Bank of Finland Bulletin 1/2013 Monetary policy and the global economy

1. Bank of Finland Bulletin 1/2013Monetary policy and the global economy Governor Erkki Liikanen 14 March 2013 Erkki Liikanen

2. Monetary policy and the global economy • Main article: • Reducing private sector indebtedness, balance sheet adjustment • Balance sheet adjustment will have long-term effects on growth prospects, monetary policy and fiscal policy • Feature articles: • The financial crisis sparked debate on the goals of monetary policy (Jarmo Kontulainen, Juha Kilponen and Antti Suvanto) • A model of the international monetary and financial economy (Mika Kortelainen) • Global energy markets at a turning point (Laura Solanko and Lauri Vilmi) Erkki Liikanen

3. Themes of the presentation • Near-term outlook for the global economy subdued • Recession in Europe more protracted than earlier foreseen • Signs of recovery particularly in the United States and China • Monetary policy remains accommodative • Uneven monetary policy transmission poses a problem in the euro area • Low interest rates facilitate debt servicing, but cannot solve the balance sheet problem • Deleveraging is a slow process • In the United States, household debt adjustment took five years • Debt adjustment only beginning in some crisis countries Erkki Liikanen

4. Near-term outlook for the global economy subdued Erkki Liikanen

5. Advanced economies released weak output data for late 2012 Erkki Liikanen

6. Stock prices rising since summer 2012, divergent performance since February 2013 Erkki Liikanen

7. Government bond yields dropped in 2012, divergent performance in 2013 Erkki Liikanen

8. Market confidence in Ireland and Portugal strengthened in 2012 Erkki Liikanen

9. Rising confidence in the engines of global trade… Erkki Liikanen

10. … but major regional differences remain Erkki Liikanen

11. Differences also reflected in position of households Consumer confidence Unemployment rates Erkki Liikanen

12. Background to the Bank of Finland forecast • Confidence increased in second half of 2012 • OMT programme bolstered functioning of the markets • EU-level decisions: ESM, single banking supervision and resolution • Member States carried through their fiscal and structural policy programmes • Forecast assumption: confidence will continue to improve • Consolidation programmes progressing as planned • Beginning to show in costs and intermediation of funding for crisis countries • Deleveraging of high levels of debt will be a slow process • Private sector balance sheet adjustment will subdue growth. • Fiscal policy will remain fairly tight. Erkki Liikanen

13. Bank of Finland forecast:GDP in main economic regions Erkki Liikanen

14. Bank of Finland forecast:Inflation in main advanced economic regions Erkki Liikanen

15. Forecast risks mainly on the downside • Debt crisis still largest single risk to growth • Successful completion of consolidation programmes important • Loss of confidence pushes up market rates • Risk calculation: domestic demand suffers, GDP and inflation ease back • US growth could recover faster than forecast • Private sector balance sheet adjustment progressing • As confidence returns, activity could reactivate quickly • Would bolster growth in Europe and Asia, push up commodity prices Erkki Liikanen

16. Monetary policy remains accommodative Erkki Liikanen

17. Monetary policy focus on non-standard measures Erkki Liikanen

18. Eurosystem policy rate and short market rates remain extremely low Erkki Liikanen

19. Bank funding getting easier since last autumn Erkki Liikanen

20. Interest rates on new housing loans declined… Erkki Liikanen

21. … but interest on corporate loans in GIIPS countries still high Erkki Liikanen

22. Deleveraging is a slow process Erkki Liikanen

23. High aggregate indebtedness hampers growth in several EU countries Erkki Liikanen

24. Vicious circle of weak economic activity and tight financing conditions in the euro area • Prerequisites for economic growth • Healthier banking sector • Reversal of housing market trend in a number of countries • Essential adjustment of private sector indebtedness to a lower level in several countries • Limited ways to speed up deleveraging in the private sector • Households’ residential loans will only grow smaller gradually. • Bank recapitalisations can enhance balance sheet adjustment in the corporate sector. Erkki Liikanen

25. Deleveraging still at an early stage Erkki Liikanen

26. Current account deficits being reduced Erkki Liikanen

27. Structural unemployment cannot be tackled with monetary policy; large regional differences Cyclicalunemployment Structuralunemployment Unemploymentratebelowestimatedstructuralunemploymentrate Erkki Liikanen

28. Housing markets key to household finances Erkki Liikanen

29. Many GIIPS countries show improvements in competitiveness… Erkki Liikanen

30. … with higher exports than in 2008 Erkki Liikanen

31. Public debt no longer available as engine for growth Erkki Liikanen

32. Fiscal multipliers and economic policy • What are fiscal multipliers? • Impact of fiscal policy on GDP • Today: how much will GDP contract with fiscal tightening? • How are they estimated? • Methods: statistics or macroeconomic models • Time span: how far into the future do we follow the impact? • Economic environment: single-country problem or global crisis? • Lively exchange on fiscal multipliers • IMF opened the discussion in October 2012. • Contributors: IMF, Commission, ECB; Krugman, De Grauwe… Erkki Liikanen

33. Fiscal multipliers and economic policy • Key results of the discussion • Short-term impact can be aggravated by financial crises. • Confidence effects can lower interest rates and lead to smaller fiscal multipliers. • Policy makers must consider a broad range of issues beyond short-term fiscal multipliers. • Accommodative policies must be financed – a paradox of economic policy • Countries with large fiscal multipliers usually cannot afford accommodative policies. • Countries that can often have smaller fiscal multipliers. Erkki Liikanen

34. In conclusion Erkki Liikanen

35. Summary • Euro area monetary policy remains accommodative • Shortest rates still exceptionally low • OMT programme is important pillar in calming the situation • Real economy needs real economy solutions • Monetary policy has its limitations • Government measures vital for sustaining confidence • Deleveraging is a slow process • Will subdue euro area growth in immediate years ahead, risk of a balance sheet recession • Reducing public debt a challenge that must be met Erkki Liikanen

36. Thank you! Erkki Liikanen