1. SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND Bank of Finland Bulletin 1/2013 Monetary policy and the global economy Governor Erkki Liikanen 14 March 2013 Erkki Liikanen14.3.2013 1

2. SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND 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) 14.3.2013 2 Erkki Liikanen

3. SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND 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 14.3.2013 3 Erkki Liikanen

4. SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND Near-term outlook for the global economy subdued 14.3.2013 4 Erkki Liikanen

5. SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND Advanced economies released weak output data for late 2012 14.3.2013 5 Erkki Liikanen

6. SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND Stock prices rising since summer 2012, divergent performance since February 2013 14.3.2013Erkki Liikanen 6

7. SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND Government bond yields dropped in 2012, divergent performance in 2013 14.3.2013Erkki Liikanen 7

8. SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND Market confidence in Ireland and Portugal strengthened in 2012 14.3.2013Erkki Liikanen 8

9. SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND Rising confidence in the engines of global trade… 14.3.2013Erkki Liikanen 9

10. SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND … but major regional differences remain 14.3.2013Erkki Liikanen 10

11. SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND Differences also reflected in position of households Consumer confidenceUnemployment rates 14.3.2013Erkki Liikanen 11

12. SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND 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. 14.3.2013 12 Erkki Liikanen

13. SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND Bank of Finland forecast: GDP in main economic regions 14.3.2013 13 Erkki Liikanen

14. SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND Bank of Finland forecast: Inflation in main advanced economic regions 14.3.2013 14 Erkki Liikanen

15. SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND 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 14.3.2013 15 Erkki Liikanen

16. SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND Monetary policy remains accommodative 14.3.2013 16 Erkki Liikanen

17. SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND Monetary policy focus on non-standard measures 14.3.2013 17 Erkki Liikanen

18. SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND Eurosystem policy rate and short market rates remain extremely low 14.3.2013 18 Erkki Liikanen

19. SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND Bank funding getting easier since last autumn 14.3.2013 19 Erkki Liikanen

20. SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND Interest rates on new housing loans declined… 14.3.2013 20 Erkki Liikanen

21. SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND … but interest on corporate loans in GIIPS countries still high 14.3.2013 21 Erkki Liikanen

22. SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND Deleveraging is a slow process 14.3.2013 22 Erkki Liikanen

23. SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND High aggregate indebtedness hampers growth in several EU countries 14.3.2013 23 Erkki Liikanen

24. SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND 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. 14.3.2013 24 Erkki Liikanen

25. SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND Deleveraging still at an early stage 14.3.2013 25 Erkki Liikanen

26. SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND Current account deficits being reduced 14.3.2013 26 Erkki Liikanen

27. SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND Structural unemployment cannot be tackled with monetary policy; large regional differences Structural unemployment Unemployment rate below estimated structural unemployment rate Cyclical unemployment 14.3.2013 27 Erkki Liikanen

28. SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND Housing markets key to household finances 14.3.2013 28 Erkki Liikanen

29. SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND Many GIIPS countries show improvements in competitiveness… 14.3.2013 29 Erkki Liikanen

30. SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND … with higher exports than in 2008 14.3.2013 30 Erkki Liikanen

31. SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND Public debt no longer available as engine for growth 14.3.2013 31 Erkki Liikanen

32. SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND 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… 14.3.2013 32 Erkki Liikanen

33. SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND 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. 14.3.2013 33 Erkki Liikanen

34. SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND In conclusion 14.3.2013 34 Erkki Liikanen

35. SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND 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 14.3.2013 35 Erkki Liikanen

36. SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND Thank you! 14.3.2013 36 Erkki Liikanen