The staff report for the 2004 Article IV Consultation on Denmark focuses on economic developments and policies. Labor market reforms led to a sustained increase in structural employment, while careful fiscal policy in the context of a clear medium-term sustainability strategy delivered budget surpluses and a steady decline in government debt as a share of GDP. Fiscal policy in Denmark is based on a medium-term strategy to accommodate the pressures from an aging population while maintaining the welfare state without increasing taxes.


The staff report for the 2004 Article IV Consultation on Denmark focuses on economic developments and policies. Labor market reforms led to a sustained increase in structural employment, while careful fiscal policy in the context of a clear medium-term sustainability strategy delivered budget surpluses and a steady decline in government debt as a share of GDP. Fiscal policy in Denmark is based on a medium-term strategy to accommodate the pressures from an aging population while maintaining the welfare state without increasing taxes.

I. Background

1. Denmark’s stability-oriented economic reforms took hold in the early 1990s and the country enjoyed a period of rapid economic growth over 1993–2000 (Figure 1). Initially, accommodative fiscal policy and a consumption boom stimulated by lower interest rates and mortgage market reforms provided the impetus. In the subsequent period of robust economic activity, labor market reforms led to a significant and sustained labor supply response, reinforcing the pickup in growth and ensuring its sustainability. Fiscal reforms, the introduction of a formalized medium-term fiscal framework, and the growing economy transformed fiscal deficits into sizable surpluses. Government debt fell from a peak of almost 80 percent of GDP in 1993 to 45 percent by the end of the decade. Consistent with the improvement in domestic saving, Denmark registered current account surpluses through most of the 1990s and its foreign debt position also improved markedly.

Figure 1.
Figure 1.

Denmark: Long-Term Indicators

Citation: IMF Staff Country Reports 2004, 240; 10.5089/9781451811056.002.A001

Sources: Danmarks Statistik, OECD.

2. Denmark has maintained high employment even in the presence of generous social benefits. Denmark offers unemployment insurance replacement rates that are among the highest in the OECD and generous welfare benefits, but labor market participation rates are also among the highest in the OECD (Figure 2). At least part of this may be credited to Denmark’s flexible recruitment and dismissal rules, strict requirements regarding participation in active labor market programs such as education and training, and clear availability-for-work criteria to qualify for benefits.

Figure 2.
Figure 2.

Participation Rates 2003

Citation: IMF Staff Country Reports 2004, 240; 10.5089/9781451811056.002.A001

Source: Danmarks Statistik, OECD.

3. As in much of Europe, growth slowed starting in 2001 (Table 1, Figures 35). Consumption spending weakened in response to domestic fiscal initiatives aimed at cooling an overheating economy, while investment and net exports supported growth. More recently, net exports slowed as the appreciating euro and the global economic slowdown reduced external demand. Investment, which had remained strong as storm related construction and major infrastructure investment projects where completed, eventually weakened as well in 2003 as tepid external demand undermined business confidence. Toward the end of 2003 domestic demand picked up resulting in annual growth of 0.4 percent. With output now estimated to be roughly 1 percent below potential, the unemployment rate has risen steadily from its trough of 5 percent in 2002 to 6½ percent.

Table 1.

Denmark: Selected Economic Indicators

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Sources: IMF, International Financial Statistics; IMF, World Economic Outlook; and staff projections.

Staff estimates.

Contribution to GDP growth.

Fiscal revenues and financial balance from 2002 reduced by 0.5 percent of GDP due to a transfer of pensions to private sector.

Lending growth for banks and mortgage institutions.

Data for 2004 refer to April 2004.

Based on relative normalized unit labor cost in manufacturing.

Figure 3.
Figure 3.

Denmark: Output Developments, 1992–2005 1/

Citation: IMF Staff Country Reports 2004, 240; 10.5089/9781451811056.002.A001

Sources: Danmarks Statistik, staff calculations.1/ Fund staff projections for 2004-2005.2/ Consumption plus investment.
Figure 4.
Figure 4.

Denmark: Demand Developments and Components, 1995–2003

Citation: IMF Staff Country Reports 2004, 240; 10.5089/9781451811056.002.A001

Sources: Danmarks Statistik, staff calculations.
Figure 5.
Figure 5.

Denmark: Employment, Unemployment, and Participation Rate, 1995–2004

Citation: IMF Staff Country Reports 2004, 240; 10.5089/9781451811056.002.A001

Sources: OECD, Analytical database; and Employment Outlook 2000; Eurostat; staff calculations; and data provided by the authorities.1/ Labour Cost Index (non-seasonally adjusted, in nominal values) in whole economy (except agriculture, education and health). Growth rate Q/Q-4.

