capital income

Kroner Per cent

Below 177,900 ............................................... 37.5 32.5 177,900 – 276,900 .......................................... 43.5 32.5 Above 276,900 ............................................... 58.5 32.5

Note: The local-government tax rate is set at 32.5 per cent. 1 2001 limits.


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standing debt. Cash loans are not subject to taxation of capital gains on the first redemption in connection with change of ownership.

The rules relating to the minimum coupon rate introduced in 1985 are to prevent the issue of bonds at yields which include a significant capital-gain element that was previously tax exempt for private indi-viduals, e.g. cash loans financed via bonds issued considerably below par. The minimum-coupon-rate rule means that the coupon rate on issue of mortgage-credit bonds is always close to the market rate. As a con-

YIELD ON A BOND INVESTMENT Box 1

The real-interest rate before tax is calculated approximately as the coupon rate less

inflation. Chart 1 shows that for a given real-interest rate before tax the real return

after tax on nominal bonds depends on the level of inflation. The capital-income tax

system is thus not neutral in relation to the rate of inflation for a given real-interest

rate before tax. The charts are based on capital-income-tax rates of 32.5 per cent and

58.5 per cent, respectively, and three different real-interest rates before tax: 3 per

cent, 4 per cent and 5 per cent.

REAL-INTEREST RATE AFTER TAX ON A BOND INVESTMENT Chart 1

Investments in index-linked bonds are generally ensured a positive rate of real inter-

est after tax. The yield on an index-linked bond is composed of the real-interest rate

plus an inflation component. Only the former is taxed; the latter is tax exempt, but

cannot be deducted from a borrower's capital income. This means that index-linked

bonds are taxed at a lower rate than other bonds. For a more detailed discussion, see

Andersen and Gyntelberg (1999).

As the charts illustrate, the nominal taxation of bonds results in higher real taxation

at higher inflation. Taxation of index-linked bonds with tax exemption for the infla-

tion component, on the other hand, will always give a positive real yield after tax.

At higher marginal tax rates the real-interest rate after tax may be negative, even

when inflation is moderate. For e.g. a bond with a direct yield of 5 per cent, inflation

at 2.5 per cent and a capital-income tax rate of 58.5 per cent, the real-interest rate

after tax is 5*(1-0.585) -2.5 per cent = -0.425 per cent. For an index-linked bond with a

direct yield of 2.5 per cent, the real-interest rate after tax is 2.5*(1-0.585) = 1.0375 per

cent, since the inflation component, as stated, is not taxed.

-1.00

-0.50

0.00

0.50

1.00

1.50

2.00

2.50

3.00

1 2 3 4 5 6 7Rate of real interest before tax, 3 per centRate of real interest before tax, 4 per centRate of real interest before tax, 5 per centIndex-linked bond 2.5 per cent

Inflation, per cent

Rate of real interest after tax, per centTax rate 32.5 per cent

-4.00-3.50-3.00-2.50-2.00-1.50-1.00-0.500.000.501.001.50

1 2 3 4 5 6 7Rate of real interest before tax, 3 per centRate of real interest before tax, 4 per centRate of real interest before tax, 5 per centIndex-linked bond 2.5 per cent

Inflation, per cent

Rate of real interest after tax, per centTax rate 58.5 per cent


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sequence, when the level of interest rates fluctuates loan conversion activity is considerable. Loans can be converted down to a lower interest rate in line with declining market rates, or up to a higher rate, but a lower outstanding debt, if the market rate increases.

The minimum-coupon-rate rule applies only to accounts in Danish kroner. For loans in other currencies, e.g. euro, all capital gains are tax liable, and all capital losses are deductible. This applies to private and corporate borrowers alike, regardless of loan type and purpose, includ-ing change of ownership. The tax rules relating to foreign-exchange loans are thus far more transparent and symmetrical than the tax rules for loans in Danish kroner, which, as stated, are subject to distinctions between individuals and companies and between loan types. Shares In contrast to the simple rules applying to shares under pension schemes, private individuals' income from shares is subject to complex taxation rules. The yield received by the shareholder comprises dividend, as well as realised capital gains or losses, hereinafter referred to as gains. Table 15 outlines the main rules for taxation of share dividends and gains aris-ing from free savings invested in shares. Dividend is always taxed as equity income for the shareholder, i.e. at 28 per cent of the first kr. 38,500 (2001 limit), and thereafter at 43 per cent. Taxation of gains on shares depends on length of ownership, share type, i.e. listed or unlisted share, and the size of the share holding (known as the kr. 100,000 limit). If the shares have been owned for less than 3 years, gains are always taxed as capital income and thereby independently of the shareholder's other fiscal circumstances, cf. above. If the shares have been owned for more than 3 years, gains are taxed as income from shares, i.e. taxation is fully symmetrical, so that no distinction is drawn between capital gains and dividend. For portfolios of listed shares below a certain value, how-ever, gains are tax exempt after 3 years' ownership, cf. Table 5.

TAXATION OF PRIVATE INDIVIDUALS' SHARE HOLDINGS Table 5

Over 3 years' ownership Under 3 years' ownership

Listed shares Unlisted shares

Market value below kr. 121,4001

Market value above kr. 121,4001

Gains are tax exempt, dividends are taxed as income from shares2

Both gains and dividend are taxed as income from

shares2

Both gains and dividend are taxed as income from

shares2

Gains are taxed as capital income, dividends as income from shares2

1 2001 limit, called the "kr. 100,000 limit". 2 Income from shares is taxed at 28 per cent of the first kr. 38,500 (2001 limit), and thereafter at 43 per cent.


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The entitlement to deduct capital losses is a complex issue that depends, inter alia, on whether the shares are listed or unlisted, and whether there is a share gain from which the loss can be deducted. Capital gains and losses are thus not treated symmetrically. For details, see Møller and Plenborg (1997).

In addition to being complex and administratively cumbersome, the rules on taxation of share income entail that the real taxation of share-holders can vary considerably from person to person. If, for instance, the share portfolio is small, and the entire income relates to gains, i.e. the company does not pay out dividends, the taxation will be zero. At the other extreme, a shareholder with positive net capital income who is in the upper income-tax bracket and sells the shares within 3 years may have to pay tax of up to 58.5 per cent on the share, again assuming that all of the profits are retained by the company. However, the real taxa-tion can be reduced by retaining the share, as the taxation relates to realised gains. In combination with the 3-year rule and the kr. 100,000 limit an inappropriate lock-in effect may be created, which is inexpedi-ent from a financial-market point of view.

A working group under the Ministry of Taxation has put forward a proposal for considerable simplification of the taxation of capital gains on shares, cf. the Ministry of Taxation (1999). Investment associations Accumulative investment associations are fully taxable under the Corporation Tax Act. At the same time, the owners of investment certificates are taxed under the Act on taxation of capital gains on shares, so that the 3-year rule and the kr. 100,000 limit, etc. apply, as described above. Losses can be deducted from the corresponding share gains if they are realised within the first 3 years of ownership, but otherwise not. Investment in these associations, which invest mainly in bonds, may therefore be taxed differently from direct investments in bonds.

Unlike accumulative funds, dividend-paying funds are not independ-ently tax liable if they meet the distribution requirement. To remain tax exempt, all income which would have been taxed had the owner of the investment certificate owned an equivalent portfolio directly must be distributed. This ensures that the distributed profits are taxed as the underlying income types, i.e. capital income as capital income, share income as share income, etc. This is known as the transparency principle. The account-holding investment associations are taxed according to the same principle.

The yield on an investment-association certificate consists of current yields such as interest and dividend, and of the capital gains or losses on


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the certificates. The varying fiscal treatment of pension customers versus private customers investing free funds may result in a conflict of interest for the investment association. For the pension customer, both current yields and capital gains are taxed at 15 per cent. The free funds invested in an accumulative investment association are, however, subject to taxa-tion of capital gains on shares, so that capital gains on minor portfolios are generally tax exempt after 3 years' ownership. This can lead to a conflict between the two types of investor, since the investment associa-tion may have to choose between a high dividend, to the advantage of the pension customers, or minimisation of the tax burden, to the benefit of private customers investing free funds. A high dividend may not al-ways be in the latter's interest if it also triggers additional tax. An in-vestment association which trades frequently and cashes in capital gains in order to achieve a high yield may therefore be attractive to pension customers, and less attractive to private customers with free funds. The trend is therefore to split the associations according to fiscal allegiance, so that they cater for either pension customers or private individuals. This must be described as an unintentional consequence of the tax rules, and entails a considerable need to advise investors.

