Erkki Liikanen

1Unrestricted

Bank of Finland

Finnish economy, monetary policy and financial stability

10 December 2015

10.12.2015

Suomen Pankki – Finlands Bank – Bank of FinlandErkki Liikanen 2Unrestricted

Economy generating less income, spending increasingly financed by borrowing

Five important changes:

10.12.2015

Suomen Pankki – Finlands Bank – Bank of FinlandErkki Liikanen 3Unrestricted

90

92

94

96

98

100

102

2007 2009 2011 2013 2015 2017

GDP per capita GDP per person employedVolume index, 2007 = 100

Sources: Statistics Finland and Bank of Finland.32381

1. Decrease in income generation

10.12.2015

Suomen Pankki – Finlands Bank – Bank of FinlandErkki Liikanen 4Unrestricted

2. Economic dependency ratio weakened

-50 0 50 100 150 200 250

Other

Under-15-year-olds

Employed

Unemployed

Pensioners

Forecast change, 2007–2017, thousand persons

Sources: Finnish Centre for Pensions, Statistics Finland and Bank of Finland.32381

10.12.2015

Suomen Pankki – Finlands Bank – Bank of FinlandErkki Liikanen 5Unrestricted

70

75

80

85

90

95

100

105

110

2007 2009 2011 2013 2015 2017

Private and public consumption Exports Corporate fixed investmentVolume index, 2007 = 100

Sources: Statistics Finland and Bank of Finland.32381

3. Notable decline in exports and investment, increase in consumption

10.12.2015

Suomen Pankki – Finlands Bank – Bank of FinlandErkki Liikanen 6Unrestricted

-3

-2

-1

0

1

2

3

4

70

80

90

100

110

120

130

140

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Current account (right-hand scale)Aggregated household and public sector debt (left-hand scale)

% of GDP

Sources: Statistics Finland and Bank of Finland. 32381

% of GDP

4. Standard of living maintained by continued debt accumulation

10.12.2015

Suomen Pankki – Finlands Bank – Bank of FinlandErkki Liikanen 7Unrestricted

5. Pensions and unemployment benefits erode public services funding

59 %29 %

3 %9 %

55 %32 %

5 %

8 %

2007

2017

Publicly funded services

Pensions

Other currenttransfers

Unemployment-related expenditure

Sources: Statistics Finland and Bank of Finland.32381

10.12.2015

Suomen Pankki – Finlands Bank – Bank of FinlandErkki Liikanen 8Unrestricted

What corrective measures are needed?Will they restore confidence?

10.12.2015

Suomen Pankki – Finlands Bank – Bank of FinlandErkki Liikanen 9Unrestricted

We have to take determined, corrective economic policy measures

Restoration of cost-competitiveness Structural reforms Halt upward trend in public debt Economic recovery also supported by

monetary policy At the same time, macroprudential policy

must mitigate risks arising from protracted period of low interest rates

10.12.2015

Suomen Pankki – Finlands Bank – Bank of FinlandErkki Liikanen 10Unrestricted

1. Improvement in cost-competitiveness supports exports and employment

When cost-competitiveness improves, export businesses with production in Finland can

make profitable offers at a price that translate into contracts;

it pays to invest in production that takes place in Finland;

production and employment grow in export industries; income generation in the economy as a whole

increases, which supports demand and employment in a sustainable manner also in production for the domestic market.

10.12.2015

Suomen Pankki – Finlands Bank – Bank of FinlandErkki Liikanen 11Unrestricted

20

30

40

50

60

70

80

90

100

110

120

1990 1995 2000 2005 2010

Manufacturing ServicesIndex, 2000 = 100

Non-financial corporations’ net operating surplus divided by net vaue addedSource: Statistics Finland. 31563

Profitability of production taking place in Finland has weakened, particularly in manufacturing

10.12.2015

Suomen Pankki – Finlands Bank – Bank of FinlandErkki Liikanen 12Unrestricted

2. Structural reforms

Structural reforms needed to improve growth potential and ensure fiscal sustainability– Pension reform is an important step, but further efforts are needed– New assessment of the long-term sustainability gap in public

finances is 3½%

Lengthening of working careers– From the beginning, middle and end

Conditions for supply of housing

Social and health care reform that improves productivity and curbs expenditure growth