Denmark: Contributions to GDP Growth, 2000–05

In Percent

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Source: Danmarks Statistics, Staff Forecast 2004 -05

4. Once the slowdown started to affect unemployment, a sound underlying fiscal position provided space to let automatic stabilizers work (Figure 6). Consistent with medium-term sustainability objectives and reflecting overruns in 2002, constraints on public consumption expenditure in 2003 led to a small tightening of the structural fiscal position. However, this was more than offset by the cyclically-driven increase in social transfers and unemployment benefits together with slower tax collections (also partly due to a tax freeze). The fiscal surplus fell to 1.2 percent of GDP in 2003 from 1.6 percent the preceding year.

Figure 6.
Figure 6.

Denmark: General Government, 1990–2004 1/

Citation: IMF Staff Country Reports 2004, 240; 10.5089/9781451811056.002.A001

Sources: Danmarks Statistik, Ministry of Finance, staff calculations.1/ Fund staff projections for 2004.

Summary of General Government Accounts

(In percent of GDP)

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Change in primary structural balance.

5. Inflation remains well under control, helped by the longstanding fixed exchange rate of the krone. 1 Headline HICP inflation is down below 1 percent, partly due to reductions in taxes on alcohol and tobacco (Figure 7). As of April, the krone has appreciated by nearly 30 percent against the dollar since the low point in 2000 and by roughly 10 percent in real effective terms putting downward pressure on import prices. Wages continued to grow in 2003 at the trend rate of roughly 4 percent, above that in most partner countries, but supported by labor productivity growth. While equity prices have recovered along with the upturn in major international markets, the long but gradual upward trend in real housing prices appears to be tapering off (Figure 8). Policy interest rates in Denmark have been adjusted simultaneously with those in the euro area, and a spread of about only 10 basis points on short-term interest rates reflects the credibility of the peg (Figures 9 and 10).

Figure 7.
Figure 7.

Denmark and the Euro Area: Inflation, 1998–2004

Citation: IMF Staff Country Reports 2004, 240; 10.5089/9781451811056.002.A001

Source: EuroStat.
Figure 8.
Figure 8.

Denmark: Asset Prices and Inflation

Citation: IMF Staff Country Reports 2004, 240; 10.5089/9781451811056.002.A001

Source: Bloomberg; and Danmarks Statistik.
Figure 9.
Figure 9.

Denmark: Interest Rates and Monetary Conditions, 1998–2004

Citation: IMF Staff Country Reports 2004, 240; 10.5089/9781451811056.002.A001

Sources: Staff estimates; and data provided by the authorities.1/ A weighted average of deviations of interest rates (3-month for monetary conditions, and 10-year for financial conditions) and the nominal effective exchange rates from their January 1998 levels.
Figure 10.
Figure 10.

Denmark: Exchange Rates Developments, 1995–2004

Citation: IMF Staff Country Reports 2004, 240; 10.5089/9781451811056.002.A001

Sources: International Financial Statistics, staff calculations.1/ A decline denotes depreciation.

6. Economic activity remained weak in early 2004. Given the increasing slack in the labor market and uncertainty about the strength of the recovery, the government, using its fiscal margin of maneuver, introduced a small package of fiscal measures on March 16 (see below) to help stimulate growth. Subsequently, leading indicators have evolved positively (Figure 11).

Figure 11.
Figure 11.

Denmark: Current Economic Indicators, 1998–2004

Citation: IMF Staff Country Reports 2004, 240; 10.5089/9781451811056.002.A001

Sources: Bloomberg; Danmarks Statistik, staff calculations; data provided by the authorities.

7. Denmark’s policies continue to be broadly in line with the Fund’s recommendations in earlier consultations. The authorities felt that Fund advice had helped to influence their thinking. In particular, Fund discussions focused on economic fundamentals with an international view, while the domestic debate is often more politically motivated. It was noted that Fund advice about overheating in the late 1990s proved to be both correct and helpful. Further, the Fund’s emphasis on spending discipline and structural reform had helped generate domestic focus and build public support for the medium-term sustainability strategy.

II. Report on Policy Discussions

8. The discussions focused on the near-term prospects for a return to more rapid growth and making further progress in the longer-term challenge of accommodating the fiscal pressures arising from an aging population. Growth in Denmark has been on a slowing trend for the last three years and discussions focused on the macroeconomic fundamentals underlying the expected rebound: the stance of monetary and fiscal policy; the state of household, firm and public sector balance sheets; and Denmark’s external competitiveness. Adherence to its coherent medium-term strategy, designed to ensure long-term fiscal sustainability while maintaining the welfare state without resorting to tax increases, has placed Denmark on a path with a strong fiscal position that should ensure resources will be available to fund the costs of an aging population (Figure 12). However, additional efforts will be required to achieve the medium-term employment and public expenditure targets. In this regard the discussions reviewed: the need to control public consumption expenditures; additional labor market reforms required to achieve the structural employment targets given Denmark’s already high participation rates; and product market reforms required to improve overall Danish competitiveness.

Figure 12.
Figure 12.