The rules relating to taxation of investment associations are very de-tailed and thereby complicated as they often seek to set out taxation conditions relating to the individual types of investment-association products offered. These highly product-specific taxation rules may con-tribute to inhibiting product development in the market. In addition, the rules help to keep foreign providers away from the Danish market, and thus hamper competition. Finally, it is inexpedient that for many investors in investment certificates the tax rules are impenetrable. There appears to be a need for simpler, less product-specific taxation of in-vestment associations. This was also the conclusion in the report from the Committee on the Financial Sector after the Year 2000, cf. the Ministry of Economic Affairs (1999).


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APPENDIX 1

BONDS – OWNERSHIP Table 6

Direct Investment association

Net capital income Type

Positive Accumulative Dividend-paying

Income type Income type

Below 177,900

177,900 -

276,900

Above

276,900 Negative Current revenue Dividend Sale

Current revenue Dividend Sale

38% 44% 59% 33%

As a com-pany

(30%) - As a directly-owned share 0%

As a directly-owned bond

As a directly- owned bond

SHARES – OWNERSHIP Table 7

Direct

More than 3 years' ownership Less than 3 years' ownership

Listed shares Unlisted shares Listed and unlisted shares

Market value below kr. 121,400

Market value above kr. 121,400

Dividends Gains Dividends Gains Dividends Gains Dividends

Gains First

38,500

In excess

of 38,500

First 38,500

In excess

of 38,500

First 38,500

In excess

of 38,500

First38,500

In excess

of 38,500

First 38,500

In excess

of 38,500

Below177,900

177,900-

276,900 Above

276,900 First

38,500

In excess

of 38,500

0% 28% 43% 28% 43% 28% 43% 28% 43% 28% 43% 38% 44%. 59% 28% 43%

INDEX-LINKED BONDS Table 8

Issued before 1 January 1999 Issued after 1 January 1999

Ownership Ownership

Direct Pension Direct Pension

Real component

Nominal component

Real component

Nominal component

Real component

Nominal component

Real component

Nominal component

As a directly- owned bond 0% 0% 0%

As a directly-owned bond 0% 15% 0%


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Table 6 (cont.)

Pension

Deduction at time of contribution Current disbursements Taxation at time of disbursement

Type Type Type

Capital pension

Regular-premiumpension

Capital pension

Regular-premium pension

Capital pension


Personal marginal

income tax rate, max. 44%

Personal marginal

income tax rate 15% 15% 40%

Personal marginal

income tax rate

Table 7 (cont.)

Investment association

Type Pension

Accumulative Dividend-paying Deduction at time of

contribution Current taxation

Taxation at time of disbursement

Income type Income type Type Type Type



Capital pension

Regular- premium pension

Capital pension


Capital pension

Regular- premium pension

As a company

(30%) -

As a directly- owned share 0%

As a directly- owned share

As a directly- owned share

Personal marginalincome tax rate,

max. 45%

Personal marginal income tax rate 15% 15% 40%

Personal marginal income tax rate

Note: Based on a local-government tax rate of 33%.


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66

APPENDIX 2

To gain an impression of the extent to which the tax system is neutral in terms of the savings opportunities open to a private investor, a comparison can be made between the real effective tax rate, calculated as the difference between the real return before and after tax in relation to the real return before tax, cf. Table 9. It is assumed that the real return after tax in the international markets is 2 per cent, regardless of whether savings are made via home ownership, shares, bonds or a pen-sion scheme.

Pension savings are seen to be taxed more leniently than other sav-ings. This is a long-standing tradition. It is disputable whether this results in higher overall savings or merely shifts the pattern of savings which would still have taken place. Owner-occupied homes are also taxed at a lower rate than e.g. bond investments, in any case at the lower end of the progression scale. As a consequence of the asymmetrical fiscal treatment of respectively positive and negative net capital income the taxation of an investment in bonds is greatly dependent on the invest- or's fiscal circumstances. The real effective yield requirements before tax in Table 9 are calculated as follows: RHousing (2%) = Rental value - tax on value of property (1%) - land tax (0.25*2.5%)

If it is assumed that the land tax is shifted to the land value, the last leg is disregarded. This shifting means that land prices fall in line with the present value of the future land taxes. RShare (2%) = Gain from share*(1 - 0.43) - 0.385*(0.43 - 0.28)

A gain of kr. 100,000 is used. The proportion below kr. 38.500 kr., tax-able at 28 per cent, is thus 0.385. Corporation tax is payable by both

EFFECTIVE REAL TAXATION OF VARIOUS TYPES OF SAVINGS Table 9

Housing Shares Bonds

Fully

shifted Not

shifted

Negative net capital

income

Positive net capital

income1

Pension savings

Real yield after tax ............................ 2.0 2.0 2.0 2.0 2.0 2.0 Real yield before tax ......................... 3.0 3.6 3.6 3.9 5.5 2.4 Effective real tax rate . ...................... 33 45 44 49 64 15

Note: See the text for the assumptions on which the calculations are based. 1 It is assumed that the taxpayer is in the upper bracket.


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67

domestic and foreign investors. Differences in corporation tax rates be-tween the countries are capitalised in the share price and thus do not affect the tax calculation. RBond (2%) = Yield - coupon rate (6%)*0.32

The bond is assumed to be issued close to par. RPension (2%) = Return*(1 - 0.15)

It is assumed that the tax rate at the time of contribution is equivalent to the rate at the time of disbursement of pension payments. Only the current taxation is thus taken into consideration. The figures in Table 9 are reached by determining the value of gain for which the equation is true.

The figures are sensitive to the assumptions made, but the ranking of the various types of savings is reasonably robust.


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68

LITERATURE

Andersen, J. V. and J. Gyntelberg, Index-Linked Mortgage Bonds, Dan-marks Nationalbank, Monetary Review, 1st Quarter 1999. Direct and indirect taxes (in Danish), Statistics Denmark, 2001 The Danish Economic Council, Danish Economy, Spring 2001. Møller, M., C. Parum and T. Sørensen, The New Act on Taxation of Pen-sions (in Danish), Finans/Invest no. 1, 2001. Møller, U. G. and T. Plenborg, Taxation of Income from Shares in Den-mark (in Danish) , Finans/Invest no. 7, 1997 Ministry of Taxation, Betænkning nr. 1392, Taxation of Capital Gains on Shares (in Danish), 1999. Ministry of Economic Affairs, Venture capital (in Danish), Delrapport nr. 4 published by the Committee on the Financial Sector after the Year 2000, 1999.

03-04-2002 08:57 Antal sider:8 Rev. nr.17 12640-UK_LCM Oprettet af Alice Colombo

69

Market Dynamics at Low Interest Rates

Louise Mogensen, Financial Markets INTRODUCTION

In periods of low bond yields, e.g. autumn 2001, the effects of interest- rate fluctuations can be self-reinforcing. To some extent these effects are due to options built into e.g. mortgage-credit bonds and interest- rate guarantees by the pension sector. The effects are driven especially by the substantial market for US mortgage bonds, although the built-in options have also influenced the course of Danish interest rates. DEVELOPMENT IN INTEREST RATES IN 2001

In 2001, the development in long-term yields within the year was affected by strong and rapid upward and downward movements around a generally low level. These rapid shifts were seen particularly in the autumn, cf. Chart 1.

