Julkinen Monetary Policy and the Global Economy Governor Erkki Liikanen Bank of Finland Bulletin 4/

Julkinen Monetary policy and the global economy: a time for decisive action I.Monetary policy has been further relaxed - Economic growth weakened during the summer - Volatility in inflation expectations II.Forecast for the global economy and risks - Geopolitical risks have hit the headlines - Risk: limited leeway for economic policy III. Economic policy facing big questions - Monetary policy alone cannot resolve the crisis - Economic policy challenges will persist even if the financial crisis ends Bank of Finland Bulletin 4/2014 2

Julkinen I. Monetary policy has been further relaxed Bank of Finland Bulletin 4/2014 3

Julkinen Monetary policy decisions of the Governing Council of the ECB In June the Governing Council decided on a sizeable combination of monetary policy measures The package was complemented and reinforced in September Underlying the decisions: –Low levels of actual inflation –A slight downward volatility in inflation expectations –Weak economic performance and a subdued outlook for growth Bank of Finland Bulletin 4/2014 4

Julkinen Five monetary policy decisions in June Interest rate and liquidity policy measures: 1.ECB policy rates were lowered 2.Sterilisation of liquidity injected via SMP purchases was suspended 3.Full allotment liquidity policy to be continued until the end of 2016 Measures to enhance monetary policy transmission: 4.Supporting bank lending with new targeted longer-term refinancing operations (TLTROs) 5.Intensifying preparatory work related to outright purchases of asset-backed securities Bank of Finland Bulletin 4/

Julkinen Supplementary and additional monetary policy measures in September Measures relating to interest rate policy: 1.ECB interest rates decreased to historic lows Measures enhancing the functioning of the monetary policy transmission mechanism: 2.Asset-backed securities purchase programme (ABSPP) 3.Covered bond purchase programme (CBPP3) Expands, relative to the June decisions, the range of private sector assets that can be purchased. Bank of Finland Bulletin 4/

Julkinen Package of June and September decisions Measures –to bring down interest rates and generally ease financial conditions –to support financial intermediation –to safeguard the maintenance of price stability in the euro area Policy rates lowered to the zero bound Eurosystem balance sheet will grow significantly –A series of fixed-rate targeted longer-term refinancing operations (TLTROs), aimed at non-financial corporations, in particular, will commence in September. –Purchases of ABSs and covered bonds will commence in October. Bank of Finland Bulletin 4/

Julkinen Interes rate cuts bring money market interest rates to an unprecedented low Bank of Finland Bulletin 4/2014 8

Julkinen Differences in interest rate expectations and in long-term interest rates widened; euro exchange rate weakened Bank of Finland Bulletin 4/ Market expectations regarding US short-term interest rate 1 to 2 years ahead Market expectations regarding euro area short- term interest rate 1 to 2 years ahead Euro depreciated against US dollar and an average of a broad range of currencies

Julkinen Balance sheet effects in part the outcome of bank measures, in part due to outright purchases Bank of Finland Bulletin 4/

Julkinen Determination to take additional measures, if necessary ‘Should it become necessary to further address risks of too prolonged a period of low inflation, the Governing Council is unanimous in its commitment to using additional unconventional instruments within its mandate.’ Governing Council of the ECB, 4 September Bank of Finland Bulletin 4/

Julkinen II. Forecast for the global economy and risks 12 Bank of Finland Bulletin 4/

Julkinen Economic crisis escalated six years ago Bank of Finland Bulletin 4/

Julkinen Central banks’ measures in the crisis: interim statement How have our experiences from past crises helped? Aggressive interest rate cuts, partly joint measures Ensuring adequate liquidity Introduction of non-standard instruments What has differed from historical experience? This has already been fixed: –Banks’ capital and liquidity requirements, banking union This work is still in progress: –‘Too big to fail’: banking sector structural reform Bank of Finland Bulletin 4/

Julkinen Euro area has experienced a double-dip recession: GDP Bank of Finland Bulletin 4/

Julkinen Euro area has experienced a double-dip recession: private non-residential investment Bank of Finland Bulletin 4/

Julkinen Euro area has experienced a double-dip recession: unemployment rate Bank of Finland Bulletin 4/

Julkinen Differences in fiscal policy consolidation smaller than thought… Bank of Finland Bulletin 4/

Julkinen Differences in fiscal policy consolidation smaller than thought… Bank of Finland Bulletin 4/

Julkinen … as the crisis spread to the euro area via the overall level of interest rate Bank of Finland Bulletin 4/

