That´s how a Danish friend summarized the situation. Although not a euro country, Denmark has its exchange rate pegged to the euro so it´s monetary policy hands are tied, being determined by monetary policy at the ECB. The chart illustrates.
A currency peg is much less binding than a common currency arrangement, so why doesn´t Denmark opt-out? I suspect it´s very much afraid of the ‘inflationary consequences’ of such a move. Better to keep living in ‘deflation’!
Sweden would be a good counterpoint (or ‘control’) in an analysis of Denmark, given that Sweden is not in the euro or has a pegged exchange rate, being free to pursue its preferred monetary policy.
Interestingly, there´s not such a great difference in the performance of the two countries, in particular over the last couple of years. I suspect Lars Svensson´s influence has been waning!
This is how the Riksbank recently described monetary policy in 2012 (my bolds):
Poorer economic prospects led to lower inflation
The weak developments in the euro area had a clearly negative impact on the Swedish economy during 2012. Demand in Sweden slowed down and inflationary pressures were lower, which made it more difficult for companies to raise their prices. In recent years the krona has strengthened, approaching more long-run normal levels. This has also contributed to low inflationary pressures.
Inflation undershot the target in 2012
Both CPI and CPIF inflation that is the CPI with a fixed mortgage rate, were on average around 1 per cent in 2012. The fact that inflation was below the Riksbank’s target of 2 per cent was largely due to economic activity abroad being much weaker than expected and the effects this had on the Swedish economy. At the same time, long-run inflation expectations were close to 2 per cent, which shows that the public was still confident that the Riksbank would attain its inflation target.
Low repo rate to attain the inflation target
In 2012 the Executive Board of the Riksbank cut the repo rate from 1.75 to 1 per cent to support economic activity and bring inflation back on target. The forecasts for the repo rate, known as the repo-rate path, were also lowered over the course of the year. The members of the Executive Board were unanimous that the repo rate needed to be cut gradually, but there were differing opinions as to how much it should be cut.
Pretty ‘depressing’ isn´t it? Why on earth can´t the Riksbank offset negative influences from abroad? But that´s always a good excuse for central bankers! And parenthetically I lost some of the esteem for Svensson when I learned from the Riksbank website that on April 13 he´s going to make a presentation entitled “How much relative weight should policy makers place on employment, and how much on inflation?” at the conference “Fulfilling the Mandate of Full Employment: Labor Markets and Monetary Policy”, arranged by the Federal Reserve Bank of Boston.
That´s nothing more than further discussion of the parameter values (on inflation and output gap) in a Taylor-Rule set-up. In other words, a pretty useless endeavor.
Some pictures for Denmark and Sweden are illustrative. The first shows the NGDP (or spending) ‘gap’ in both countries since the crisis began. The second the rate of inflation.
Note that in 2009 there was an ‘effort’ to raise spending back towards trend, more so in Sweden. But that quickly fades once inflation moves up to ‘undesired’ levels. Monetary policy tightens as gleaned from spending falling away from trend.
The next chart is more ‘explicit’.
But according to the Riksbank it was all due to “weakness abroad”! So, ‘welcome to deflationary hell’!
Update: In the comment section James in London mentions House Price Indices (HPI) in the two countries. Below the HPI charts;
HT: James in London