Interest-rate fluctuations can be explained by factors such as the mac-roeconomic development, the general uncertainty arising after 11 Sep-tember, and issuing-policy changes in the USA. There are also a number

10-YEAR YIELDS IN THE USA, GERMANY AND DENMARK Chart 1

4

4.2

4.4

4.6

4.8

5

5.2

5.4

5.6

01/01 2001 01/04 2001 01/07 2001 01/10 2001 01/01 2002

USA Germany Denmark

Per cent


70

of dynamic effects, however, that are related to investors' reaction to the options built into several financial instruments. At low interest rates, a drop in interest rates as a consequence of the built-in options can trig-ger pressure to buy, causing interest rates to decline further. On the other hand, rising interest rates (from a low level) will exert pressure to sell, in turn causing interest rates to increase further. SELF-REINFORCING EFFECTS AND OPTIONS

Many financial products contain option elements. This contributes to increasing volatility in the long-term yields at particularly low interest- rate levels. Some of the movement in interest rates can thus be ex-plained by the self-reinforcing effects triggered by the options.

Primarily two types of option are assumed to have contributed to stronger volatility in long-term yields in the autumn of 2001. Firstly, op-tions as the right to early redemption (prepayment) of fixed-yield mort-gage bonds have had an effect, especially in the USA, but to some ex-tent also in Denmark. Secondly, the interest-rate guarantees offered by the Danish pension sector have contributed to greater volatility in Danish yields. Options in callable bonds Callable mortgage-credit bonds deviate from e.g. government bonds in that the borrower has the right to prepay the loan at par. This right is utilised when the borrower converts the loan. The right of prepayment corresponds to the holder of the mortgage-credit bond having sold a call option to the borrower1.

As a consequence of the conversion opportunity, the price-yield ratio for mortgage-credit bonds does not correspond to that for uncallable bonds, cf. Chart 2. The price of uncallable bonds increases when the general level of interest rates falls, while the price of callable mortgage- credit bonds ceases to increase at around par value. This is due to the right of the borrower (home owner) to prepayment of the underlying loan, making the investor less willing to pay a price for the bond that is significantly above par.

The interest-rate risk, by which is meant the sensitivity of the bond price to fluctuations in interest rates, is measured by the duration2.

1 The owner of a call option has the right to buy a given asset at a given price, while a put option gives

the right to sell a given asset at a given price. 2 Duration is defined as the (percentage) change in price as a consequence of a change in interest rates

of 1 per cent. For callable bonds the option-adjusted duration that accounts for the conversion prob-ability is calculated. The calculation of the option-adjusted duration is model-dependent, since as-sumptions must be made concerning e.g. the future interest-rate process and the borrowers' conver-sion behaviour.


71

When interest rates are high, the relation between price and yield for the two types of bond is almost identical, cf. Chart 2. On the other hand, if interest rates are falling, the price of the callable bond does not change as much as when interest rates are high. The duration therefore changes, and as the interest rate falls the duration of the callable bond approaches zero. Chart 3 presents the duration of various bonds on a change in interest rates.

The Chart shows that the duration of the uncallable government bond, 7 per cent 2024, is almost unchanged compared to the callable mortgage-credit bonds, irrespective of the level of interest rates. It is also seen that the sensitivity of the mortgage-credit bonds to changes in interest rates is dependent on their nominal yields. This is because when interest rates are falling high-coupon bonds are at risk of conversion before low-coupon bonds.

The changes in duration as a consequence of fluctuating interest rates is a measure of the convexity of the bond1. Due to the conver-sion opportunity, mortgage-credit bonds usually show negative con-vexity, whereby the duration declines when interest rates decrease (the conversion probability increases).

Chart 4 presents a comparison of the changes in duration arising from fluctuations in the yields on various bonds.

1 Convexity expresses the difference between the correct percentage price change and the price

change indicated by duration on a change in interest rates of 1 per cent. In popular terms, this is in-terpreted as a measure of the steepness of the curve of the price-yield ratio.

THE THEORETICAL PRICE-YIELD RATIO FOR BONDS Chart 2

Price

Yield on uncallable bond

Callable bond

Uncallable bond

100


72

DURATION ON FLUCTUATIONS IN INTEREST RATES Chart 3

Note:

For the three mortgage-credit bonds the option-adjusted duration is shown, while for the uncallable govern-ment bond the ordinary duration is shown. The option-adjusted duration is model-dependent. The basis is the level of interest rates at end-2002.

CHANGE IN DURATION AT DIFFERENT INTEREST RATES (CONVEXITY) Chart 4

Note:

The change in the option-adjusted duration is shown for the three mortgage-credit bonds. The calculation is model-dependent. The basis is the level of interest rates at end-January 2002.

-2.0 -1.0 0.0 1.0 2.0

Duration

5 per cent 2029

6 per cent 2029

7 per cent 2029

Change in interest rate in percentage points

7 per cent 2024 (government bond)

0

-2.0 -1.0 0.0 1.0 2.0

Convexity

Change in interest rate in percentage points

5 per cent 2029

6 per cent 2029

7 per cent 2029

0

7 per cent 2024 (government bond)


73

Dynamic effect for callable mortgage-credit bonds An investor holding mortgage-credit bonds will in many cases require that the portfolio's sensitivity to fluctuations in interest rates does not decline when interest rates fall, and on the other hand does not increase when interest rates rise. This can be attributed to several factors, e.g. that the investor is borrowing at fixed interest rates, that the investor requires a profit on a further drop in interest rates, or on the other hand does not wish to incur a higher loss on an increase in interest rates.

Investors that manage the interest-rate risk on their investments seek to take into account that a change in interest rates can change duration quite considerably. The duration of long-term mortgage-credit bonds can thus "disappear" when the interest rate decreases. In order to main-tain the interest-rate risk at a given level investors must buy duration using other instruments. They can do this via uncallable bonds, e.g. gov-ernment bonds, or mortgage-credit bonds that are not at risk of conver-sion, leading to further downward pressure on the level of interest rates. The dynamic effect is thus initiated.

How much extra duration the investor must buy on a drop in interest rates depends on the portfolio's convexity. The greater the numerical convexity, the more duration the investor will have to buy when interest rates fall. The convexity is strongly dependent on the level of interest rates, cf. Chart 4. If interest rates change from a level far from the nominal yield on the bond, this does not significantly affect duration, but the change in duration increases significantly when interest rates fluctuate at a level close to the bond's nominal yield.

The development in the duration of an index of Danish callable mort-gage-credit bonds is presented in Chart 5. For comparison, the yield on 10-year Danish government bonds is shown. The duration takes the con-version probability, i.e. the built-in option, into account, and it is clear that duration decreases when interest rates fall.

In 1998, the year of the highest number of Danish conversions so far (seen over one year), duration increased considerably after the conver-sions had taken place. This is because borrowers converted their old loans to newly-issued long-term fixed-yield bonds at a price below par, which were therefore subject to a lower conversion risk. In connection with the surge of conversions in autumn 2001, duration did not increase in the same way as in 1998, which can be attributed to such factors as borrowers to a high degree converting to the short-term interest- adjustment loans, rather than long-term callable loans.

The drop in interest rates thus has a self-reinforcing effect due to the change in the duration of the callable bonds, and investors' wish to maintain duration at a given level. On the other hand, an increase in


74

interest rates, particularly from a low level, can also generate self- reinforcing effects, since a sudden increase in the duration of the call-able bonds leads to sale of duration (and thereby bonds), which exerts further upward pressure on interest rates.

Part of the significant, rapid upward and downward fluctuations in in-terest rates in the autumn of 2001 can therefore be assumed to be re-lated to dynamic effects derived from the option element in callable bonds. The callable US bonds affected the international development in interest rates. In Denmark it could be noted how the yield spread nar-rowed between the mortgage-credit bonds with low nominal yields that were at least risk of conversion, and government bonds. Interest-rate guarantees in the pension sector The fact that Danish pension and life assurance companies have guaranteed a minimum interest rate to their customers also constitutes a type of built-in option. The option entails that the companies' obligations gain higher market value in step with falling interest rates. To avoid the risk of insolvency, the companies therefore have a requirement to own bonds – or other instruments – that appreciate when interest rates fall.

OPTION-ADJUSTED DURATION (OAD) FOR INDEX OF MORTGAGE-CREDIT BONDS Chart 5

Note: Source:

The option-adjusted duration is calculated by Nordea for a weighted index comprising mortgage-credit bonds issued by Nykredit, RealkreditDanmark BRF kredit, Unikredit, Danske kredit and Totalkredit, alle with an out-standing amount of minimum kr. 1 billion, and remaining maturity of more than one year. EcoWin.

