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Bank of Finland Bulletin 1/2012Monetary Policy and the Global Economy

Governor

Erkki Liikanen

15 March 2012

15.3.2012 1Erkki Liikanen


Themes

The markets, a cyclical snapshot and the forecast– Market developments and cyclical indicators

– Assumptions and the Bank of Finland forecast for the global economy

– Forecast risks

Major differences within the euro area– Condition of public finances

– Youth unemployment

Recent monetary policy measures– Global monetary policy stance

– Steps taken by the Eurosystem

15.3.2012 Erkki Liikanen 2


Market developments and cyclical indicators



25

30

35

40

45

50

55

60

65

2007 2008 2009 2010 2011 2012

USA Euro area Japan China Brazil

Balance

Source: Bloomberg.25200@PMI_teollisuus (enET)

Purchase Managers' Indices: manufacturing

Major changes in confidence



-40

-35

-30

-25

-20

-15

-10

-5

0

20

30

40

50

60

70

80

90

100

2007 2008 2009 2010 2011 2012

USA Japan Euro area (RHS)

Balance Balance

Sources: European Commission and Bloomberg.25200@Chart87 (enET)

Consumer confidence indicator

Major changes in confidence



40

50

60

70

80

90

100

110

2008 2009 2010 2011 2012

Europe (DJ Euro Stoxx wide) USA (S&P 500)

Japan (Nikkei 225)

Index, 4.1.2008=100

Source: Bloomberg.19002@stocks_main2_en

This is also reflected on the stock markets

Erkki Liikanen15.3.2012 6


Some improvement on the government bond markets

Erkki Liikanen15.3.2012

0

2

4

6

8

10

12

14

16

18

2008 2009 2010 2011 2012

Source: Reuters.

Portugal

Ireland

Italy

Spain

Germany

Finland

25874

10 year government bond yield, %

7


Stabilisation measures

The monetary policy decisions of the ECB-council– e.g. three year LTROs

The EU level decisions made in early December– ’Six-pack’ entered into force on 13th December – ’Fiscal compact’

Decisions taken at national level– The stabilisation programmes in Italy and Spain– Agreement on the 2nd package of Greece



0

1

2

3

4

5

6

2005 2006 2007 2008 2009 2010 2011 2012

ECB Main Refinancing RateInterbank overnight rate Eonia

%

Sources: ECB and Reuters. 25384@Chart27 (en)

ECB liquidity facility rate

ECB overnight deposit facility rate

Cut in policy rate and expansion in central bank credit have relaxed monetary conditions in the

euro area



-2

0

2

4

6

8

10

12

14

16

2007 2008 2009 2010 2011 2012

Euro area Finland

MFI loans to private sector, y/y, %

Sources: European Central Bank and Bank of Finland.

Country specific differences in financial conditions are still large

Euro area Finland

15.3.2012 Erkki Liikanen

25827

-4

-2

0

2

4

6

8

10

12

14

16

2005 2007 2009 2011

Non-financial corporations Households

%

Source: ECB.25840@Chart48 (en)

Yritys- ja kotitalouslainojen vuosikasvu*

10


Six-PackCoordination of Economic Policies

Amendments related to:Sanctions in Stability and Growth Pact Two-PackCorrection of macroeconomic imbalances Budgetary surveillance:Sanctions for macroeconomic imbalances Euro area countries

EDP countriesExcessive Deficit Procedure (EDP) Countries with serious risk

Amendments related to: of financial instabilitySanctions in Stability and Growth PactFiscal framework

Lisbon Treaty

Broad guidelinesfor economic policy

Avoidance ofexcessive deficits

Special rules foreuro area countries

European crisis management framework


Treaty on strengthening of economic policiesMedium-term objective for structural budget deficit

-1/2 % of GDP (main rule, -1% in exceptional cases)Automatic correction mechanism incorporated innational legislations

Assessing excessiveness of deficitsAs the main rule, contracting parties supportCommission proposals

Fiscal Compact

11


Bank of Finland‘s global economy forecast



Assumptions for Bank of Finland’s international forecast

15.3.2012

Multidimensional uncertainty– Economic uncertainty,– Political uncertainty, …

Assumption: action is taken to calm down the crisis– Euro area countries adhere to their promised adjustment

measures in respect of both 1) adjustment of debt levels and 2) strengthening the foundations of growth

