and outlook: Denmark is recovering from a deep recession. A housing market correction and domestic banking crisis exacerbated the impact of the global financial crisis. A strong policy response helped stabilize the banking system and soften the impact of the negative shocks. Supported by continued strong public consumption growth and booming exports, output is projected to expand by around 2½ percent this year. Context of past surveillance: Staff welcomed the authorities' initial response to

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... dual crisis in late 2008, and anticipated that large automatic stabilizers would be sufficient to cushion the resulting downturn. In the end, as the contraction continued to deepen, substantial additional fiscal stimulus was provided. Key challenges identified during the consultation: The focus of policies needs to shift from short-term concerns to putting growth on a steady and sustainable path while further reducing vulnerabilities. Bringing fiscal policy gradually back to a trajectory ensuring credibility of the peg and sustainability will be essential. Continued efforts to strengthen financial sector regulation and supervision, including in response to supranational initiatives, are another priority. Better allocation of resources should help address the sluggish labor productivity growth challenge. Authorities' reaction: The authorities broadly agreed with the mission's analysis of the key policy challenges facing Denmark and its recommendations. Referring to recent welfare and tax reforms, they were less concerned than staff about negative incentive effects from revenue hikes in their consolidation program. There were also some differences in emphasis among the priorities for further financial sector regulatory and supervisory reforms. The mission: Consultation discussions were held in Copenhagen during October 22-November 1, 2010. The staff team-Mr. De Broeck (Head), Ms. Babihuga, Mr. Mehrez and Mr. Ross (all EUR)-met with the Chairman of the Board of Governors of Danmarks Nationalbank; Deputy Permanent Secretaries of the Ministry of Finance; the Deputy Director General of the Danish Financial Supervisory Authority; and other senior officials. The mission also met with representatives of trade unions and business associations, and financial institutions. Contents Page I. Background .