3

3.5

4

4.5

5

5.5

6

6.5

7

7.5

8

Dec 1995 Dec 1996 Dec 1997 Dec 1998 Dec 1999 Dec 2000 Dec 2001

OAD index, year 10-year government-bond yield, per cent

Year and per cent


75

The effect can be illustrated as shown in Chart 6, based on the pension companies' balance sheets. The value of the liabilities is compiled as the net present value of the company's pension and insurance liabilities.

If the level of interest rates is close to or lower than the issued interest- rate guarantee, the obligations on the liabilities side will correspond to a high degree to a long-term fixed-yield bond with a yield requirement equivalent to the guaranteed interest rate (the liabilities side gains high duration). On the other hand, when interest-rate levels are high (above the issued interest-rate guarantee) the liabilities will correspond to a short-term bond at low duration.

The asymmetry as a consequence of the interest-rate guarantees causes the value of the obligations to increase significantly, and often by more than the assets, when the interest rate is falling, with a conse-quential risk of mismatch between assets and liabilities, and thereby a reduction of the companies' reserves. If the asset side is to correspond to the appreciation on the liabilities side, the asset portfolio is required to have a high duration, in order to achieve an equivalent capital gain when interest rates are falling. Dynamic effect at low interest rates In periods of falling interest rates the pension companies will require duration due to fear of insolvency (mismatch between obligations on the liabilities and asset sides), and because to a great extent pension

EXAMPLE OF PENSION COMPANY LIABILITIES ON FLUCTUATIONS IN INTEREST RATES Chart 6

Value of liabilities

Interest rate


76

companies own mortgage-credit bonds, and are thereby subject to the effects described in the section on options in mortgage-credit bonds.

The demand for duration on the asset side exerts further downward pressure on the interest rate, and the dynamic effect is established.

CONCLUSION

In periods with low interest rates built-in options in financial instru-ments will lead to self-reinforcing effects, increasing the volatility in the interest rates. Options are known especially from callable mortgage- credit bonds and interest-rate guarantees in pension and life assurance companies.


2002\1-kvartal-UK-2002\bna-tale.doc Oprettet af Alice Colombo

77

Speech by Bodil Nyboe Andersen at the Annual Meeting of the Danish Bankers Association on 5 December 2001

In 2001, Danish monetary and foreign-exchange policy have been very undramatic, but elsewhere in the world, monetary policy has held centre stage. This applies especially to the USA, where the Federal Reserve has been extremely active, lowering interest rates on ten separate occasions in 2001 in order to stimulate economic activity. During the year, the short-term US interest rate has been lowered from 6½ per cent to 2 per cent, which is a very significant reduction.

In Europe too, monetary policy has drawn great interest and been an issue for much discussion, especially in the euro area, where the Euro-pean Central Bank's policy has been the subject of vigorous comment by politicians, the media and economists.

It is sometimes overlooked in the monetary-policy debate that there are substantial differences across countries between the goals and de-sign of monetary policy.

The USA has a rather broad monetary-policy objective. Monetary pol-icy is expected to promote maximum employment, stable prices, and moderate long-term interest rates. In the present cyclical situation, this has been interpreted to mean that the reduction of demand over the past year should be countered with expansionary monetary policy.

The many reductions of interest rates have not prevented a cyclical downturn. The issue is now whether the lowering of interest rates can reverse this development into a new upswing in the months to come. It remains to be seen whether it is possible to ease monetary policy so much and so quickly without this leading to higher inflation, thereby threatening price stability. An indicator will be the direction of long-term yields in the near future.

In Europe, especially the euro area, there is a clearer division of work between monetary policy and fiscal policy than is the case in the USA. Monetary policy has been made responsible for price stability.

Considering the historical background, we see that in the 1970s and 1980s most European countries had both high inflation and high interest



78

rates. This led to a number of distortions of economic development be-cause decisions were also influenced by the expected development in prices.

During this period, only Germany showed remarkable price stability, attributed by many to the Bundesbank's independence and firm hand on monetary policy. The most noteworthy aspect was that Germany also enjoyed strong economic progress and favourable development in em-ployment.

The German model thus played a decisive role in the design of the Maastricht Treaty. Price stability was made the explicit objective of the European Central Bank, and the ECB was ensured political independence in its conduct of monetary policy.

This clear objective of price stability entails that the ECB can only lower interest rates in order to promote economic activity if this pre-sents no risk to price stability. This is part of the explanation for the fact that, although the ECB has lowered interest rates in 2001, its approach has been far more cautious than in the USA. Another – often neglected – fact is that at the turn of the year the level of interest rates was signifi-cantly lower in Europe than in the USA.

However, not only the European Central Bank has a clear objective to maintain price stability. During the 1990s, a number of other central banks adopted an equivalent objective and applied inflation targeting to their conduct of monetary policy. In Europe, this applies to e.g. the UK and Sweden, where such systems have been in place for almost 10 years, and Norway, which last spring restructured its monetary policy according to this system.

Although the institutional arrangements vary from country to country, the main theme is that in determining interest rates the central bank seeks to keep medium-term inflation within a specific range. With re-gard to the ECB, the objective is inflation of below 2 per cent, while for the UK it is close to 2½ per cent.

The strong emphasis on using monetary policy to maintain price stabil-ity has been successful, and generally inflation in Europe is low in cur-rent years.

Today, we tend to regard low inflation as a normal situation. This may be the explanation for the periodic pressure on the central banks to use monetary policy to achieve other goals such as increased employment, or to influence the exchange rate in one direction or the other.

However, if the official interest rate is to safeguard a particular future development in prices, its level is determined by this very factor. It is not possible also to pursue other objectives requiring a higher or lower in-terest rate, since the monetary-policy authorities have only one instru-



79

ment, the short-term interest rate. In Europe it must be used to maintain price stability.

As will be known, Danish monetary policy has a different design: as for the other European central banks, the overall objective is price stability. However, this is achieved more indirectly by keeping the krone firmly stable against the euro.

For this to be successful, fiscal policy must be designed to ensure me-dium-term development in prices that does not deviate substantially from the euro area's objective. The fixed-exchange-rate policy is only credible if our competitiveness is high.

Monetary policy is responsible for the more short-term stabilisation of the exchange rate. In calm times it must "shadow" monetary policy in the euro area. This is achieved by holding Danmarks Nationalbank's lending rate close to that of the European Central Bank, and moreover by matching any changes, apart from very small fluctuations of a few basis points.

At times of foreign-exchange unrest or fear of unrest, Danmarks Na-tionalbank widens this spread in order to make holding kroner more attractive.

This monetary-policy reaction pattern is well-known to players in the foreign-exchange and money markets. Adhering for many years to the rules of the game set by the fixed-exchange-rate policy has lent this pol-icy a high degree of credibility. Market participants closely monitor the fluctuations in the exchange rate, and when it tends to weaken, money-market interest rates will rise quickly, making krone holdings more attractive.

The banks' advice to their customers on when to buy and sell future for-eign-exchange positions helps to stabilise the market in the same way.

So in Denmark, the current situation is that the krone is not only stabi-lised by Danmarks Nationalbank's interventions in the foreign-exchange market and its adjustments of interest rates, but first and foremost by the market participants' behaviour.

In other words, the foreign-exchange market participants speculate in a stable krone/euro rate, so that market speculation has a stabilising effect.

Speculation is a very emotional word. Currency speculation usually makes one think of a situation where the market speculates in the prob-ability that the authorities will not be able to hold the fixed exchange rate firm.

However, the market can, as stated, also speculate that the authorities will actually maintain the exchange rate, in the face of fluctuating supply of and demand for currency. The market participants thus take positions



80

with this expectation in mind, and themselves actually contribute to the stabilisation. This behaviour is also "speculative", although we do not usually call it that. When the market is in agreement with the official pol-icy, the authorities instead usually describe this as "sound behaviour".