Denmark: Public Finances and Demographics

Citation: IMF Staff Country Reports 2004, 240; 10.5089/9781451811056.002.A001

Source: Denmark’s Statistik and United Nations

A. The Near-Term Outlook and the Policy Stance

9. The discussions were conducted against the backdrop of the authorities’ recent announcement of a stimulus package to spur growth (Box 1). The authorities explained that the package was focused on increasing households’ disposable income and consumption spending while limiting the fiscal impact. They estimated that the package could increase GDP growth in 2004 by between 0.2 and 0.5 percentage points, depending on the propensity to consume out of higher disposable income.

10. The authorities noted that the expected pickup in world growth, accommodative monetary policy, and the stimulus from recent fiscal initiatives laid the groundwork for a return to healthy growth. Interest rates at historical lows and the impact of the recent fiscal package were expected to support a recovery in consumption. In turn, strengthening domestic and external demand were set to sustain the emerging rebound in business confidence, stimulating investment demand. The authorities projected growth of 2.2 percent for 2004 rising to 2½ percent in 2005.

The Fiscal Measures Announced on March 16

To support the economic upturn and increase employment, the government introduced a stimulus package with the following elements.

  • Moving forward to 2004: (a) cuts in labor income tax rates originally planned to be phased in from 2004 to 2007; (b) social and healthcare spending; and (c) public housing construction and investment.

  • A temporary suspension (in 2004 and 2005) of obligatory contributions to the Special Pension scheme (one percent of income).

In addition to these measures, the government set aside funds to strengthen efforts to educate and better qualify people for work.

The fiscal costs of the package are small since the suspension of the tax deductible obligatory pension contributions increases taxable income, offsetting the additional costs of moving forward the income tax reductions.

Fiscal Costs of the March 16 Package

(Billions of DKr)

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Source: Ministry of Finance

11. The staff saw a slightly slower rebound in 2004. The staff forecast growth to be 1.8 percent in 2004 rising to 2½ percent in 2005, with employment uncertainty and high household debt inducing households to save a larger portion of the increase in their disposable income. Further, the signals of recovery in Europe remained weak, oil prices remained high, and a resumption of euro appreciation could undermine competitiveness at a vulnerable moment. The authorities recognized the downside potential, but felt that risks were evenly balanced given the upside possibility that the fiscal stimulus, together with a more robust recovery in external and domestic demand, could engender a return to labor supply constraints within 2 years.

12. In the staff’s view, the March fiscal package would provide a counter-cyclical impetus to growth. While the impact would be small—perhaps at the lower end of the authorities’ estimate—Denmark was in a strong position to support the upturn. The package was well-designed, bringing forward needed reductions in labor income taxes and increasing incentives to work, while minimizing the short and medium-term fiscal impact. Further, relative to the pre-package stance, the measures will only have a temporary impact with the stimulus effect being largely complete by the time activity is expected to reach potential. Importantly, there was agreement that discretionary counter-cyclical fiscal interventions should be kept as an exceptional response to avoid undermining the credibility of the medium-term targets. Staff noted that Denmark has been well-served by focusing fiscal policy on medium-term objectives, and relying on automatic stabilizers during cyclical swings.

13. There was agreement that price inflation is likely to remain below 2 percent over the near term. Excess capacity, reductions in indirect taxes,2 and the impact on import prices of an appreciating currency have all contributed to the easing in inflationary pressures. Although the effects of the tax reductions and currency appreciation are temporary, there was agreement that capacity utilization constraints are unlikely to be reached before 2006, suggesting inflationary pressure should remain subdued. The authorities noted that the impact of labor market slack is beginning to show in wage setting as the recent central framework for wage growth sets a benchmark of 3 to 3½ percent for annual growth in labor cost over the next three years, roughly a full percentage point below the average rate of growth over the previous four years. However, most wage agreements are still to be negotiated at the local level. The authorities were aware of the risks to competitiveness should labor costs outstrip improvements in productivity. At the same time, they pointed to the sustained current account surpluses as evidence of Denmark’s currently favorable external competitiveness (Box 2).

14. On the fiscal front, the authorities and the staff project the surplus to remain broadly unchanged in 2004. The impact of the expected pick-up in economic activity on tax revenues and current transfers will help maintain the surplus at around 1.2 percent of GDP in 2004. The expected strengthening of the recovery next year will further support public finances and the surplus is, consequently, projected to increase to around 1.4 percent of GDP in 2005 (Tables 3 and 4), below the authorities’ most recent forecast of 1.7 percent of GDP.

Table 2.

Denmark: Balance of Payments

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Source: Danmarks Statistik.

Includes errors and omissions.

Table 3.

Denmark: Medium-Term Forecast 2002–09

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Sources: IMF, International Financial Statistics; IMF, World Economic Outlook; and staff projections.

Staff projections for 2004-2009.

Preliminary estimates by staff for 2003.

Contribution to GDP growth.

Based on relative normalized unit labor cost in manufacturing.

Table 4.

Denmark Public Finance

(In percent of GDP)

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Sources: Danmarks Ministry of Finance, Staff Estimates.

