Denmark’s Fixed Exchange Rate

The Danish Krone (DKK) is the currency of Denmark. Denmark has a fixed exchange rate. Fixed exchange rate refers to an exchange rate that is fixed by the central bank of a country, and is not permitted to change in response to changes in currency supply and demand. There are several ways countries maintain a fixed exchange rate and the purest form is when its currency is pegged to set the value to a single currency. In the case of Danish Krone, it is pegged to Euro, with 7.45: 1 (DKK: EUR), with a fluctuation band of +/- 2.25 per cent.

In October 1982, Denmark decided that it would tie its fate to West Germany, which is its biggest trading partner, by adopting a fixed exchange rate for the crown against the German mark to secure its economic future. And now, as German is using euro currency instead of the German mark, the Denmark currency is fixed to euro instead of the US dollar.

In Denmark, exchange rates are fixed by the central bank and this requires constant intervention by the central bank or the government of Denmark. This intervention takes the form of buying and selling currencies by the central bank, as well as making other adjustments in the domestic economy, to shift the demand or supply curves for the currency to eliminate disequilibrium in the foreign exchange market. As shown in the diagram, suppose that demand for Danish Krone increases from D1 to D2, causing the exchange rate to increase from 7.45 DKK: 1 EUR to 8 DKK: 1 EUR, point A to point B. The government can either decrease the demand or increase the supply of Danish Pronto make the equilibrium back to the level of 7.45, point C.

Krone fixed against the EUR

In periods when the foreign-exchange market is calm, Denmark’s Nationalbank usually changes its interest rates in step with the monetary-policy interests of the ECB (European Central Bank). In situations with upward or downward pressure on the krone, Danmarks Nationalbank unilaterally changes its interest rates in order to stabilize the krone. In the short term, Danmarks Nationalbank may also influence the exchange rate of the krone by intervening, i.e. buying and selling foreign exchange in the market.

There are several advantages and disadvantages to having a fixed exchange rate. The advantages are first, a fixed exchange rate provides currency stability. This allows for more certainty in the exchange rate, which can attract foreign direct investments. Secondly, Denmark can avoid inflation if it fixes its currency to a currency of a country with a strong economy like the euro. As the European Union grows, its currency does as well. Moreover, more certainty also means that there are lower risks in international trade by agreeing to the fixed price of products. This is also beneficial for importers and exporters as there are fewer chances for speculation. Also, by maintaining a fixed exchange rate, domestic organization and employees can maintain their costs under control to cope up in the international market, lead to inflation in under control. By maintaining this to the long run, the interest rate should be down and increase trade and investment opportunities, which are beneficial for domestic markets and employees. Furthermore, this also leads to a more stable economy. Denmark can reduce the speculation to reduce the risk of destabilizing economy when the exchange rate is fixed.

While a fixed exchange rate can benefit Denmark’s economy in some way, there is also some disadvantage of having a fixed exchange rate system. Firstly, a fixed exchange rate can be expensive to maintain. In order to maintain the fixed exchange rate, Denmark’s government have to have large amount of foreign reserves require, and it will lead to opportunity costs to have these reserves. Other than this, as the needs of fixed exchange rate are dominating policy, sometimes it may not good for the economy. This is because the exchange rate is maintained by interest rates and reserves, which means the government cannot use monetary policy to achieve macroeconomic objectives such as unemployment and inflation.

In conclusion, a currency peg decision of Krone to Euro certainly brings both pros and cons to Denmark’s economy. However, in my opinion, pegging towards euro is beneficial and outweighs the potential drawbacks because this allows them to gain higher stability for their currency and attract more investments into Denmark. Also, it allows them to be more beneficial in international trade and it is also good for their domestic businesses.

 

Links to refer to:

http://www.nationalbanken.dk/en/monetarypolicy/implementation/Pages/Default.aspx

https://www.nytimes.com/2015/02/13/business/international/concern-in-denmark-as-its-currencys-peg-to-the-euro-is-strained.html

https://www.thebalance.com/fixed-exchange-rate-definition-pros-cons-examples-3306257

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