Bank of Finland Bulletin 4/2011 Monetary policy and the global economy

1. Bank of Finland Bulletin 4/2011Monetary policy and the global economy Governor Erkki Liikanen 19 September 2011

2. Themes • Global economic outlook weakened • Bank of Finland growth forecast for world economy revised downwards • Risks of even weaker developments heightened • New phase in sovereign debt crisis • Countries’ own measures necessary but no longer sufficient • Confidence in financial institutions weakened • Demand for central bank credit increased again • Addressing uncertainty is pivotal

3. Global economic outlook weakened:forecast backround

4. Market expectations of growth weakened

5. Safe haven cosiderations also important Safe haven instruments Risky instruments

6. Confidence indicators weakened Manufacturing, spring Consumers, end of summer

7. New phase in sovereign debt crisis • Previously concerned only individual countries • Greece, Ireland, Portugal • Problems in all major developed economic areas • Annual deficits elsewhere even greater than in the euro area • Confidence weakened broadly during summer • US debt ceiling negotiations • European crisis management systems

8. Phases of the sovereign debt crisis

9. Global economic outlook weakened:Bank of Finland forecast

10. What are the consequences of the confidence crisis for global economic growth? • Market indicator changes comparable to situation at end of spring 2010, some comparable even to the previous crisis • Uncertainty is already reflected in real economy • The longer uncertainty prevails, the greater the implications

11. Channels for spread of crisis of confidence to real economy • Uncertainty leads to defensive behaviour • More saving, consumption and investment both suffer • Global interdependencies increase the repercussions • Financing more costly and harder to get • Equity finance more costly • Longer-term debt finance also more costly • Investments not made on the basis of bank loans • Market-indicator-based probability of European banking crisis has risen • At worst, rumours become self-fulfilling

12. GDP in major economic areas

13. Bank of Finland forecast for world economy

14. Risks to the forecast on the downside • Forecast assumption: weakening of confidence comes to a halt • Heightened risk aversion fades • If this not possible, the worst scenario: • New global economic recession • Broad-based banking crisis • Factors affecting the severity of downside outcome + Corporate sector and bank balance sheets mainly satisfactory + Central bank liquidity windows are available • Economic policy room for maneuvre limited • Confidence in decision making under strain

15. Confidence in financial institutions weakened

16. Majority of European banks passed the stress test 5% threshold Source: EBA.

17. However, banks have medium- and long-term funding falling due

18. Sovereign debt crisis is reflected in thebanking sector

19. Spreads between secured and unsecured interest rates in the euro area have increased again

20. Excess deposits become the thermometer of the financial crisis

21. Eurosystem policy rate and money market rates

22. What if markets demand larger capital buffers for banks?

23. What if markets demand larger capital buffers for banks? 8% threshold Source: EBA.

24. Summary: How to get out of the crisis?

25. How to get out of the crisis? • Debt crisis in a new phase • No longer a problem of individual countries • Threat of a new global recession is real • Capitalisation of financial institutions • Confidence in financial institutions weakened • Capitalisation the most effective way to restore confidence • Primarily a task of shareholders • Addressing uncertainty is pivotal • Increased loss of confidence in Europe’s ability to handle the crisis • Concrete measures essential • Implementation of July 21 decisions crucial

26. Thank you!