15. Although interest rates were judged to be appropriate given the Danish business cycle, monetary conditions have tightened due to euro appreciation. With interest rates at historical lows, the authorities did not feel that further easing by the ECB would have much impact on domestic demand, particularly with the large baby-boom cohort focused on saving for retirement. The level of the real effective exchange rate was not viewed to be prohibitive as it was near historical averages, however, there was concern that further appreciation of the euro would undermine competitiveness.

Denmark’s External Competitiveness

Over the last five years, the growth in Danish labor costs has consistently outpaced that in the euro area. More recently, euro appreciation has been increasing the price of Danish goods outside of the euro area. However, trade and current account balances suggest that Denmark’s external competitiveness remains strong. It appears that Denmark’s productivity performance relative to that of its major trading partners has helped to maintain Danish competitiveness.

Over the most recent five-year period, the growth in Danish total value added per hour has exceeded that in the three large euro area countries1 and exhibited comparable performance to the three Nordic countries2 and the UK. Denmark’s advantage in comparison to the euro area is more pronounced in the tradable sector. 3 Tradable productivity growth in the three Nordic countries has been almost a full percentage point higher than in Denmark, but wage growth in these countries also exceeds that in Denmark.

Source: Ameco, EuroStat, Danmarks Statistik, Staff Calculations.
1 France, Germany, and Italy.2 Finland, Norway, and Sweden.3 Comprises agriculture and industry excluding buildings and construction.

B. The Medium-Term Strategy

16. Considerable progress has been made in pursuing medium-term economic objectives: high and stable employment, fiscal policy sustainability, and favorable conditions for growth. Price and exchange rate stability continue to be based on a credible commitment to a fixed exchange rate. Denmark’s fiscal framework is intended to ensure that government savings over the medium term are sufficient to maintain long-term sustainability of public finances in light of population aging without having to resort to tax increases while maintaining the main elements of the welfare state (Box 3). Staff viewed the strategy as having been appropriately designed to achieve Denmark’s medium-term sustainability objectives. 3 The strategy calls for fiscal surpluses through 2010 that reduce public debt and free resources to accommodate the increase in spending associated with an aging population. Efforts are under way to reduce taxes, contain the growth of public expenditures, and increase growth through labor and product market reforms. Denmark has made considerable progress toward meeting its objectives: substantial fiscal surpluses continue to be realized; labor market participation rates are amongst the highest in the OECD; and structural employment has increased.

Denmark’s Medium-term Fiscal Framework

Denmark began formalizing its medium-term fiscal framework in the early 1990s, with the initial impetus coming from the EU’s deficit targets, debt ceilings and convergence programs. Significant further steps were taken in 1997, when the government published a more ambitious medium-term consolidation plan, Denmark 2005. This plan introduced objectives for debt and real public consumption growth. Later versions of the framework targeted a general government budget surplus of at least 2 percent of GDP.

In 2001 the planning horizon was extended and the government presented the current medium-term framework in Denmark 2010. The framework is intended to ensure that government savings over the medium term are sufficient to maintain long-term sustainability of public finances. Specifically:

  • An average general government budget surplus of 1½–2½ percent of GDP over the medium term is targeted while making room for a reduction in the tax burden. The aim is to halve the government’s debt-to-GDP ratio to 27½ percent by 2010.

  • The framework targets real public consumption growth to 0.7 percent in 2004 and 0.5 percent thereafter.

  • A tax freeze was introduced in 2002 applying to both tax rates and taxes expressed in nominal terms.

  • Reductions in labor income taxes and structural reforms have been implemented, with further reforms envisaged, to achieve a 2 percent increase in structural employment by 2010.

For further information see IMF Country Report No. 02/102.

17. There was recognition that two key elements of the strategy will be particularly challenging. First, in the medium term, the real growth in public spending is to be held to 0.5 percent, below the rate of GDP growth, and significantly less than the 1.6 percent average growth over the last five years. Second, the targets incorporate an increase in structural employment of 1.6 percent of the working age population, based on increasing participation rates and reducing the NAIRU to 4½ percent by 2010 from its currently estimated level of roughly 5½ percent.

Constraining public consumption expenditure

18. The authorities pointed to progress in containing the growth in public consumption expenditure, an area where slippages have occurred in the past. To contain spending overruns, they had introduced a tax freeze and imposed legally binding rules on counties to comply with budgeted targets to have their first full-year effect in 2003. Preliminary results for 2003 pointed to progress in containing expenditure, with real public consumption growing by 0.5 percent compared to around 2 percent the previous year. Although this implied average real growth over 2002–03 in excess of the 1 percent target, staff welcomed the resulting overall strengthening of spending control.

19. Staff cautioned that additional measures to control spending may be required. While commending the useful check on the size of government provided by the constraints on public spending growth, the staff noted that demand for additional spending in such areas as heath care will likely put pressure on the targets. Going forward, the staff recommended expressing the expenditure target in nominal rather than real terms. The staff argued that this could enhance transparency and enforceability and more directly link the target to the ultimate objective, the nominal fiscal surpluses necessary to reduce the debt ratio and secure long-term fiscal sustainability. It might also improve incentives to provide public services more cost effectively. The authorities noted that annual budgets negotiated with local authorities were set in nominal terms based on expected price developments and thereby in a sense were nominal targets. Moreover, they pointed out that it was important politically to demonstrate to the public that there would be real increases in the standards of public services.

