Danish Central Bank Cut Key Lending Rate by 75 Basis Points

December 4, 2008

The Danmarks Nationalbank matched the ECB’s action. Denmark’s central bank does not have an independent monetary policy reacting to price and growth conditions in its economy. Officials instead target the krone/euro cross rate, which is currently trading near 7.4500 or roughly in the middle of today’s high-low range of movement. Denmark’s arrangement is reminiscent of the 1970’s when the mark had many so-called satellite currencies. The Bundesbank set credit policy for Germany, and various other West European central banks targeted the rate differential between their overnight money rate and the Bundesbank’s. Whenever the German policy was changed, the interest rates in these countries moved in lockstep or by what amount was deemed necessary to retain a stable exchange rate. Denmark’s lending rate of 4.25% is 175 basis points above the ECB refinancing rate. Prior to mid-May, that spread was much narrower than now at 25 basis points, but the depletion of reserves to support the krone forced Danish authorities to make their interest rates more attractive. Denmark’s experience underscores the net benefit that smaller European countries reaped by exchanging a semblance of sovereignty over monetary policy, which in reality didn’t really exist, for accepting the euro as the national medium of exchange. These currencies had been objects of speculation at times of far less fragile regional and world economic circumstances than exist now. Typically, when there were runs on the mark’s satellites such as the Italian lira or French franc, monetary authorities were forced to lift short-term interest rates to inappropriately punishing levels or devalue their currencies, a step that would lift the servicing burden of foreign currency-denominated debt.



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