– Contributes to public confidence and lower interest rates

Finding a new balance is a slow and gradual process– Restoring credibility and correcting high debt levels take

time

Erkki Liikanen 13


Bank of Finland’s forecast outcomes

15.3.2012

GDP 2010 2011f 2012f 2013f 2014f

United States 3,0 1,7 2,3 2,6 2,5 (1,5) (1,9) (2,6) EU20 1,9 1,5 -0,2 1,0 1,6 (1,6) (0,9) (1,6) Japan 4,5 -0,9 1,4 1,5 1,7 (-0,6) (2,4) (1,3) China 10,4 9,2 8 8 7 (9) (8) (8) Russia 4,3 4,3 3,7 3,7 3,4 (4,4) (4,4) (3,6) World 5,3 3,8 3,2 3,9 3,9 (3,9) (3,6) (4,0) World trade 13,7 6,0 3,5 5,8 6,3 (6,2) (6,1) (7,1)

f = forecast

% change on the previous year (previous forecast in brackets).

Source: Bank of Finland.

Erkki Liikanen 14


Inflation slows during the current year

Inflation Inflation expectations


-4

-2

0

2

4

6

8

10

2007 2008 2009 2010 2011 2012

USA Euro area Japan China Brazil Finland

% change from previous year

Source: National statistical authorities.25200@Kuluttajahinnat (enET)

Consumer prices

1,5

2

2,5

3

3,5

4

2007 2008 2009 2010 2011 2012

Market expectations, euro area Market expectations, United States

SPF-survey, euro area SPF-survey, United States%

Inflation expectations based on 5-year inflaation swaps. 3- day moving averages.SPF-survey 5 years ahead.Sources: Bloomberg, ECB, Fed of Philadelphia and Bank of Finland calculations.25456@ET 2012-1 (en)

5-years inflation expectations 5-years time

15


94

96

98

100

102

104

106

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14

Why is this crisis different:slow recovery from financial crises

Horizontal axis: time since peak in quarters.Vertical axis: median of observations, index: peak = 100.Sources: IMF WEO April 2009, Eurostat, BEA, and Statistics Finland.

Recessions excl. financial crisesRecessions related to financial crises

GDP

USA 2008–Euro area 2008–Finland 2008–

25856

Erkki Liikanen15.3.2012 16


Risks to the forecast mainly on the downside

Recovery from the debt crisis a slow and uneven process – A positive spiral may come to a halt abruptly and unexpectedly

– Reasons: failure in carrying out adjustment programmes, market reactions to weaker-than-expected data releases, …

Euro area countries’ ability to implement reforms of critical importance– How is crisis countries’ external balance adjusted?

– How does the adjustment affect the credibility of the euro area as a whole?

– How far is it necessary to go to find the new balance?

There are also positive risks– Recent developments in the United States



Major internal differences in the euro area



Faster inflation than elsewhere and the resultant low level of real interest rates led to over-indebtedness in GIPS countries


Developments in euro area countries’ consumer prices vis-à-vis Germany, 1999-2011.

95

100

105

110

115

120

125

other EA countries Ireland GreeceSpain Portugal Euro areaGermany

Source: Eurostat

Index, 1999 = 100

25005

19


Fiscal policy faces important challenges

Projected Deficit

Objectives of Stability and Convergence Programmes*

2011 2011 2012 2013

Euro area -4,3 -4,3 -3,1 -2,1

Germany -1,1 -2,5 -1,5 -1,0

France -5,7 -5,7 -4,6 -3,0

Italy -3,9 -3,9 -1,6 0,0

Spain -8,5 -6,0 -4,4 -3,0

UK .. -8,6 -7,8 -6,5

US .. -9,5 -8,0 -6,4

* UK and US figures are IMF projections for deficit.Sources: IMF, European Commission and announcements by countries .



Italy, Spain and France implementing strongest adjustments

2012 2013


Spain34 %

France17 %

Italy28 %

Netherlands10 %

Other euro area

countries11 %

Euro area Fiscal Consolidation -Country Breakdown

Sources: IMF, European Commission, announcements by countries and Bank of Finland calculations.

Spain16 %

France35 %

Italy28 %

Other euro area countries

21 %

Euro area Fiscal Consolidation -Country Breakdown


21


Italy, Spain and France implementing strongest adjustments

2012 2013


Spain29 %

France18 %

Italy30 %

Netherlands10 %


13 %

Euro area Fiscal Consolidation - Country Breakdown


Spain25 %

France31 %

Italy25 %


19 %

Euro area Fiscal Consolidation - Country Breakdown


22


05

101520253035404550

2007

2011

2007

2011

2007

2011

2007

2011

2007

2011

2007

2011

2007

2011

2007

2011

Spain Portugal Ireland Italy Sweden Finland Germany Euro area

%Youth All

Source: Eurostat.