20. The staff recommended that user fees be considered as a means to better align demand for services with need, thereby more efficiently allocating scarce resources. Revenue from user fees could provide room for further reductions in labor income taxes that would help achieve medium-term employment targets while maintaining the laudable objectives of the tax freeze. The authorities pointed out that the current specification of the tax freeze prevented them from implementing user fees.

21. A reorganization of local governments is under consideration, aimed at improving delivery of public services and harnessing economies of scale. Key questions under consideration are the size of municipalities and the division of tasks. A decision is expected before the next local elections in January 2006. The authorities noted that realized economies of scale might generate some cost savings, but they expected the largest impact would be in improved delivery of public services. An underlying tension is evident in the process as the central government seeks to retain control over local expenditure (a large share of total spending), while local authorities feel they need more control because they are held responsible for service delivery. The authorities, cognizant of the potential spending pressures during the reform period, have imposed constraints to prevent excess capital expenditures prior to reorganization.

Structural reform in labor and product markets

22. The authorities outlined that to achieve the structural increase in employment, policy has focused on groups with relatively low participation rates: the young, older workers, and immigrants. Attention has focused on speeding students’ passage through the education system, reducing incentives for early retirement, and increasing the incentives and opportunities for recent immigrants to enter the workforce. In addition to increasing labor supply, the employment targets also embody a decline in the NAIRU to 4½ percent by 2010. A broad range of initiatives has been implemented over the last five years (Box 4) to increase structural employment and, although the authorities noted that it was still too early to judge the effectiveness of many of the initiatives, they indicated that a comprehensive monitoring program was in place.

Labor Market Initiatives Aimed at Increasing Structural Employment

To achieve the medium-term objective of a 2 percent increase in structural employment by 2010, the government has focused on increasing the participation rates of particular groups and lowering the NAIRU. The following initiatives have been introduced:

  • The number of years of tertiary education that the state fully funds has been reduced to the minimum normally required to complete the program of study.

  • Incentives to postpone early retirement have been increased (1999).

  • The disability pension system has been reformed to ensure that any ability to work is fully utilized.

  • Long-term sickness benefit programs have been changed so that reintegration into work can occur gradually and thereby sooner to avoid marginalization. Further, financial incentives have been increased for local governments to ensure that reintegration occurs as quickly as possible.

  • Social benefits have been reduced for couples that are both receiving benefits and the marginal incentives to take a job for those on social benefits have been increased by slowing the rate at which some benefits are withdrawn once employed (More People in Work, October 2002).

  • Labor market activation programs have been refocused to ensure that employment and not simply participation is the goal (More People in Work, October 2002).

  • For the first seven years of residence, social assistance benefits to new immigrants and repatriated Danes have been reduced to 50 to 70 percent of the level that long-term residents receive. A wage subsidy program has also been introduced for recent immigrants (The Integration Package for Immigrants, March 2003).

23. The authorities recognized that achieving the targeted increases in labor supply will require further reforms. Staff noted that measures to increase direct financial incentives were likely to be most effective. In particular, a reduction in the incentives for early retirement would be an important, if politically very sensitive step. The recently formed Welfare Commission is to outline the reform options and stimulate public debate. 4 The first report from the Commission, to be published in late May, was expected to clarify the key issues. The final report with policy options is planned for late 2005, after the elections.

24. The staff suggested that there was further scope to consider changes in tax and labor compensation structures to increase incentives to supply labor or invest in human capital. Denmark has one of the highest top marginal labor income tax rates amongst the OECD and it applies to almost 40 percent of employees. Further, wage compression has long been a feature in the Danish labor market. Discussions revealed various undesirable effects stemming from tax and wage structures, such as workers’ preferences for increased holidays over increased wages, some worrying trends in tertiary educational attainment in Denmark relative to other industrial countries (Figure 13), and some of the employment difficulties faced by low-skilled workers. The staff, while commending the recent progress in reducing labor income taxes, argued that efforts to reduce the top marginal rate should be pursued and that consideration should be given to allowing for greater wage dispersion. Removing the nominal tax freeze that has been imposed on some components of property taxes could provide the space to lower the top marginal tax rate, shifting the tax burden from mobile to immobile factors. While not disagreeing in principle, the authorities argued that full state funding of tertiary education and the quick pace of advancement for the highly educated helped to maintain sufficient incentives to invest in human capital. Further, the authorities indicated that the egalitarian principles underlying wage compression and the partial freezing of property taxes were very popular and would be politically difficult to change.

Figure 13.
Figure 13.

