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

Julkinen

Monetary Policy and the Global Economy

Governor Erkki LiikanenBank of Finland Bulletin 4/2014

16.9.20141

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

16.9.2014 Bank of Finland Bulletin 4/2014 2

Julkinen

I. Monetary policy has been further relaxed


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


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 4/2014 516.9.2014

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.


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.


Julkinen

Interes rate cuts bring money market interest rates to an unprecedented low


-0,5

0

0,5

1

1,5

2

2,5

2010 2011 2012 2013 2014

Eurosystem key policy rate Overnight deposit rate

Marginal lending rate Eonia

3-month euribor 12-month euribor%

Sources: ECB and Reuters.

Interes rate cuts bring money market interest rates to an unprecedented low

Julkinen

99

100

101

102

103

104

105

106

1.28

1.30

1.32

1.34

1.36

1.38

1.40

1.42

01/2014 03/2014 05/2014 07/2014 09/2014

EURUSD (left-hand scale)

Effective exchange rate of the euro (EER-20) (right-hand scale)EURUSD Index

Source: Bloomberg.

-0.2

0

0.2

0.4

0.6

0.8

1

1.2

01/2014 03/2014 05/2014 07/2014 09/2014

United States (fed funds, year-on-year)

Euro area (Eonia, year-on-year) %

Source: Bloomberg.

Differences in interest rate expectations and in long-term interest rates widened;

euro exchange rate weakened


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


-5

0

5

10

15

20

25

30

35

40

2008 2009 2010 2011 2012 2013 2014

FED Eurosystem BOJ BOE

Balance sheet change, 2008/1, percentage point of GDP

Sources: National statistical authorities, Eurostat and Bank of Finland calculations.

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 2014


Julkinen

II. Forecast for the global economy and risks

12Bank of Finland Bulletin 4/201416.9.2014

Julkinen

60

80

100

120

140

160

180

200

90

95

100

105

110

115

120

125

2008 2010 2012 2014 2016

United States EU21 Japan China (right-hand scale)

GDP: 2008/I = 100 GDP: 2008/I = 100

EU21 = Euro area, Sweden, Denmark and United Kingdom.Sources: National statistical authorities and Bank of Finland.

Economic crisis escalated six years ago


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


Julkinen

90

92

94

96

98

100

102

104

106

108

110

2008 2010 2012 2014

Euro area United States

Index, 2008/I=100

Source: Macrobond and the calculations by the Bank of Finland.28107@BKT

Euro area has experienced a double-dip recession: GDP


Julkinen

Euro area has experienced a double-dip recession: private non-residential investment


70

75

80

85

90

95

100

105

110

2008 2009 2010 2011 2012 2013 2014


2008/I = 100

Sources: Macrobond and ECB.28108@

Julkinen

Euro area has experienced a double-dip recession: unemployment rate


0

2

4

6

8

10

12

14

2008 2010 2012 2014


%

Source: Macrobond.28107@Työttömyysaste

Julkinen

Differences in fiscal policy consolidation smaller than thought…


-8

-6

-4

-2

0

2

4

2007 2009 2011 2013 2015

Change in total fiscal deficit, euro area Change in total fiscal deficit, United States

% of GDP

Source: IMF and calculations by the Bank of Finland.28107@dFipoYht

Change in total fiscal deficit

Julkinen

Differences in fiscal policy consolidation smaller than thought…


-8

-6

-4

-2

0

2

4

2007 2009 2011 2013 2015

Change in structural fiscal deficit, euro area

Change in structural fiscal deficit, United States

% of GDP

Source: IMF and calculations by the Bank of Finland.28107@dFipoRak

Change in structural fiscal deficit

Julkinen

0

2

4

6

8

10

12

14

16

18

2010 2011 2012 2013 2014

United States Germany France Italy Spain

%, 10-year government bond yields

Loan maturities about 10 years.Source: Bloomberg.

