Despite model weaknesses and unlimited modification possibilities, the empirical analysis reached some key conclusions. In the comparison of the actual official bank rate and the Taylor 1993 rate, it became clear that Denmark’s monetary policy has gone through different phases and been advanced over the years, most likely due to enhanced insights of important dynamics. Most
101 interesting was the observation of how the alignment between the rates differed. At certain periods, there were detected significant deviations, which were also identified in the estimated housing price models. These periods are argued to be reflections of country-specific shocks, as the Taylor rate can be defined as an interest rate that expresses the Danish business cycle. Hence, it provides evidence of how the rate could have developed if its determination was based solely on Danish circumstances, though perceived through a backward-looking perspective. Due to the fixed-exchange-rate system, the actual official bank rate is indirectly an expression for the ECB's official bank rate and thus the euro area's market conditions. Significant and prolonged deviations between these rates can, therefore, be seen as arguments against Denmark's commitment to the fixed-exchange-rate model. Stated simply, when ECB and thereby the central bank in Denmark, pronounce a higher interest rate level than the actual Danish economic conditions request, the economy forcedly slows down and growth is restrained. In relation to the housing market, this would imply in simple terms that it becomes more expensive to finance mortgage loans than the actual Danish economy would suggest, which in turn pushes the prices for housing down. This was evident in 1992 when the market observed interest rate reached its maximum, whereas the Taylor predicted bank rate was negative. This caused an unnatural downward sloping trend in housing prices, as seen in the modified housing price model in figure 17. Conversely, when a lower interest rate than the economy needs is imposed forcedly, the effect can be described as adding fuel to the fire, where economic factors are continuously pushed towards their breaking points. This can lead to an unnatural rise in housing prices. It can be speculated, whether this is where today’s economic situation is headed.
At the end of this thesis’ considered period, the official bank rate was reported at -0.65 %. Throughout 2015 it was even lower at -0.75 %, which denotes the minimum-level observed over the entire period.
This is a direct consequence of the financial crisis and the ongoing European sovereign debt crisis.
A review of figure 4 in section 2.2.4 reveals that a significant gap between the official bank rate and the long-term lending rate appeared in late 2008, which has sustained throughout the estimation period. This provides evidence to the argument that long-term interest rates react more slowly to market changes and do not fall as much under recessions. Although the short-term interest rate consistently follows the official bank rate closely, an enlarged deviation is observed also between these rates from 2008. As a negative official bank rate does not in itself initiate a lower penetration effect on interest rates, the one- and two-years mortgage bond rate is also below zero, starting in 2015. This means that when investors are willing to buy mortgage bonds with negative interest, this money is directly transferred to homeowners holding mortgage loans. The transfer transpires either as a reduced payment obligation or a greater loan instalment. Individuals may thus save money in
102 times of negative interest rates, which makes it attractive to hold loans that include such rates. As these loans have short maturities, many choose a loan with a fixed interest rate over a longer period, as this may be more beneficial in the long run (Nielsen, 2017).
High indebtedness in several euro-member states indicates continuously low growth and inflation going forward. Despite the turning trend in the official bank rate seen in the plot as of 2016, a low interest rate level is expected to continue for an extensive period. Nevertheless, it seems like the most critical point has been passed as an upward trend is observed in GDP-related factors in Europe and the overall improvement is on hold primarily due to a stagnant inflation rate ("Interest Rate in Eurozone", 2018). In Denmark, economists claimed in the transitional months between 2017 and 2018 that the country was in the beginning phase of an economic upswing, only withheld a restricted labour force (Batchelor, 2017 and Juel, 2018). A prolonged period of low interest level in Europe can become problematic for Denmark if this develops into a substantial cyclical upturn in the shorter run, in light of the fixed-exchange-rate policy. This matter is reflected in the predictions of the Taylor rule, where the situation at the end of the estimation period is described somewhat contradictory to that of the actual rates. This is impacted by the bias that stems from the application of the HP filtering method. Nevertheless, it seems reasonable to assume that an interest rate that was solely determined by Denmark’s business cycle would suggest a faster upswing when taking into consideration the country’s economic situation relative to the majority of euro-member states. If the future deviation between the performance of the actual official bank rate and the Taylor-predicted rate gets severe, it can be seen as an argument against Denmark’s fixed-exchange-rate system as an unnaturally low interest rate will lead to unsustainable pressure on the domestic economy.
Besides, pegging a currency to another can be expensive, and the currency might become a target for speculators (Amadeo, 2018). On the other side, there are several positive sides of a fixed-exchange-rate system for a small economy like Denmark. One of the positive effects is that Denmark indirectly secures stable prices through ECB’s low inflation goal and the fixed-exchange-rate system additionally ensures currency stability, which makes Denmark’s businesses more attractive to foreign investors. Furthermore, although there were predicted significant deviations between the Taylor rate and the actual rate prior to 1999, this thesis does not perceive the Danish arrangement of a fixed currency as critically threatened. The deviations are considered partly related to other factors not specific for Denmark, and they might suggest that during the estimation period, the concern of asymmetric shocks was not of high relevance for Denmark (Ravn, 2012, p. 23).
Additionally, the alignment has proved well after the euro was introduced. This conclusion, however, depends on the development of today’s market tensions.
103 Expectations of a continuously low official bank rate in the forthcoming future have significant implications for the housing market. Low interest rates and hence loans, motivate rising housing prices. The historically minimum-level for interest rates that have been present the last years indicates that it has never been cheaper for individuals to finance one square meter despite the high housing prices. The expected future price increase will probably not reach 2015- and 2016-growth levels but will be noticeable. In addition to low interest rate, the increase will possibly be impacted by improvement in employment, which will lead to higher incomes and enhanced purchasing power (Dengsøe, 2016). The Ministry for Economic Affairs and the Interior has predicted that the development in interest rates and disposable income will increase the housing prices in Denmark by 2-2.5 % yearly until 2020 (OIM, 2013). This statement is also supported by the Danish Construction Association. Additionally, high housing optimism in relation to consumer confidence is expected to contribute to the upsurge. In light of the predicted Taylor rate, the housing price increase would possibly have become less prominent, and the market would most likely have turned at an earlier point than what is anticipated for the actual market situation. However, market trends and particularly interest rates are hard to predict. Both the short-term interest rate and the long-term rate have for several years, been forecasted to increase (Berlingske Business, 2017). However, the rates are still at an ever-lasting low level, implicating that these allegations should be viewed as speculations rather than factual conclusions.
An important aspect to enlighten in the discussion of monetary market dynamics is that central banks conduct their monetary policy using other instruments in addition to interest rates. The impact of such instruments is, however, disregarded in this thesis, with the aim of supplying an easily interpretable analysis with clear conclusions. This can arguably be said to contribute to a somewhat simplified representation of monetary market dynamics. For instance, in light of recent years’
economic conditions with exceptionally low interest rates, unconventional monetary policy tools have been adopted by central banks to mitigate the extraordinary market situations. One such tool is Quantitative easing (QE) methods, where central banks create more money by purchasing securities in the market. The money supply is enlarged by overflowing financial institutions with capital, with the aim of encouraging increased liquidity and lending (Spange et al., 2017, p. 2). However, QE does not involve the printing of new banknotes. ECB has introduced the QE policy strategy. Taking this, and the impact of other monetary policy instruments than the interest rate into consideration, the interpretation of today’s market conditions become more complex but possibly also more reasonable.
This statement additionally accounts for the housing market. Nevertheless, this complexity is out of
104 scope for this thesis, which is why the implications of the assumption affecting this are mentioned but not elaborated on further.