Mitchell, B. (2015) “Denmark should abandon its euro peg, Bill Mitchell Blog, 21 January.
In my soon-to-be-published book on the Eurozone I examined the case of Denmark in some detail in the context of the evolution of the European Monetary System, the European Exchange Rate Mechanism (ERM), and the ratification process of the Treaty of Maastricht. Denmark was a participant in all the attempts to maintain fixed exchange rates after the Bretton Woods system collapsed in 1971. Further, while Denmark did not formally enter the monetary union by adopting the euro that doesn’t mean that they have maintained their currency independence. They chose instead to peg the Danish kroner against the euro (effectively continuing the ERM parities), which immediately meant that its central bank had to follow ECB monetary policy. Fiscal policy then became a passive player to ensure it didn’t exacerbate the peg parity and Denmark also bought into the Stability and Growth Pact fiscal rules. This meant that internal devaluation (wage cutting) was the only real counter-stabilisation option available to them when facing external imbalances and domestic recession. It hasn’t worked well as one would expect. In fact, the euro peg works against the interests of the Danish people, particularly low income workers prone to unemployment. Yet the nation has an obsession with maintaining it. Groupthink abounds. The correct policy strategy which would give the Danish government a wider range of policy tools to enhance the well-being of its people would be for Denmark to abandon its euro peg. It should do that virtually immediately.
There was an interesting Bloomberg Op Ed earlier this week (January 19, 2015) – Denmark Should Cut Loose From Euro.
It was reflecting on the decision by the SNB last week to break its short-term peg with the euro – effectively declaring that the Swiss franc was undervalued and that the SNB wanted to break free of ECB influence (through the peg).
There has been a lot of so-called contagion from that decision with many speculators going broke. One should have little sympathy for them – they play the game and lose – so what.
But one consequence of the decision has been the upward pressure on the Danish krone against the euro, which presumably is a reflection of the speculators betting that the Danmarks Nationalbank (the Danish central bank) might also be forced to break its peg with the euro too.
So buying Danish currency assets would be a good bet if the Danmarks Nationalbank bails out on the peg, given the rapid appreciation in the Swiss franc last week.
For the Danmarks Nationalbank, it lowered deposit interest rates to -0.2 per cent and the lending rate (to commercial banks) to 0.05 per cent, as a way of discouraging capital inflows.
It is also facing up to having to sell lots of krone if the ECB introduces QE this week, which means it would be building ever large euro-denominated currency reserves. Why? To maintain the peg.
The Bloomberg article notes that while this will challenge the Danmarks Nationalbank:
… maintaining the peg is an act of faith in Denmark.
The Op Ed suggests that:
The central bank should rethink its commitment. With a more flexible monetary policy, it could have done more to stimulate the economy since the global financial crisis, just as it could have prevented some of the overheating that took place in the years running up to the crisis.
To understand where Denmark is now some brief history is required.
Early Danish fixed exchange rate pretensions
In 1873, Denmark created a multinational currency experiment with Sweden when they formed the Scandinavian Currency Union (SCU). Norway joined two years later.
It was a monetary union based on gold where each nation created a common unit of currency in decimal form – the Scandinavian krona. The currencies of the member nations (gold coins and other silver and bronze tokens) were fixed against the price of gold and would remain freely exchangeable at parity for a period of eight years, whereupon the common currency unit would prevail.
Political developments undermined the system. For example, when Norway broke with Sweden in 1905, the Swedes limited convertibility. But the monetary instability associated with the onset of World War I, was the last straw. The formal arrangement was terminated in 1921.
Relevant posts:
- Verhelst, S. (2014) “Τhe Sense and Nonsense of Eurozone Level Democracy“, Egmont Paper 70, Royal Institute for International Relations, October.
- Wren-Lewis, S. (2014) “Why We Need Our Fiscal Policy Instrument Back, Social Europe Journal, 24 November.
- Cohen-Setton, J. (2013) “Blogs review: The comparative performance of fixed and flexible ER regimes“, Bruegel, 29 October.