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On top of the tax cuts implemented at the beginning of 2004, the government recently announced further measures to boost activity. Although this extra easing is relatively small, it risks coinciding with new interest rate cuts and already accelerating output. Some of this stimulus will therefore need to be removed as the expansion gathers steam. Further initiatives to raise labour force participation would help to sustain the upturn and bring employment closer to the government's long-term target.
Increasing household spending signals recovery
Activity slowed last year as businesses reduced investment and exports were restrained by a steady appreciation of the krone vis-a-vis non-euro currencies. However, private consumption picked up strongly in the fourth quarter, which also saw solid private sector investment and renewed growth in exports. The pick-up in household spending probably came in anticipation of the previously-announced tax cuts for 2004, and rising consumer confidence points to sustained high spending. The steady worsening of labour market conditions last year has brought the standardised unemployment rate up to 6 per cent, more than 1 percentage point above its estimated structural level, and the weak labour market has led to a moderation of wage increases in the private sector. Consumer price inflation has also fallen markedly recently, partly because of one-off factors and a reduction in excise duties, but also reflecting the lower underlying inflation, which has followed from the negative output gap.
Fiscal policy is boosting household income ...
Despite indications that a recovery is getting under way, the government has recently proposed various measures to boost household incomes and consumption, including advancing to 2004 the additional tax cuts that were to be phased in over 2005-07 and suspending the compulsory Special Pension contributions this year and next. Other government proposals include bringing forward public investments to 2004 and further encouraging housing investment. Even so, a general government surplus of around 1 per cent of GDP is projected this year and next, which however implies a reduction of the primary structural surplus given projected growth in excess of potential and sharp declines in interest payments. One risk to public finances is the prospect of amalgamations of local governments that could involve significant adjustment costs over coming years.
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... along with an easing of monetary policy
Monetary conditions continue to follow euro area developments, with a cut in interest rates projected in the short term followed by a gradual tightening in 2005. European Central Bank interest rates, to which Danish interest rates are aligned, will probably be better suited for the Danish economy than previously expected, as the output gap has widened and now more closely resembles that of the euro area.
Growth should accelerate in 2004 and 2005 ...
With accommodative fiscal and monetary settings, output is projected to increase by around 2 per cent in 2004 and 2 1/2 per cent in 2005. The growth of private consumption is likely to pick up in the second half of 2004 as households react to the fiscal package, and a rebound of exports due to recovering foreign demand may also add to increased activity this year. Developments in household spending and exports should continue to be strong in 2005, while business investment may provide further underpinning of growth. The unemployment rate is projected to fall back as the business sector starts to increase hiring during 2004, but wage and price increases should be moderate throughout the projection period as output remains below its potential level.
... although this is highly dependent on household behaviour
The main source of uncertainty is the reaction of households to the policy stimulus, especially the degree to which they turn to other tax-deductible pension schemes as substitutes for the Special Pension contributions. The strength of the European recovery and exchange rate developments constitute further risks to the outlook through their effect on exports.
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