This may sound like splitting hairs. The point is that in most situations currency trading has a very beneficial function in society. The market's contribution to stabilising the Danish krone entails a continuous very large number of currency trades to ensure that supply and demand are constantly set off in the foreign-exchange market.

Moreover, the foreign-exchange market actually has a very important economic role to play by financing foreign trade and other international transactions. If a Danish exporter to Mexico receives Mexican pesos in payment, these funds must be exchanged to Danish kroner. This takes place via a chain of transactions in the foreign-exchange market that may for example entail Mexican pesos being exchanged for dollars, which are then exchanged for euro, which are finally exchanged for Danish kroner. This entire series of transactions helps to make interna-tional trade more flexible, and thereby cheaper.

A tax on all currency trading, called the Tobin tax, will undermine the economic usefulness of currency trading to stabilise the exchange rate and reduce the costs of international trade. Such transactions actually account for the predominant share of the foreign-exchange trading volume. Especially a small country with an independent currency is very dependent on a well-functioning foreign-exchange market.

The proponents of a Tobin tax only argue on the basis of detrimental speculative transactions, which in spite of everything are actually quite rare. However, when they do occur, they are very dramatic and provoke major news headlines. They can also have serious consequences for the currency that is affected. However, seeking to fight them by taxing all foreign-exchange transactions is out of proportion.

Moreover, dramatic speculation is often, but not always, founded on fundamental imbalances in the country concerned. Such speculation is therefore motivated by profit expectations that are so high that a tax of 1 per mille is no deterrent. However, a tax at that level will destroy a well-functioning foreign-exchange market.

Therefore Danmarks Nationalbank finds that the discussion of a Tobin tax should cease. This tax will not prevent detrimental speculation and it will have a negative effect on ordinary foreign-exchange transactions.

When we one day write the history of 2001, the main heading is hardly likely to be the more or less aggressive monetary policies of different countries, or the discussion of the Tobin tax. The main topic will be the meaningless, tragic terrorist attacks on New York and Washington.



81

Despite the extensive damage, we can state that the events on 11 September did not in themselves present a threat to financial stability.

Central banks all over the world immediately made extra liquidity available in order to counter the effects of the delays arising in the fi-nancial markets. This is a natural task for a central bank. A very positive aspect was that, in these difficult times, financial institutions all over the world showed quite extraordinary solidarity and willingness to assist each other. Institutions, which usually engage in cut-throat competition, were instead helping each other and taking care not to profit from oth-ers' difficulties.

The markets have now returned to normal conditions, and it is busi-ness as usual on the competition front.

The slowdown in the economy seen all over the world will not only af-fect securities price trends, but also the financial institutions, after many good years of economic growth.

In Denmark, the Danish Financial Supervisory Authority, and not Dan-marks Nationalbank, is responsible for overseeing the individual finan-cial institutions. The Authority has rules and procedures to which the institutions must adhere, and we must expect them to do this, for better or for worse. The rules are there amongst other things to ensure that any detrimental development in a financial institution does not get out of hand before measures are taken to intervene. It would be wrong to expect the Authority to simply lower its requirements when develop-ments are less favourable.

In many countries, the supervision of credit institutions is the responsi-bility of the central bank, and the future supervisory structure is subject to lively debate at the European level.

In Denmark, there is no wish to change the present structure. Dan-marks Nationalbank cooperates very positively with the Danish Financial Supervisory Authority and the division of work between us is very clear. Among other things, this entails that Danmarks Nationalbank takes an interest in "financial stability". In recent years this has become a specific central-bank task, regardless of whether the central bank in question is responsible for supervision or not. Financial stability concerns the condi-tions for the overall sector, and not the more detailed matters related to individual institutions, which is the province of the Authority.

For a couple of years, Danmarks Nationalbank has published articles on financial stability. As from 2002, we will issue a separate annual pub-lication on this subject. In the course of this work, we draw great benefit from our cooperation with the financial sector.

In 2001, there is also reason to cite another major project undertaken in cooperation with the financial sector. This is the KRONOS payment



82

system that was launched on 19 November. It is a very sophisticated sys-tem with a host of facilities. Its structure enables the banks to select among different solutions according to their requirements.

In these and other areas of cooperation, such as trading activities, cash handling, statistics, committee work, and much more, Danmarks Nation-albank has cooperated on a very positive basis with the Danish Bankers Association and its member banks. On behalf of Danmarks National-bank, I would like to extend a warm vote of thanks.

Tables

Interest rates and share-price index ......................................................... 1 Selected items from the Nationalbank's balance sheet .......................... 2 Factors affecting the banks' and the mortgage-credit institutes' net position with the Nationalbank........................................ 3 Selected items from the consolidated balance sheet of the MFI sector and the money stock.................................................................................. 4 The banks' lending..................................................................................... 5 Selected items from the balance sheet of the mortgage-credit institutes .................................................................. 6 External payments (net payments from abroad)..................................... 7 GDP by type of expenditure...................................................................... 8 Principal items of the balance of payments (net revenues).................... 9 Development in consumer prices and net retail prices ........................... 10 Exchange rates ........................................................................................... 11 Selected monthly economic indicators ..................................................... 12 Selected quarterly economic indicators ................................................... 13 Danmarks Nationalbank's Statistical Publications 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. Date of going to press: 25 March 2002. The Tables section of this publication is thus based on more recent information than the equivalent section of the Danish edition. Danmarks Nationalbank is the source for Tables 1-7, while the Copenhagen Stock Exchange is the source for series of bond yields and the share-price index in Table 1. Statistics Denmark is the source for Tables 8-13, apart from the ex-change-rate series in Table 11, for which Danmarks Nationalbank is the source. The calculations in Table 10 has been made by Danmarks Nationalbank.

INTEREST RATES AND SHARE-PRICE INDEX Table 1

The Nationalbank's interest rates Bond yields

Discount rate

Lending and

certifi-cates of deposit

The ECB'sminimumbid rate (in the main

refinanc-ing

opera-tions)

Inter-bank interest

rate, 3-months uncollat-eralized

10-year central- govern-

ment bond

30-year mort-gage-credit bond

The Copen-hagen Stock

Exchange share-price index KFX

Effective end-of-year/ from Per cent per annum End of period Per cent per annum

3.7.89 =100

1997 ................ 3.50 3.75 … 1997 ............. 3.93 5.63 7.28 210.55 1998 ................ 3.50 3.95 … 1998 ............. 4.05 4.35 7.10 219.34 1999 ................ 3.00 3.30 3.00 1999 ............. 3.57 5.64 7.45 255.69 2000 ................ 4.75 5.40 4.75 2000 ............. 5.33 5.20 7.30 313.90 2001 ................ 3.25 3.60 3.25 2001 ............. 3.54 5.15 6.55 272.45

2001 18 Sep..... 3.75 4.15 3.75 2001 Feb ..... 5.14 5.06 7.19 316.80

5 Oct ..... 3.75 4.10 3.75 Sep ..... 4.02 5.01 6.44 255.45 9 Nov .... 3.25 3.60 3.25 Oct ..... 3.80 4.65 6.31 262.05 2002 1 Feb. .... 3.25 3.55 3.25 Nov .... 3.54 4.76 6.39 270.72 Dec..... 3.54 5.15 6.55 272.45 2002 Jan ..... 3.59 5.16 6.53 263.06 25 Mar . ... 3.25 3.55 3.25 Feb ..... 3.55 5.17 6.51 272.81

SELECTED ITEMS FROM THE NATIONALBANK'S BALANCE SHEET Table 2

The banks' and the mortgage-credit institutes' net position with the

Nationalbank The

foreign-exchange reserve (net)

Notes and coin in circula-

tion

The central govern-ment's account with the National-

bank

Certifi-cates of deposit

Deposits (current account) Loans

Total net position

End of period Kr. billion

1997 ............................... 129.7 38.7 34.0 52.7 18.4 19.9 51.2 1998 ............................... 101.4 41.0 37.1 34.7 12.6 29.8 17.5 1999 ............................... 165.3 46.4 39.7 99.8 6.5 33.1 73.2 2000 ............................... 117.5 44.8 37.7 51.8 8.1 25.3 34.6 2001 ............................... 148.4 47.3 43.5 113.5 3.7 63.5 53.7

