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The policy of a fixed exchange rate was adopted back in 1982 during the worst economic crisis in the Danish context in the post-war period. It was considered to be an economic advantage both at that time and in future. The notion of an active foreign exchange policy that embraces “fixed but adjustable” rates as an unsuitable and harmful economic-political instrument has been deeply rooted in the political system, the civil service, and the National Bank since 1982. This view has underpinned several practical economic-political experiences as well as fundamental considerations in the division of labor and macroeconomic policy. The use of a fixed exchange rate has led to mixed economic outcomes in Denmark.
The economic-political experience affects foreign exchange policy in Denmark. The practical experience is linked to two necessary observations that have stood out in the organization of Danish macroeconomic policy since 1982. First, the occurrence of a high interest rate has been spreading throughout the years. The interest rate spread was a direct result of expectations of continued Danish devaluation and was a significant factor behind the deep economic crisis of the early 1980s (Zoega, 2017, p. 420). Second, in critical economic situations, especially in the weak economy and recession, interest rates rose due to pressure exerted on the fixed-exchange-rate policy. Such increases in interest rates amplify an economic crisis since Denmark’s National bank has to raise the low interest rate when there was pressure on the currency (Gagnon et al., 2017, p. 192). Such a move was necessary to give oversight to the fixed krone exchange rate and sustain the growth of GDP.
The fixed Danish currency had numerous effects on Denmark’s GDP growth. It is vital to mention that monetary and foreign exchange policy is, in any case, only a short-term economic policy. To the extent that cyclical adjustments continue to be needed, this is better achieved through the application of fiscal and structural policies within a medium- and long-term framework of economic policy (Ravn & Spange, 2014, p. 454). Interests that are short term are strong enough to offset the probable rise in the long-term interest rate as a result of weakened confidence if a system of a static exchange rate is adopted. As a result, Denmark experienced a high inflation rate in the early 1980s and a drop in GDP index.
A short-term positive cyclical effect of a weakening exchange rate and reduced interest rates within a short period can also affect GDP. If both events take place at the same time, the benefits will be greater compared to the negative effects of higher interest rate spreads in future typical situations (Abildgren, 2017, p. 308). Hence, there is no time-consistency in deviations from the persistent fixed exchange rate. That is why the GDP growth of Denmark lacked long-term stability.
On the other hand, a policy of fixed exchange rate provides security for the division of labor in an economy. For instance, Danmark’s National bank maintains the krone exchange rate against a large currency area with minimal but stable inflation. This ensures reduced and unchanging Danish inflation. It consequently favors a rise in GDP. The Government and parliament know that they are responsible for ensuring a stable and sound economic growth.
Denmark should strike a balance between holding onto the current exchange system and changing to a flexible policy. The differences in defending and abandoning a policy of fixed exchange rate and switching to flow and inflation targets concerning the long interest spreads can be illustrated by the difference between Denmark and Sweden before, during and after the crisis in 1992 to1993. For many years, Denmark had substantially higher and more volatile interest rates than Sweden (Abildgren, 2017, p. 317). However, the situation changed after the introduction of a standard exchange rate approach. After 1987, the country had a generally lower and more stable interest rate, as well as a stable inflation and exchange rates than Sweden. Up until the crisis in 1992-1993, the Swedish interest rate was only slightly higher than the Danish one. However, Denmark had a more credible fixed exchange rate system than Sweden, which for some years had high wage and price increases. It also enjoyed a fiscal and structural policy that did not support a fixed exchange rate and low inflation (Ravn & Spange, 2014, p. 454). In such a case, a fixed exchange rate did not favor the growth of GDP in Denmark. That is why the Swedish economic growth increased more than Danish during the crisis. Hence, Denmark should abandon the fixed exchange rate approach in seasons when it is not favorable to the rise in GDP.
It is primarily Denmark’s and the Danish economic policy that is crucial in preventing and managing crises in Denmark. Nonetheless, Denmark has a limited influence on crises in the euro area, especially when it is not part of the euro cooperation. However, Denmark has a particular influence on how a given crisis in the euro area affects the Danish economy, primarily through Danish fiscal and structural policy. Denmark can also influence the choice of monetary and foreign exchange policies.
Denmark can also opt-out of the current economic policy. If Denmark decides to leave the fixed-exchange-rate policy by independently lowering or raising the monetary-policy interest rate and changing the exchange rate, it will be out of broad political confidence (Gagnon et al., 2017, p. 228). Besides, a sizeable cyclical advantage can be achieved in the short term. The effects of abandoning the present policy are far-reaching. Hence, more fundamental considerations on the foreign exchange policy alternatives would be needed by Denmark.
A fixed exchange rate has led to mixed economic outcomes. The Danish fixed exchange rate system is determined by the fact that the krone exchange rate is completely fixed. It is not included in the economic policy considerations that deviations from the consistent fixed exchange rate policy can be made, but only that there is a risk that such deviations may be imposed. Discussions about deviations have not been made political or included in the economic-political agenda. Indeed, there are both negative and positive effects of the current policy on the exchange rate. However, Denmark should consider adjusting the policy periodically depending on the state of economic seasons.
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