Julkinen … as the crisis spread to the euro area via the overall level of interest rate Bank of Finland Bulletin 4/

Julkinen Fiscal policy stance and outlook Stability and growth pact serving as an anchor of confidence –European Council announced that it will respect the pact –Commission will report on the application of the EU governance framework in December Major fiscal consolidation measures already in place –Negative growth impact will recede over the forecast horizon Juncker: EU-level investment package of EUR 300 billion –Three-year plan on a scale of 1% of GDP per year –Growth, employment, competitiveness Bank of Finland Bulletin 4/

Julkinen Bank of Finland forecast: GDP Bank of Finland Bulletin 4/

Julkinen Bank of Finland forecast: inflation Bank of Finland Bulletin 4/

Julkinen Risk assessment: outlook overshadowed by conflicts Serious crises in Europe and its environs –North Africa and Middle East –Ukraine and Russia Of key importance: human suffering –Areas’ share of world GDP relatively small –But not everything can be measured only in terms of GDP The question that is on everyone’s mind: –How much will uncertainty hamper growth? => Risk calculations for the euro area and Finland 25 Bank of Finland Bulletin 4/

Julkinen III. Economic policy facing big questions 26 Bank of Finland Bulletin 4/

Julkinen Growth has been subdued, with forecasts promising no strong recovery Questions raised in international debate: 1.Have the long-term growth prospects for advanced economies weakened? 2.Are the growth prospects for the economy so weak and inflation expectations so low that the zero lower bound prevents the conduct of a sufficiently accommodative monetary policy? 27 Bank of Finland Bulletin 4/

Julkinen Is GDP growth on a permanent downward trajectory? Bank of Finland Bulletin 4/

Julkinen Factors underlying slow growth Cyclical factors (temporary): -Temporary fluctuations in demand -Accumulation and reduction of debt Structural (permanent): -Functioning of the markets -Declining size of working-age population -Low level of investment -Productivity growth 29 Bank of Finland Bulletin 4/

Julkinen How high can debt ratios climb? Bank of Finland Bulletin 4/

Julkinen Real interest rates have fallen ever since the 1980s Bank of Finland Bulletin 4/

Julkinen Economic Structures in 2008 and the impact of the crisis on GDP Bank of Finland Bulletin 4/

Julkinen Summary 33 Bank of Finland Bulletin 4/

Julkinen Summary: factors supporting euro area recovery Monetary policy exceptionally accommodative Credit supply improved Euro depreciated in recent months Employment situation grown gradually better Fiscal policy no longer tightening Commodity prices lower than before Global economy recovering 34 Bank of Finland Bulletin 4/

Julkinen Summary Monetary policy and the global economy I. A sizeable package of monetary policy measures formulated by the Governing Council of the ECB - Reductions in interest rates - Supporting financial intermediation - Safeguarding price stability II.Situation in the global economy deteriorated in the summer - Geopolitical risks hit the headlines - Limited leeway for economic policy III.Monetary policy alone cannot resolve the crisis - All economic policy segments are needed - Monetary policy, fiscal policy, structural policy Bank of Finland Bulletin 4/

Julkinen Risk assessment Impact of uncertainty on economic growth 36 Bank of Finland Bulletin 4/

Julkinen Risk assessment: impact of uncertainty on the economy Channels through which uncertainty affects the economy: –Postponement of investment decisions (corporations) –Contingency saving (households) –Higher risk premia (corporations, households and the public sector) Measurement of uncertainty –VSTOXX (implied volatility of stock prices) –CISS (widespread uncertainty on the financial markets) –Economic policy uncertainty indices, statistical surprises Bank of Finland Bulletin 4/

Julkinen Risk assessment: measurement of uncertainty Bank of Finland Bulletin 4/

Julkinen Risk assessment: impact on euro area GDP Bank of Finland Bulletin 4/

Julkinen Risk assessment: impact on Finland’s GDP Bank of Finland Bulletin 4/

Julkinen Bank of Finland forecast for the global economy GDP e2015e2016e United States2,22,13,1 2,83,1 EU210,01,11,61,9 1,41,61,7 Japan1,51,11,2 1,31,21,1 China7,77,0 6,0 7,0 6,0 Russia1,30,00,51,5 0,51,02,0 World3,13,23,7 3,53,7 World trade3,23,95,15,4 4,85,45,5 % change from previous year. Previous forecast underneath. EU21 = Euro area, Sweden, Denmark and United Kingdom Bank of Finland Bulletin 4/

Julkinen Thank you! 42 Bank of Finland Bulletin 4/