Cross-Country Trends in Tertiary Education

Citation: IMF Staff Country Reports 2004, 240; 10.5089/9781451811056.002.A001

Source: OECD

25. Staff offered that increasing competition in goods markets was a necessary complement to the authorities’ efforts to increase labor supply. With the passage of legislation in 2002 increasing penalties for anti-competitive behavior, the authorities noted that Denmark’s legal framework for competition policy meets the northern European standard. However, strict enforcement will be required to attain the average in practical terms. The authorities pointed to liberalization in the energy market as an indicator that progress was being made. However, it was agreed that considerable improvements were still possible particularly in construction, transportation, rental housing, and retail. Staff research using a multi-country optimizing model (the Fund’s new Global Economic Model) illustrates that increasing the competitiveness in product markets would increase labor demand and help achieve the structural employment targets (Box 5 and Selected Issues (SM/04/218)).

Estimated Impact of Regulatory Reform in Denmark and the Euro Area

The European Council’s Lisbon agenda sets out an ambitious schedule for regulatory reform in labor and goods markets so that European countries can exploit all the opportunities of globalization and the information technology revolution to achieve their full potential in terms of employment and productivity growth. In goods markets, excessive regulation can reduce employment and slow productivity growth if it constrains competition and allows firms to keep output too low thereby keeping prices too high. Among others, regulations such as import licensing, quotas, product standards, public and private monopolies, administrative burdens and access to capital all help to determine the extent to which firms can constrain output and keep prices too high. In labor markets, the regulatory environment can lower employment and output if it allows workers to constrain the supply of labor available to firms, thereby keeping real wages artificially high. The amount of power that workers have to reduce the labor supply and artificially drive up the real wage depends on factors such as minimum wage legislation, the generosity of unemployment insurance and welfare benefits, legislation that influences unionization and the wage bargaining process, and immigration policy.

The IMF’s new Global Economic Model (GEM) has been used to estimate the benefits of regulatory reform that increases competition in goods and labor markets. The analysis suggests that if the levels of goods and labor market efficiencies in Denmark and the euro area increased to match the levels estimated to be the best among industrial countries, then real GDP will increase in the long-run by roughly 7 percent in Denmark and 12 percent in the euro area. Although the empirical estimates suggest that Denmark needs to undertake less reform than the euro area on average, the benefits in Denmark are still quite large because of positive spillovers from the reform undertaken in the euro area, Denmark’s major trading partner. The increase in real GDP resulting from more efficient labor and product markets comes from an increase in the capital stock and an increase in hours worked. The results, although dependent on model calibration, are consistent with that Danish government’s medium-term target of an increase in structural employment of 2 percent. However, the results suggest that both labor and product market reforms will be required. For further details see Denmark: Selected Issues (SM/04/218).

Impact of Regulatory Reform in Denmark and the Euro Area

(Percent deviation from baseline)

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Source: IMF’s Global Economic Model simulations in upcoming Selected Issues Paper.

C. Exchange Rate and Financial Sector

26. The authorities viewed Denmark’s fixed exchange rate in ERM II as a central pillar of their framework for macroeconomic stability and noted that it had served the country well. The commitment to the fixed exchange rate has been the central element underlying the evolution of macroeconomic policy for the last two decades and the staff agreed with the authorities’ positive assessment of its role. Inflation has been low and stable, and fiscal policy has been focused on ensuring that fundamental savings and investment balances in Denmark are consistent with the peg. The authorities noted that the success of the fixed exchange rate was partly due to Denmark’s historical experience, and as such not necessarily replicable elsewhere. The poor macroeconomic outcomes in the 1970s and early 1980s served to build public support for the policies that were required over the subsequent decades to sustain the peg. In particular, the historical experience helped build support for prudent fiscal policy focused on medium-term objectives, reforms to make the economy more flexible, and unhesitating use of interest rates to defend the peg when necessary. Eventual euro adoption continues to be the authorities’ favored exit strategy, but this has not received the necessary support from a population concerned about loss of sovereignty. A referendum on joining the euro was rejected by a small margin in 2000 and another is unlikely to take place at least until after the next elections.

27. Despite the three-year slowdown, the quality of banks’ assets remain high and loan losses have been minimal (Table A3). Some debtors, notably in the agricultural sector, have come under some stress, but the share of such loans is small and authorities saw no systemic concerns. The authorities conduct periodic stress tests and these suggested that while there was some dispersion among banks, there were sufficient buffers to absorb significant risks in the banking system. Denmark has requested an FSAP that is now planned to take place in late 2005 in the context of next Article IV consultation cycle.

28. Insurance companies and pension funds benefited from the favorable performance of equity markets in 2003. Solvency ratios remained healthy, and the authorities considered that the potential for systemic problems was extremely limited. The risks related to liabilities linked to interest guarantees have to a high degree been hedged through various financial instruments.

29. There was agreement that the risks from rising house prices and household debt levels appear contained. The increase over recent years in household indebtedness, particularly mortgage debt, and the wider use of adjustable-rate mortgages have increased households’ exposure to changes in short-term interest rates. While household debt is high by international standards, the authorities noted that debt-servicing costs remain quite low because of low interest rates. Furthermore, net debt is lower in Denmark as household assets are substantial, partly a reflection of high home values. While housing prices have been on a ten-year rising trend, the increase remains well below that in some other countries (Box 6).