10.12.2015

Suomen Pankki – Finlands Bank – Bank of FinlandErkki Liikanen 13Unrestricted

Structural reforms:Increased competition

Improves productivity and constrains the rise in prices– Advantages to consumers: lower prices, better products– Advantages to the economy: higher productivity, more innovation

Regulatory reforms are key

Removal of barriers to competition often resisted by groups enjoying special benefits– Changes therefore require determination and long-term

commitment from decision-makers.

10.12.2015

Suomen Pankki – Finlands Bank – Bank of FinlandErkki Liikanen 14Unrestricted

3. Fiscal stimulus cannot resolve problems in the export industry

Particularly weak dynamics in exports and export industry investments

Decline in the number of persons employed has affected mainly manufacturing• In the service sector, the number of persons employed has

increased since 2008.

Export production cannot be supported by stimulus measures that sustain domestic demand and fuel public debt• Nevertheless, selected public investments that support private

investment can be beneficial.

10.12.2015

Suomen Pankki – Finlands Bank – Bank of FinlandErkki Liikanen 15Unrestricted

-6 -3 0 3 6 9 12

GreeceRomania

LatviaEstonia

Czech RepublicHungary

LithuaniaItaly

SlovakiaMalta

SloveniaPortugal

SpainIrelandPolandFrance

GermanyAustria

United KingdomBelgium

NetherlandsBulgaria

LuxembourgSweden

DenmarkCyprusFinland

Source: European Commission. 27795

Exceptionally large support from fiscal policy to the general economy in FinlandStructural balance of public finances / GDP, change in 2008–2014, % points

Fiscal policyrelaxed ← │→ tightened

10.12.2015

Suomen Pankki – Finlands Bank – Bank of FinlandErkki Liikanen 16Unrestricted

Why does the public deficit need to be reduced now?

Accumulation of public debt would be a smaller problem if we could expect a prolonged period of strong economic growth.

Additional debt taken by Finland now must be serviced in future in a situation in which a smaller portion of the population is of working age– and in which a larger portion of the population needs social and

health care services.

Age structure weighs on the outlook for the public finances, aggravated by continued debt accumulation.

10.12.2015

Suomen Pankki – Finlands Bank – Bank of FinlandErkki Liikanen 17Unrestricted

What if public consolidation is postponed far into the future?

If consolidation measures are not fully implemented, the youth of today will have to not only– pay the majority of the pensions as well as

social and health care services for the baby-boomers, but also

– service the debt of the previous generation– and seek work in a situation in which the

problems in the economy are still unresolved.

10.12.2015

Suomen Pankki – Finlands Bank – Bank of FinlandErkki Liikanen 18Unrestricted

How does monetary policy support economic recovery?

10.12.2015

Suomen Pankki – Finlands Bank – Bank of FinlandErkki Liikanen 19Unrestricted

Euro area monetary policy very accomodative

The ECB’s monetary policy measures have already had significant positive effects on financial conditions, credit and the real economy.

Decisions of 3 December 2015 strengthen forward guidance and the asset purchase programme.– Full implementation of all monetary policy measures

secures a sustained adjustment in the path of inflation consistent with price stability

The ECB is willing and able to act, if warranted, by using all the instruments available within its mandate.

10.12.2015

Suomen Pankki – Finlands Bank – Bank of FinlandErkki Liikanen 20Unrestricted

Monetary policy measures and forward guidance

Monetary policy measures and the Governing Council’s commitment to introduce additional measures, if necessary, keep inflation expectations anchored.

Key decisions of 3 December 2015:

– The asset purchase programme was extended until March 2017, and it was announced that the principal payments on the securities purchased under the programme will be reinvested as they mature.

– The interest rate on the deposit facility was lowered to -0.3%.

– Fixed rate tender procedures with full allotment will be continued until at least the end of 2017.

