NAUG: FACTORS BEHIND MOVEMENTS IN THE KRONE EXCHANGE RATE – AN EMPIRICAL ANALYSIS 115 Chapter 7 – Factors behind movements in the krone exchange rate – an empirical analysis1

The effective krone exchange rate appreciated considerably from May 2000 to January 2003. This article analyses factors behind the appreciation using an estimated model of the krone exchange rate (trade-weighted exchange rate index) based on monthly data. We find that the appreciation is related to (i) a strong rise in the interest differential against other countries from spring 2000 to November 2002 and (b) the fact that this differential was positive and high throughout the entire appreciation period. The wider interest differential may explain around 40 per cent of the appreciation from May 2000 to January 2003. The positive interest differential caused the krone to strengthen as a result of the fall in international stock markets and expectations of lower fluctuations between the major currencies. This effect may explain more than half of the appreciation. The appreciation in 2002 is also related to the sharp in-crease in the oil price and the krone’s status as a safe-haven currency during the unrest in the Middle East. Changes in the interest differential have the largest effect on the krone when share prices have fallen sharply over a six-month period and when only narrow fluctuations are expected between the major currencies. In such a situation, investors are cautious and sceptical of the possibility of achieving (substantial) capital gains in the stock and currenc