2001 Feb ......................... 115.7 42.6 35.4 66.3 8.5 42.8 32.0

Sep ......................... 143.4 44.4 83.6 73.1 2.7 63.1 12.7 Oct ......................... 146.1 44.4 82.1 63.0 11.8 58.3 16.5 Nov......................... 147.8 44.8 61.1 71.5 3.5 37.8 37.2 Dec ......................... 145.0 47.3 40.2 113.5 3.7 63.5 53.8

2002 Jan.......................... 163.6 45.2 55.4 97.7 8.2 52.2 53.8 Feb ......................... 171.2 44.8 68.9 77.9 9.3 41.4 46.0

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

Central-government finance

The banks' and the mortgage-credit

institutes' net position with the

Nationalbank

Domestic gross

financing require-

ment

Sales of domestic central-govern-

ment securities

Liquidity effect

Net purchase

of foreign

exchange by the

National-bank

The National-

bank's net

bond purchases

Other factors

Change in net

position End of period

Kr. billion

1997 .................. 73.8 73.0 0.8 43.2 -1.5 -3.8 38.7 51.2 1998 .................. 64.1 68.0 -3.8 -28.7 3.2 -4.5 -33.7 17.5 1999 .................. 67.9 68.8 -0.9 62.7 1.9 -7.9 55.7 73.2 2000 .................. 62.3 65.7 -3.4 -37.7 2.1 0.4 -38.7 34.6 2001 .................. 81.2 87.7 -6.5 28.4 1.0 -3.7 19.2 53.7

2001 Feb ............ 19.0 9.8 9.2 1.1 0.2 -1.8 8.6 32.0

Sep ............ -3.9 10.1 -14.0 20.0 0.0 0.2 6.2 12.7 Oct ............ 15.8 15.2 0.5 3.7 0.6 -1.0 3.7 16.5 Nov............ 15.6 -7.3 22.9 -0.1 0.2 -2.1 20.8 37.2 Dec ............ 19.3 1.9 17.4 0.7 -0.3 -1.2 16.5 53.8

2002 Jan............. -0.5 15.6 -16.0 16.0 -2.1 2.1 0.0 53.8 Feb ............ -0.5 13.0 -13.5 7.5 -2.0 0.1 -7.9 46.0

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

of which:

Domestic lending

of which:

Total balance Total

House-holds

Non-financial

companies

Holdings of domestic securities

other than shares

Foreign assets, net 1

Money stock (M3)


1997 .................. 2,140.0 1,362.4 843.5 383.8 138.3 159.0 504.5 1998 .................. 2,407.2 1,491.0 929.6 408.2 153.3 154.6 523.2 1999 .................. 2,612.8 1,578.2 994.0 420.0 125.8 163.7 523.2 2000 .................. 2,806.0 1,757.8 1,066.7 499.1 114.0 49.6 506.4 2001 .................. 2,932.7 1,925.6 1,157.5 573.2 133.1 -46.8 546.2

2001 Feb ............ 2,874.4 1,791.4 1,071.4 522.0 122.7 9.6 542.0

Sep ............ 3,018.9 1,878.0 1,120.7 559.6 141.5 -2.4 577.3 Oct ............ 2,956.1 1,883.9 1,125.9 564.1 143.1 -23.9 587.2 Nov............ 3,008.3 1,906.7 1,136.2 571.5 129.7 -50.4 578.5 Dec ............ 2,932.7 1,925.6 1,157.5 573.2 133.1 -46.8 546.2

2002 Jan ............ 3,012.6 1,935.2 1,150.6 577.3 133.1 -79.6 558.9

Feb ............ 3,036.8 1,935.8 1,158.1 578.7 143.3 -72.0 555.0

Change compared with previous year, per cent

1997 .................. 10.8 7.6 9.1 3.7 -7.3 -7.9 8.0 1998 .................. 12.5 9.4 10.2 6.4 10.8 -2.8 3.7 1999 .................. 8.5 5.8 6.9 2.9 -17.9 5.8 0.0 2000 .................. 7.4 11.4 7.3 18.8 -9.4 -69.7 -3.2 2001 .................. 4.5 9.5 8.5 14.8 16.8 -194.5 7.9

2001 Feb ............ 8.3 10.4 6.6 18.8 -5.2 -83.1 2.9

Sep ............ 3.4 8.3 6.8 11.8 26.7 -102.1 9.2 Oct ............ 0.1 8.3 7.1 13.3 26.9 -124.7 9.1 Nov............ 4.5 9.2 7.6 14.3 11.0 -199.0 11.4 Dec ............ 4.5 9.5 8.5 14.8 16.8 -194.5 7.9

2002 Jan ............ 5.7 9.1 7.6 13.2 4.4 -392.0 4.1 Feb ............ 5.6 8.1 8.1 10.9 16.8 -849.8 2.4 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 forerign assets of the MFI sector has been compiled as the differencen between all assets and liabilities

vis-a-vis non-residents.

THE BANKS LENDING Table 5

From banks in Denmark From Danish owned banks

abroad

of which: of which:

To Danish residents, total

To non-

Danish residents

House-holds

Non-financial

companies

Total

To Danish resid-ents

To non-

Danish residents

Total lending


1997 .................. 334.1 178.3 96.4 113.7 220.0 84.6 135.4 667.7 1998 .................. 379.0 194.7 112.5 74.8 248.1 96.4 151.7 701.8 1999 .................. 399.8 203.2 117.2 105.0 345.4 123.2 222.1 850.2 2000 .................. 525.4 235.9 186.3 104.7 312.5 66.2 246.3 942.6 2001 .................. 587.8 249.7 228.8 112.7 293.5 34.6 259.0 994.0

2001 Feb ............ 541.6 230.5 201.6 110.4 … … … …

Sep ............ 578.1 244.3 221.5 121.2 308.0 47.3 260.7 1,007.2 Oct ............ 573.1 241.0 222.6 109.6 … … … … Nov............ 580.9 239.1 228.1 123.7 … … … … Dec ............ 587.8 249.7 228.8 112.7 293.5 34.6 259.0 994.0

2002 Jan ............ 594.6 242.2 230.5 122.0 … … … …

Feb ............ 584.6 241.7 231.3 128.9 … … … …


1997 .................. 9.2 6.7 11.9 31.8 28.2 14.4 38.7 18.5 1998 .................. 13.4 9.2 16.7 -34.2 12.8 13.9 12.0 5.1 1999 .................. 5.5 4.4 4.2 40.4 39.2 27.9 46.4 21.1 2000 .................. 31.4 16.1 59.0 -0.2 -9.5 -46.3 10.9 10.9 2001 .................. 11.9 5.9 22.8 7.6 -6.1 -47.8 5.1 5.4

2001 Feb ............ 22.8 9.5 46.5 20.3 … … … …

Sep ............ 11.2 7.6 16.4 2.6 -8.8 -33.2 -2.4 3.2 Oct ............ 10.9 7.1 20.7 -5.7 … … … … Nov............ 12.4 5.9 23.7 15.6 … … … … Dec ............ 11.9 5.9 22.8 7.6 -6.1 -47.8 5.1 5.4

2002 Jan ............ 11.5 4.0 19.1 12.6 … … … … Feb ............ 8.0 4.9 14.8 16.8 … … … … Note: Lending to households includes lending to self-employed individuals.