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Suomen Pankki – Finlands Bank – Bank of FinlandErkki Liikanen 21Unrestricted

0

300

600

900

1200

1500

1800

0

300

600

900

1200

1500

1800

03/2015 09/2015 03/2016 09/2016 03/2017

omaisuusvakuudelliset arvopaperit katetut joukkolainat

julkisen sektorin velkapaperitmrd. EUR

Lähde: Bloomberg

mrd. EUR

Purchases under the expanded asset purchase programme

Asset-backed securities Covered bondsEUR bn

Public sector securities EUR bn

Source: Bloomberg.

10.12.2015

Suomen Pankki – Finlands Bank – Bank of FinlandErkki Liikanen 22Unrestricted

ECB monetary policy and Finland

Accommodative monetary policy also supports the Finnish economy.– The low level of interest rates has been transmitted to loan

interest rates paid by households and non-financial corporations.– Improved potential for exports to euro area

In the years to come, monetary policy will provide an effective stimulus to the economy, if1. measures are implemented to correct current

domestic economic trends2. and the stability of the banking system is safeguarded.

– In this event, accommodative monetary policy will boost investment.

10.12.2015

Suomen Pankki – Finlands Bank – Bank of FinlandErkki Liikanen 23Unrestricted

5. Can low interest rates pose a risk to financial stability?

10.12.2015

Suomen Pankki – Finlands Bank – Bank of FinlandErkki Liikanen 24Unrestricted

Finland must prepare in good time for risks to financial stability

Experiences in many other countries are a warning sign of the risks related to higher house prices and household debt.

Current macroprudential instruments available in Finland are limited.

Risk weights on housing loans should also cover systemic risks related to lending for house purchase.

10.12.2015

Suomen Pankki – Finlands Bank – Bank of FinlandErkki Liikanen 25Unrestricted

Finnish financial system stable, but vulnerabilities remain

Banks have maintained a good level of capital adequacy and profitability in an otherwise weak operating environment.

Finnish financial system and economy vulnerable to housing market shocks– Higher household debt– Low risk weights on housing loans– Importance of housing loans as collateral for covered bonds

The Finnish banking system is among the most concentrated in the euro area, with a significant level of cross-border interconnectedness.

10.12.2015

Suomen Pankki – Finlands Bank – Bank of FinlandErkki Liikanen 26Unrestricted

Short-term risks to financial stability have decreased in the euro area

An expected gradual recovery in the real economy supports financial institutions and markets.

Banking Union and other policy measures have decreased the negative feedback loop between banks and sovereigns.

Banks have strengthened their capital adequacy and profitability.

A high level of nonperforming loans and low level of interest rates burden banks’ balance sheets and profitability.

10.12.2015

Suomen Pankki – Finlands Bank – Bank of FinlandErkki Liikanen 27Unrestricted

Have financing conditions for SMEs tightened in Finland?

Low risk weights on housing loans steer bank lending towards housing loans instead of corporate loans.

In recent years some signs of a slight deterioration in access to finance by SMEs, but financing conditions are still less tight than in many other countries.

1.5

2

2.5

3

3.5

4

4.5

5

2011 2012 2013 2014 2015

Germany Spain Finland France Italy Euro areaNew small corporate loans*, average interest rate, %

*Loan size: EUR 250,000 – EUR 1 million.Source: ECB. patu32193@Chart27 (en)

10.12.2015

Suomen Pankki – Finlands Bank – Bank of FinlandErkki Liikanen 28Unrestricted

Single deposit guarantee scheme planned

Missing part of Banking Union– Already in place: single rulebook, supervision and crisis resolution

If implemented correctly, would increase resilience to crises

– Would weaken the negative feedback loop between banks and sovereigns

Would limit risks to public finances, particularly in countries with banking sector concentration similar to Finland

Essential to examine if Finland’s priorities can be achieved in context of gradual introduction of the scheme, as proposed by the Commission– If conditions imposed on countries are tight

enough and their compliance is monitored

10.12.2015

Suomen Pankki – Finlands Bank – Bank of FinlandErkki Liikanen 29Unrestricted

Thank you!

10.12.2015