Unemployment and youth unemployment

Large differences in youth unemployment by country



Financial crisis affected different areas in different countries


-18

-15

-12

-9

-6

-3

0

3

6

Ireland Spain Finland Italy France Germany

Change in number of jobsShare of construction sectorShare of industry

Sector specific employment trends

% change

Change calculated between post 2005 employment peak and employment situation in 2011/Q3.Source: Eurostat

24


Recent monetary policy measures



Monetary policy globally accommodative

Central bank interest ratesCentral bank balance sheets

15.3.2012

0

1

2

3

4

5

6

7

2003 2005 2007 2009 2011

USA: fed funds target rateJapan: over night rateEuro system: main refinancing rate*UK: repo rateSweden: repo rate%

* To 15 Oct 2008, minimum bid rateSource: Bloomberg. 25200@Keskuspankkikorkoja (enET)

Central Bank policy rates

Erkki Liikanen

0

5

10

15

20

25

30

35

2007 2008 2009 2010 2011 2012

FED BOJ ECB BOE Riksbank

% of GDP

Sources: National statistical authorities, Eurostat ja Bloomberg.25200@KP_taseet (enET)

Central Bank balance sheets

26


On Eurosystem monetary policy

Standard monetary policy measures– Key interest rates reduced on two occasions to 1%.

Non-standard monetary policy measures– Three-year longer-term refinancing operations in December and

February– Expansion of eligible assets– Reduction of minimum reserve ratio 2% => 1%

Preliminary estimates suggest that measures have been effective



Refinancing operations by maturity


-1 200

-1 000

-800

-600

-400

-200

0

200

400

600

800

1 000

1 200

2007 2008 2009 2010 2011 2012

Longer-term refinancing operations (3 mth)Supplementary longer-term refinancing operations (1-12 mth)Main refinancing operations (1 week)Net recourse to the standing facilities (overnight)Fine-tuning operations (1-7 days)Supplementary longer-term refinancing operations (36 mth)

Monetary policy operations

EUR bn


28


Bank of Finland’s claims relating to payment systems


-20

-10

0

10

20

30

40

50

60

70

80

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Bank of Finland claims related to Target and correspondent accounts (net)

Use of deposit facility and fixed-term deposits of banks operating in Finland

Lending to banks operating in Finland related to monetary policy operations


EUR billions

29


Operation has eased interbank market tensions

Banking risk indicators Money market indicators


-0,5

0,0

0,5

1,0

1,5

2,0

2,5

2008 2009 2010 2011 2012

1 month 3 month 12 month

Source: Bloomberg.

Percentage points

1, 3 ja 12 kuukauden euribor- ja repokorkojen välinen erotus

0

80

160

240

320

400

0

20

40

60

80

100

2008 2009 2010 2011 2012

VSTOXX index (LHS) iTraxx Europe Finance (RHS)

Source: Bloomberg.25902@Pankkiriski (en)

Otsikko

30


Sovereign risk premia have also decreased

10-year Italian government bonds10-year Spanish government

bonds


2

3

4

5

6

7

8

1999 2001 2003 2005 2007 2009 2011

Italy average

%

Source: Bloomberg.25200@Italia 10v (en)

Italian 10v. korkotuotto

2

3

4

5

6

7

8

1999 2001 2003 2005 2007 2009 2011

Spain average

%

Source: Bloomberg.25200@Espanja 10v (en)

Espanjan 10v. korkotuotto

31


Conclusion

Central bank measures can calm the markets– Recent measures have ensured bank liquidity– Operating environment continues to be challenging

Permanent resolution requires government action– Countries need to take advantage of the window for

opportunities– Public finances need to be put back on a sustainable

footing– Measures to strengthen growth potential are necessary

Efficiency of crisis management is assessed ex post– Timely exit strategies important part of overall action



Bank of Finland Bulletin 1/2012 contents

Main article: Monetary policy and the global economy– Cyclical situation and risks– Monetary and fiscal policy– Structural policy and macroeconomic imbalances

Additional articles:– Monetary policy transmission and debt in the euro area– Euro area economic policy coordination: what has been

done, and why? – Quantitative easing in monetary policy


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