SELECTED ITEMS FROM THE BALANCE SHEET OF THE MORTGAGE-CREDIT INSTITUTES Table 6

of which:

Domestic lending 1

Debt securities

issued Total

balance Total

of which: Lending to

households 2

of which: Interest adjusted lending

of which: Lending in

foreign currency


1997 .................. 1,054.8 909.9 661.9 … … 1,038.5 1998 .................. 1,172.2 987.8 731.0 … 1.4 1,122.4 1999 .................. 1,222.9 1,050.9 785.8 59.7 9.6 1,116.2 2000 .................. 1,341.1 1,095.9 823.5 99.8 15.5 1,212.9 2001 .................. 1,579.5 1,191.8 900.5 239.0 54.5 1,421.3

2001 Feb ............ 1,238.1 1,108.6 833.7 110.1 17.4 1,160.3

Sep ............ 1,321.8 1,153.3 868.9 172.6 34.2 1,223.0 Oct ............ 1,332.0 1,164.1 877.6 187.7 39.1 1,251.1 Nov............ 1,402.2 1,179.0 889.8 206.4 44.4 1,300.0 Dec ............ 1,579.5 1,191.8 900.5 239.0 54.5 1,421.3

2002 Jan ............ 1,345.1 1,194.3 901.2 259.2 62.6 1,242.7

Feb ............ 1,371.5 1,203.1 909.1 269.7 66.6 1,261.6


1997 .................. 8.7 7.5 9.9 … … 9.8 1998 .................. 11.1 8.6 10.4 … … 8.1 1999 .................. 4.3 6.4 7.5 … … -0.6 2000 .................. 9.7 4.3 4.8 67.3 61.2 8.7 2001 .................. 17.8 8.8 9.4 139.4 252.2 17.2

2001 Feb ............ 5.5 5.2 5.6 61.4 65.2 7.8

Sep ............ 7.1 6.5 6.7 81.8 159.8 10.0 Oct ............ 8.7 6.9 7.2 95.1 188.2 12.1 Nov............ 13.4 7.7 8.1 110.9 211.8 15.1 Dec ............ 17.8 8.8 9.4 139.4 252.2 17.2

2002 Jan ............ 10.0 8.3 8.7 149.8 281.9 8.5 Feb ............ 10.8 8.5 9.0 145.0 282.2 8.7 1 The distribution of lending to households, interest adjusted lending and lending in foreign currency may coincide.

Therefore, some lending has been included in more than more than one of the above categories. 2 Lending to households includes lending to self-employed individuals.

EXTERNAL PAYMENTS (NET PAYMENTS FROM ABROAD) Table 7

Financial payments

of which:

Direct investments

Current payments

Capital transfers Total

Foreign in

Denmark Danish abroad

Danish krone-

denomi-nated bonds

Errors and

omissions

Increase in the

foreign-exchange reserve

Kr. billion

1997 .................. 9.7 0.7 52.7 18.5 -27.8 44.8 -20.1 43.0 1998 .................. -8.7 0.3 -18.7 52.0 -30.0 0.1 -2.1 -29.2 1999 .................. 9.9 0.9 63.7 111.0 -112.7 14.6 -10.2 64.2 2000 .................. 25.5 -0.1 -23.7 261.0 -196.9 -21.2 -44.7 -43.0 2001 .................. 45.0 -0.2 -38.3 56.1 -73.3 -17.9 21.0 27.5

Feb 00 - Jan 01... 31.3 0.0 -10.0 265.0 -212.0 -31.7 -49.9 -28.6

Feb 01 - Jan 02... 43.6 -0.4 -13.0 52.4 -58.3 -19.0 14.7 45.0

2001 Jan ........... 6.8 0.1 -13.7 5.2 -19.0 -8.1 4.4 -2.4

Aug ........... 5.1 0.0 -8.8 1.4 -3.8 -2.2 6.8 3.0 Sep ............ 1.9 0.0 21.5 4.5 -2.9 3.3 -2.5 20.9 Oct ............ 3.9 0.0 -9.0 0.9 -2.3 -5.7 7.8 2.7 Nov............ 2.6 0.0 1.8 2.2 1.3 -8.0 -2.7 1.7 Dec ............ -1.2 -0.2 1.1 7.0 -4.7 5.3 -2.5 -2.8

2002 Jan............. 5.4 -0.1 11.6 1.5 -4.0 -9.2 -1.8 15.2

GDP BY TYPE OF EXPENDITURE Table 8

Final domestic demand

GDP

Private consump-

tion

General-govern-

ment consump-

tion

Gross fixed

capital formation

Change in invent-ories Total

Exportsof goods

and services

Imports of goods

and services

Kr. billion

1997 .................. 1,116.3 560.9 284.5 220.5 11.2 1,077.1 406.9 367.7 1998 .................. 1,155.4 581.3 300.5 240.3 10.1 1,132.1 413.4 390.1 1999 .................. 1,213.6 597.5 313.9 248.1 -3.2 1,156.3 459.6 402.3 2000 .................. 1,296.1 613.3 325.8 283.0 -1.8 1,220.2 567.4 491.4 2001 .................. 1,352.1 633.8 343.2 279.3 2.6 1,258.9 610.8 517.6

2000 Q4 ............ 344.2 159.8 82.3 70.8 4.4 317.4 162.6 135.7

2001 Q1 ............ 327.6 155.1 83.0 67.1 0.4 305.6 150.4 128.4 Q2 ............ 337.9 158.4 85.6 71.0 1.2 316.1 152.5 130.7 Q3 ............ 334.6 155.5 86.9 67.7 -1.6 308.4 152.1 125.9 Q4 ............ 351.9 164.9 87.7 73.4 2.7 328.7 155.8 132.6

Real growth compared with previous year, per cent

1997 .................. 3.0 2.9 0.8 10.9 … 4.9 4.1 10.0 1998 .................. 2.5 2.3 3.1 10.1 … 4.0 4.3 8.9 1999 .................. 2.3 0.2 1.8 1.0 … -0.5 10.8 3.3 2000 .................. 3.0 -0.3 0.6 10.7 … 2.6 11.5 11.2 2001 .................. 1.2 1.1 1.5 -1.7 … 0.8 3.4 2.6

2000 Q4 ............ 2.7 -1.5 0.2 7.9 … 1.8 12.7 11.7

2001 Q1 ............ 2.0 0.8 0.6 -3.9 … -0.2 12.8 7.5 Q2 ............ 0.9 1.0 1.2 -1.6 … 0.6 4.7 4.2 Q3 ............ 1.2 0.8 1.7 -4.6 … 1.3 -0.9 -0.9 Q4 ............ 0.7 1.5 2.4 3.2 … 1.5 -1.4 0.0

Real growth compared with previous quarter (seasonally adjusted),

per cent

2000 Q4 ............ 0.8 -0.5 0.3 -2.8 … 0.8 1.2 1.4

2001 Q1 ............ -0.5 1.4 0.5 -2.6 … -0.5 -1.1 -0.3 Q2 ............ 0.4 0.1 0.5 1.7 … 0.9 -0.8 0.0 Q3 ............ 0.5 -0.2 0.4 -0.8 … 0.1 -0.3 -1.9 Q4 ............ 0.2 0.3 0.7 3.7 … 0.5 0.7 1.6

PRINCIPAL ITEMS OF THE BALANCE OF PAYMENTS (NET REVENUES) Table 9

Goods (fob) Services

Goods and services

Wages and property income

Current transfers

Total current account

Kr. billion

1997 ............................... 38.4 0.8 39.2 -22.5 -12.3 4.4 1998 ............................... 25.3 -2.0 23.3 -18.4 -15.2 -10.2 1999 ............................... 44.6 11.7 56.3 -16.6 -19.5 20.2 2000 ............................... 54.6 20.0 74.5 -29.1 -24.8 20.6 2001 ............................... 56.8 29.0 85.8 -29.4 -22.5 33.9

Feb 00 - Jan 01 ............... 56.6 22.3 78.9 -28.8 -24.0 26.1

Feb 01 - Jan 02 ............... 58.7 27.9 86.7 -30.0 -21.7 34.9

2001 Jan......................... 3.6 1.9 5.5 -1.8 1.2 4.8

Aug........................ 6.1 3.4 9.5 -1.8 -1.6 6.0 Sep......................... 5.9 1.7 7.6 -1.1 -3.1 3.4 Oct......................... 6.2 2.4 8.7 -4.8 -2.1 1.8 Nov........................ 6.1 1.3 7.4 -4.7 -2.1 0.6 Dec ........................ 3.0 3.3 6.2 -2.9 -3.9 -0.6