30. The authorities recognized that further euro area integration of the financial sector presents challenges for supervision. They were fully cognizant of the importance of regulatory harmonization in the context of increasing conglomeration and cross-border mergers. One large Danish bank is merging its subsidiaries across the Nordic region into a single bank chartered in Sweden, and will operate in Denmark as a systemically-important branch. Cross-border cooperation will be enhanced by the adoption of the EU’s financial services directive and Basel II accord. However, the authorities noted that the new regulations would effectively imply a loosening of provisioning and capital adequacy requirements for Danish banks. The authorities were encouraging domestic banks to move gradually to the new lower levels of capital adequacy, although they were aware of the competitive pressures.

House Prices and Household Debt


Real Residential Price Indices 1975–2002

Citation: IMF Staff Country Reports 2004, 240; 10.5089/9781451811056.002.A001

  • Denmark has experienced three episodes of strong house price gains since the mid-1970s. The last episode since 1993 has been the longest expansion, with real house prices rising by over 5½ percent a year. The steady rise reflects in part an increase in the demand for houses associated with a reduction in mortgage interest rates and greater access to credit.

  • During this period, household debt has increased steadily as homeowners have shifted to mortgage secured loans to repay bank debt taking advantage of lower interest rates of mortgage credits. Household income gearing—the ratio of interest payments to disposable income—remains low by historical standards, reflecting low interest rate levels, but household exposure to changes in short-term interest rates has increased.

  • Compared to other countries, the household debt, as a ratio of gross disposable income, appears high, but debt as a ratio of owner occupied housing prices has remained fairly stable. Among the debtors, limited micro data showed that the mostly liquidity constrained amounted to roughly 30–40 percent of total households.


Household Debt and Income

Citation: IMF Staff Country Reports 2004, 240; 10.5089/9781451811056.002.A001


Household Debt

(in percent of gross disposable income)

Citation: IMF Staff Country Reports 2004, 240; 10.5089/9781451811056.002.A001

D. Statistical and Other Issues

31. Denmark has consistently supported trade liberalization within the context of EU membership. Staff welcomed the authorities’ intention to press for resuming negotiations under the Doha round. The authorities also reiterated their support for CAP reform and the EU’s flexibility on the “Singapore issues” (investment, competition, government procurement, and trade facilitation).

32. Denmark subscribes to the SDDS and its economic data coverage is comprehensive. The gap between exports based on trade data (Danmarks Statistiks) and exports based on balance of payments data (Danmarks Nationalbank) has widened in recent years and ongoing discussions between to the two organizations have not as yet led to a reconciliation of the two series.

33. Denmark maintains its leadership in development assistance and the staff encouraged the continuation of this policy in the future. Although aid as a share of gross national income has fallen slightly in recent years, the staff commended the policy of maintaining development assistance at a level representing at least 0.7 percent of gross national income—still among the highest of any country.

34. Denmark has adopted the OECD’s anti-bribery convention and has satisfied the 40 Financial Action Task Force (FATF) recommendations in the area of money laundering. Denmark has completed the questionnaire on anti-money laundering and the financing of terrorism. Based on their response and discussions held during the Article IV consultation, the AML/CLFT regime appears to have a solid foundation.

III. Staff Appraisal

35. A decade of successful structural reform and prudent fiscal management put Denmark in a strong position to weather the recent world-wide economic slowdown. Labor market reforms commencing in the mid 1990s resulted in a significant increase in structural employment that helped fuel a sustained period of robust economic growth leaving households and firms with balance sheets capable of withstanding the recent slowdown in growth. Over the same period, prudent fiscal management, formalized in a medium-term framework for achieving sustainability in public finances, resulted in fiscal surpluses and a significant reduction in government debt as a share of GDP. However, key challenges remain in Denmark’s quest to maintain the key elements of the welfare state and ensure long-term fiscal sustainability without increasing taxes.

36. Conditions for a return to healthy growth appear to be in place. Accommodative fiscal and monetary policy, healthy balance sheets, favorable external competitiveness and several leading indicators point to a resumption of growth that is close to the economy’s potential. Household sector employment concerns and possible weakness in trading partner demand appear to be the key downside risks, while the risk of a sharp retrenchment in house prices undermining the recovery appears low.

37. The package of fiscal measures introduced by the government in March is expected to provide a helpful impetus to the current recovery without undermining medium-term objectives. However, to maintain the momentum to address the remaining medium-term issues, it is important to avoid generating the expectation that fiscal fine tuning will become a regular tool for short-run stabilization.

