Real interest rate: For the time-series regression the real interest rate differential is defined as the difference between the nominal yield on 10-year government bonds and a 5-year moving average of percent changes in the CPI. For the cross-country regression the real interest rate is defined as the difference between the nominal yield on 10-year government bonds and the percent change in the CPI for the same year. For Finland the yield for the 7-year government bond is employed.
Real interest rate differential: Defined as the difference between the real interest rate and Germany’s real interest rate.
Dummy for changes in the Swedish krona/deutsche mark exchange rate: The dummy takes the value of 0 for any year in which the change in the nominal Swedish krona/deutsche mark exchange rate is less than 10 percent. For years in which the change is greater than 10 percent the dummy takes the value of the percent change in the exchange rate.
ERM dummy: The ERM dummy takes a value of 0 for any year prior to 1979 whereas it takes a value of 1 for the years 1979-1994, the years during which Denmark participated in the ERM.
Relative general government budget balance/GDP ratio: The ratio is defined as the difference between a country’s general government budget balance as a percent of GDP and Germany’s general government budget balance as a percent of GDP.
Relative trade balance/GDP ratio: The ratio is defined as the difference between a country’s trade balance as a percent of GDP and Germany’s trade balance as a percent of GDP.
Relative current account balance/GDP ratio: The ratio is defined as the difference between a country’s general government budget balance as a percent of GDP and Germany’s general government budget balance as a percent of GDP.
Sources: All data are from the World Economic Outlook and International Financial Statistics databases.
This chapter was prepared by Mark Griffiths.
Some have concluded that, under perfect capital mobility, the current account should no longer matter, to the extent that it reflects undistorted private sector saving and investment decisions. According to this view, which arguably has been discredited by recent events, the current account itself is not the problem: it can only be a symptom of the underlying problem of insufficient government saving. Corden (1994, Chapter 6) discusses this view.
The nominal interest rate was estimated as the ratio of net investment income to net foreign debt; European Commission (1991) makes similar calculations.
Net foreign debt in a given period equals net foreign debt of the previous period plus the current account deficit, plus any debt revaluation effects. From this one can infer the magnitude of debt revaluation in a given year which, when divided by the net external debt, provides a measure of the rate of debt revaluation. See European Commission (1991) for an application of this approach to Denmark.
It should be conceded that hardening of the exchange rate would reduce the extent of unfavorable debt revaluation.
The dependency ratio is defined as the population aged 65 and over and below 15 as a proportion of those aged 15-64; the old age dependency ratio the population 65 and over as a proportion of those aged 15-64.
However, the aggregate net foreign debt numbers conceal a shifting of the foreign debt burden from the private sector (which is now a net foreign creditor) to the public rector, whose net foreign debt increased substantially in 1993.
Norway recorded the same achievements, though considerably assisted by increased energy production; Ireland’s similar current account transformation is one of many parallels that have been observed between the Danish and Irish economies (Giavazzi and Pagano (1990)).
Paradoxically, the reforms of the early 1980s led to an unintended worsening of the current account deficit, despite a substantial increase in government saving and a significant real exchange rate depreciation. Only in the mid-1980s were unwarranted incentives for private borrowing significantly reduced, and with it the private savings rate increased.
To cyclically adjust the trade balance, OECD estimates of the domestic output gap and of an export-weighted average of partner country output gaps were used, combined with the assumption that the respective income elasticities both equal two.
Based on OECD statistics.
Defined as the price of manufactured exports divided by the price of manufactured imports.
Foreign market size is calculated as a weighted average of manufacturing import volumes of Danish trading partners. Since the trend toward increasing market integration has raised the share of exports and imports in GDP, using foreign income as the explanatory variable tends to lead to implausibly high estimates of the income elasticity, as the estimated coefficient attempts to pick up this trend. To correct for this effect, actual import volumes were used to measure market size. All the data is annual and comes from OECD Economic Outlook. Estimation is carried out using (natural) logarithms of the data.
The “correct” approach to resolving the problem of trending variables is to test for the stationarity of each variable and then to apply cointegration analysis. Lack of observations prevents such an approach with recent annual data. However, unreported research applying cointegration techniques to quarterly data from the OECD analytical database produced supportive results.
It fails the Chow forecast test at a 1 percent significance level. Similar results were reported on page 40 of the previous Recent Economic Developments, (SM/94/15), in an equation using relative unit labor costs in place of relative export prices.
Using goods and services imports instead of manufacturing provides wider coverage and allows data going back to 1960 to be used. The results are broadly similar to those reported in the 1994 Recent Economic Developments (SM/94/15).
With re-estimation the income and price elasticities barely changed and the Durbin Watson statistic improved to 1.58.
However, there is considerable statistical uncertainty attached to the trade volume data for 1993, reflecting the change in data reporting methods associated with the introduction of the EU single market.
However, the development of energy production has also been associated with significant increases in investment in the energy sector which might offset part of the trade balance improvement, at least in the initial years.
The description of macroeconomic policy that follows is based on Andersen (1994), European Commission (1991), De Grauwe and Vanhaverbeke (1990), Ministry of Finance (1994), Nielsen and Sondergaard (1991) and Wyplosz (1994).
Even worse, such a policy could not improve the current account unless there was considerable slack in the economy, since transferring resources to meet the increased demand for labor-intensive nontraded goods sector must mean a reduction in the supply of tradable goods, counteracting any favorable effects of the demand-switch on the trade balance.
The current account--the main goal of the new policy--did improve in 1983, but largely in delayed reaction to the devaluations of the preceding years. With the unexpected increased in demand the current account deficit worsened again, prompting the introduction of additional restrictive measures in 1986 and 1987.
For further examples of the expansionary consequences of exchange rate stabilization see Kiguel and Liviatan (1992).
Ministry of Finance, April 1994, p. 6.
The package included measures to front load after-tax mortgage interest payments, raise indirect taxes, reduce the deductibility of interest expenses on consumer loans, and restrict the terms of consumer credit. See OECD, 1987, p. 62.
Medium Term Economic Survey, April 1994, p. 22. The tax reform separated capital income from personal income, allowing the deductibility rate for those with negative net capital income to be fixed at 50 percent, even if they faced a higher marginal tax rate on personal income.
House prices fell roughly 20 percent in nominal terms from mid-1986 to early 1993, before recovering suddenly in early 1994 to rise within 5 to 10 percent of the 1986 peak; however, in real terms house prices are still some 30 percent below their 1986 levels.
Norway is excluded from the comparison because of the importance of its North Sea oil production.
This chapter was prepared by R. Corker.
For more details of the staff’s estimate, see SM/94/15. For a description of the authorities’ estimate see Ministry of Finance (1995).
The output gap might be expected to exceed the labor market gap in a period of cyclical recovery because of the procyclical behavior of productivity and because the reversal of discouraged worker effects would raise labor market participation. On average, the Okun coefficient for the years 1991-94 is 1.5, in line with historical experience.
The extent of public expenditure savings would depend on the nature of the implicit labor market policies. Targeted job subsidies and tax relief, for example, could lead to a substantial erosion of the fiscal savings described here.
The official medium-term scenario is articulated in Denmark’s updated Convergence Program, as submitted to the Monetary Committee of the EU on January 9, 1995, although subsequent refinements were made to the projections for 1995-96.
Originally, the regressand was expressed in nominal terms and the expected inflation term included as a separate regressor. However, the coefficient on expected inflation was statistically indistinguishable from unity.
Several other variables were tried in this equation including unemployment differentials and net external debt/GDP. None proved satisfactory. In addition the equation was run on monthly data for a wide variety of interest differentials of different maturities.