2002 Jan......................... 5.6 0.8 6.4 -2.4 1.9 5.9

DEVELOPMENT IN CONSUMER PRICES AND NET RETAIL PRICES Table 10

Domestic prices

Consumer-price index

Index of net

retail prices Energy Imports

Total Food stuffs Rent

Public services IMI

Weights

HICP CPI 1.000 0.088 0.149 0.763 0.140 0.235 0.037 0.351

Year-on-year growth, per cent

1995 .................. 2.0 2.1 1.9 -2.5 2.5 2.2 3.1 1.8 2.5 2.0 1996 .................. 2.1 2.1 2.0 6.6 0.1 1.9 1.7 1.6 1.1 2.4 1997 .................. 1.9 2.2 2.2 2.7 0.9 2.4 3.6 2.8 2.2 1.8 1998 .................. 1.3 1.8 1.5 -2.8 0.6 1.9 1.8 2.1 -0.9 2.3 1999 .................. 2.1 2.5 2.1 2.1 -0.3 2.5 0.6 2.7 3.5 2.9 2000 .................. 2.7 2.9 3.1 19.5 4.3 1.7 2.4 3.1 3.7 0.1 2001 .................. 2.3 2.4 2.4 -0.9 2.4 2.7 3.4 3.0 3.3 2.1

1999 Q1 ............ 1.4 2.0 1.5 -7.0 -0.7 2.4 0.3 2.8 2.1 3.1 1999 Q2 ............ 1.8 2.3 1.8 -1.4 -0.8 2.4 -0.2 2.5 4.5 3.1 1999 Q3 ............ 2.3 2.6 2.3 5.7 -0.2 2.5 0.7 2.8 3.8 2.8 1999 Q4 ............ 2.8 3.0 2.8 11.5 0.4 2.6 1.7 2.7 3.6 2.7

2000 Q1 ............ 2.8 3.1 3.3 24.1 2.1 2.1 2.3 3.1 3.5 1.0 2000 Q2 ............ 2.9 3.2 3.4 21.6 4.1 2.0 3.2 3.4 3.7 0.3 2000 Q3 ............ 2.6 2.7 2.9 18.3 5.1 1.4 2.2 3.0 4.2 -0.5 2000 Q4 ............ 2.6 2.6 2.8 14.9 5.9 1.3 1.8 2.8 3.6 -0.3

2001 Q1 ............ 2.3 2.4 2.5 2.2 4.6 2.2 2.8 2.9 3.3 1.2 2001 Q2 ............ 2.5 2.6 2.7 2.4 2.8 2.8 4.0 3.0 2.4 2.1 2001 Q3 ............ 2.3 2.4 2.4 -1.3 1.9 2.9 3.7 3.0 3.5 2.2 2001 Q4 ............ 2.0 2.1 2.0 -6.5 0.6 3.1 3.1 3.0 3.8 2.9

2002 Jan............ 2.5 2.5 2.7 -0.5 -0.1 3.4 3.4 3.0 3.9 3.7

Note: Weigting basis of December 2000. The index of net retail prices is the consumer price index adjusted for indirect taxes, duties and subsidies for

general price reductions. "IMI" is a measure of domestic market-determined inflation. "IMI" normally increases faster than the index of net

retail prices due to an overweight of services, for which the price development is typically stronger than for other commodities.

HICP is the Harmonised index of Consumer Prices.

EXCHANGE RATES Table 11

EUR1 USD GBP SEK

Effective krone rate

Real effective

krone rate based on consumer

prices

Kroner per 100 units 1980=100

Average

1997 ............... 745.10 660.86 1,082.32 86.54 100.0 103.1 1998 ............... 744.87 669.70 1,109.36 84.23 101.3 104.6 1999 ............... 743.56 698.34 1,129.49 84.46 99.6 104.3 2000 ............... 745.37 809.03 1,223.32 88.26 95.6 100.6 2001 ............... 745.21 831.88 1,197.73 80.58 96.9 101.8

2001 Feb......... 746.31 809.49 1,176.84 83.17 96.9 101.7

Sep......... 744.14 817.05 1,194.54 76.93 97.6 102.5 Oct......... 743.67 820.79 1,191.44 77.65 97.6 102.8 Nov........ 744.53 838.10 1,203.92 79.12 96.8 102.1 Dec ........ 744.33 833.06 1,199.59 78.97 97.2 102.7

2002 Jan......... 743.29 841.68 1,205.53 80.55 97.2 102.6 Feb......... 742.99 854.00 1,214.84 80.91 96.9 …

1 In 1997 and 1998 the euro rate has been calculated on the basis of the conversion rate between DEM og EUR fixed

on 1 January 1999.

SELECTED MONTHLY ECONOMIC INDICATORS Table 12

Quantitative index for sales in sectors

of Composite cyclical

indicator for

Unem-ployment

Per cent

of labour force

New passen-ger car

registra-tions

Con-sumer confi-dence

indicator

Forced sales of

real property

Bank-ruptcies

Industry

Building and

construc-tion

Extrac-tion of

raw materials

and manufac-

turing

1995=100

Retail trade

1990=100 Number Balance per cent

1997 ............... 7.9 107 111.8 2,824 1,759 152,869 9 2 8 1998 ............... 6.6 109 114.3 2,426 1,652 162,708 2 -3 -2 1999................ 5.7 111 115.6 2,397 1,636 144,259 -2 -11 -8 2000 ............... 5.4 118 116.6 2,584 1,771 113,633 2 5 -1 2001 ............... 5.2 120 117.2 2,682 2,329 96,134 0 -3 -11

Sæsonkorrigeret

2001 Feb ........ 5.4 120 116.8 216 153 7,693 2 5 -5

Sep ........ 5.1 119 119.5 213 221 7,876 -1 -9 -15 Oct ........ 5.0 119 117.4 226 206 8,053 -3 -10 -14 Nov........ 5.0 120 119.0 244 287 8,060 0 -9 -14 Dec ........ 5.0 117 118.3 262 200 7,732 3 -9 -12

2002 Jan......... 5.0 117 … 256 198 8,551 4 -2 -9 Feb ........ … … … 250 217 8,683 3 -3 -10

SELECTED QUARTERLY ECONOMIC INDICATORS Table 13

Employment

Total Private

Hourly earnings

in manufactur-ing industry

1,000 persons Feb. 1996 =100

Real effective krone rate based on hourly earn-

ings

1980=100

Property prices (purchase sum,

one-family dwellings)

As a per-

centage of property

value 1995

1997 ........................ 2,607 1,813 105.2 100.1 123.5 1998 ........................ 2,652 1,839 109.8 103.0 134.4 1999 ........................ 2,685 1,864 114.4 102.5 143.7 2000 ........................ 2,706 1,883 118.4 98.4 153.0 2001 ........................ 2,720 1,889 123.5 100.8 …

Seasonally adjusted

2000 Q4 .................. 2,707 1,885 120.0 97.9 156.9

2001 Q1 .................. 2,715 1,889 121.4 100.5 159.7 Q2 .................. 2,721 1,892 123.2 100.3 161.9 Q3 .................. 2,723 1,890 124.2 101.0 163.2 Q4 .................. 2,724 1,889 125.3 101.5 …


1997 ........................ 1.3 1.1 3.8 -2.0 11.4 1998 ........................ 1.7 1.5 4.4 2.9 8.8 1999 ........................ 1.3 1.3 4.1 -0.5 6.9 2000 ........................ 0.8 1.0 3.5 -4.0 6.5 2001 ........................ 0.5 0.3 4.3 2.4 …

2000 Q4 .................. 0.3 0.5 3.5 -3.1 7.5

2001 Q1 .................. 0.3 0.4 3.6 0.8 8.0 Q2 .................. 0.7 0.7 4.8 2.3 6.5 Q3 .................. 0.7 0.3 4.5 3.1 5.0 Q4 .................. 0.6 0.2 4.4 3.6 …

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2002

Da

nm

ark

s Na

tion

alb

an

kM

on

eta

ry R

ev

iew

02


Monetary Review 1st Quarter

Danmarks Nationalbank Havnegade 5 DK-1093 Copenhagen K

Telephone +45 33 63 63 63 Fax +45 33 63 71 25

www.nationalbanken.dk E-mail: [email protected]

D A N M A R K S

N A T I O N A L

B A N K 2 0 0 2

1

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