38. Denmark has already made considerable progress in preparing for the fiscal pressures from aging and medium-term sustainability continues to be the appropriate policy focus. Although recent developments suggest some progress has been made in reducing public consumption growth, containing it remains a cornerstone of the medium-term strategy. Consideration should be given to specifying spending targets in nominal terms. Increasing healthcare costs, above and beyond the volume effects from an aging population, represent a key risk to the containment of public consumption expenditures. Introducing user fees should be considered to more efficiently allocate scarce healthcare resources and contain demand pressures. Further, revenues from user fees could provide the fiscal room to achieve other labor market objectives while respecting, in aggregate, the tax freeze.

39. Given Denmark’s high overall participation rate, achieving the targeted increases in structural employment may require politically difficult measures. The authorities are appropriately focusing on the sectors of the labor market where participation rates are low, including both the older and younger age groups and first- and second-generation immigrants.

40. Achieving substantial increases in medium-term employment will likely require changes to early retirement schemes. The time profile for participation among the elderly indicates that early retirement schemes have been the key reason for the decline in participation of this group. While changes to the system of early retirement incentives will not be easy politically, they could have a more rapid impact on employment than other areas where improvements are likely to be more gradual.

41. Further reductions in labor income taxes should be considered. Demographics are shrinking the relative size of the working age population, and policy should be focused on reducing the extent to which the structure of the tax system constrains labor supply. Labor income taxes in Denmark continue to be amongst the highest in the OECD and there are some worrying signals that this may be undermining incentives to invest in human capital.

42. Denmark’s fixed exchange rate system remains a cornerstone of the economic strategy. It has served the country well as an anchor for expectations, and an effective discipline on fiscal and other economic policies. The low spreads in interest rates vis-à-vis the euro attest to the credibility of the peg.

43. It is proposed that the next Article IV consultation be conducted on the 24-month cycle.

APPENDIX I Denmark: Basic Data

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Sources: IMF, International Financial Statistics; IMF, World Economic Outlook; and staff projections.

Staff estimates.

Change as percent of previous year’s GDP.

In percent of labor force.

Fiscal revenues and financial balance from 2002 reduced by 0.5 percent of GDP due to a transfer of pensions to private sector.

Banks and mortgage-credit institutions.

Data for 2004 refer to April 20, 2004.

Based on relative normalized unit labor cost in manufacturing.

APPENDIX II Denmark: Fund Relations

(As of April 30, 2004)

I. Membership Status: Joined March 30, 1946. Denmark has accepted the obligations of Article VIII.

II. General Resources Account:

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III. SDR Department:

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IV. Outstanding Purchases and Loans: None

V. Financial Arrangements: None

VI. Projected Obligations to Fund: None.

VII. Exchange Rate Arrangements:

  • Denmark participates in the exchange rate mechanism II (ERMII). It maintains 2¼ percent fluctuation margins vis-à-vis the euro with a central fixed rate at DKr 746.038 per €100.

  • In accordance with UN resolutions and EU restrictive measures, Denmark applies targeted financial sanctions under legislation relating to Al-Qaeda or Taliban, and individuals, groups, and organizations associated with terrorism; certain persons associated with the former Government of Iraq and its state bodies; specific assets of certain persons associated with to important government functions in Myanmar; funds related to military activities in Somalia; funds in relation to Mr. Milosevic and those persons associated with him; funds, other financial assets and economic resources of individual members of the Zimbabwe Government and natural or legal persons associated with them; certain claims by Libya, Liberia, Sudan, Republic of Congo, and the Haitian authorities. These restrictions have been notified to the Fund under Decision 144-(52/51).

VIII. Article IV Consultation: Denmark is on the 24-month consultation cycle. The staff report for the last Article IV consultation (IMF Country Report No. 02/101) was discussed at EBM/02/47 (May 8, 2002).

IX. Technical Assistance: None.

X. Resident Representative: None.

APPENDIX III Denmark: Statistical Appendix

Denmark has a full range of statistical publications, many of which are on the Internet. The quality and timeliness of the economic database are very good and generally adequate for surveillance purposes. Denmark subscribes to the Fund’s Special Data Dissemination Standard (SDDS). Metadata are posted on the Dissemination Standards Bulletin Board.

The gap between exports based on trade data (collected by Danmarks Statistiks) and exports based on balance of payments statistics (collected by the Nationalbank Danmark) has widened in recent years. The discrepancy reflects different sources of information and methodologies used by the two organizations. Ongoing discussions between the two organizations, however, have not yet led to a satisfying reconciliation of the two data series.

The authorities have introduced new data on monetary financial institutions that conform to the ESA95 and expand the set of financial institutions covered in the Nationalbank’s statistical bulletin. This permits an examination of some categories of financial institutions not covered before (e.g. money market funds, small banks, and cooperative banks) allowing a more thorough look at the financial sector. Some of the financial account data come from this enhanced source. Data for the central bank and other depository corporations are reported to STA on a timely and regular basis.

Denmark subscribes to the Fund’s Special Data Dissemination Standards (SDDS). Metadata are posted on the Dissemination Standards Bulletin Board.

Denmark: Core Statistical Indicators

as of June 1, 2004

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