Euro area government bond yields to decline in early 2014

… as the crisis spread to the euro area via the overall level of interest rate


Julkinen

0

2

4

6

8

10

12

14

16

18

2010 2011 2012 2013 2014

United States Germany France Ireland Italy Portugal Spain

%, 10-year government bond yields

Loan maturities about 10 years.Source: Bloomberg.

Euro area government bond yields to decline in early 2014

… as the crisis spread to the euro area via the overall level of interest rate


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


Julkinen

Bank of Finland forecast:GDP


60

80

100

120

140

160

180

200

90

95

100

105

110

115

120

125

2008 2010 2012 2014 2016

United States EU21 Japan China (right-hand scale)

GDP: 2008/I = 100 GDP: 2008/I = 100

EU21 = Euro area, Sweden, Denmark and United Kingdom.Sources: National statistical authorities and Bank of Finland.

Julkinen

Bank of Finland forecast:inflation


-2

-1

0

1

2

3

4

5

2010 2011 2012 2013 2014 2015 2016

EU21* United States Japan Finland

%

*Euro area, United Kingdom, Sweden and Denmark.Sources: National statistical authorities and Bank of Finland calculations.

EU21 inflation still sluggish

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


Julkinen

III. Economic policy facing big questions


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?


Julkinen

Is GDP growth on a permanent downward trajectory?


-4

-2

0

2

4

6

8

1960 1970 1980 1990 2000 2010

Annual GDP growth, OECD area

%

Source: OECD and calculations by the Bank of Finland.28107@BKT_OECD

1960-1973

1974-2007

2010-2013

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


Julkinen

How high can debt ratios climb?


0

50

100

150

200

250

300

350

1991 1996 2001 2006 2011

Germany, public and private debt Germany, public debt

United States, public and private debt United States, public debt

% of GDP

Public debt: EMU debt, European Comission.Private debt: Domestic credit to the private sector, World Bank.Sources: European Comission and World Bank.28107@Velka

Julkinen

Real interest rates have fallen ever since the 1980s


-6

-4

-2

0

2

4

6

8

10

1960 1970 1980 1990 2000 2010

Germany United States

%

10-year government bond yield - actual consumer price inflation.Source: [email protected]

10-year real interest rate

Julkinen

Economic Structures in 2008 and the impact of the crisis on GDP


AustriaBelgium

Cyprus

Estonia

Finland

France

Germany

Greece

Ireland ItalyLatvia

Luxembourg

Malta

Netherlands

Portugal

Slovakia

Slovenia

Spain

-25

-20

-15

-10

-5

0

5

10

0 0.1 0.2 0.3 0.4 0.5 0.6 0.7

Change in real GDP, 2008–2013 (%)

The value of the WEF indicator is shown as relative ranking (0=top and 1=bottom) according to results for 2008.Sources: Macrobond, World Economic Forum and Bank of Finland calculations.

World Economic Forum (WEF) structural indicator 2008 (relative ranking)

Julkinen

Summary


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


Julkinen

SummaryMonetary 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


Julkinen

Risk assessmentImpact of uncertainty on

economic growth


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


Julkinen

Risk assessment: measurement of uncertainty


-2

-1

0

1

2

3

4

5

99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14

VSTOXX index CISS index

CISS and VSTOXX indices and uncertainty shocksDeviation from average relative to standard deviation

Source: Bank of Finland.

Russia & LTCM default

9/11

WorldCom & Enron

NorthernRock

Lehman, AIG, GSE

Greece, EFSF

Spain, Italy

Draghi’s speech

Julkinen

Risk assessment: impact on euro area GDP


-1,2

-1

-0,8

-0,6

-0,4

-0,2

0

0,2

t + 1 t + 2 t + 3

No monetary policy constraints Monetary policy constrained

Source: Bank of Finland.28124 BKT1

Difference in growth rate, % points

Shock in year t

Julkinen

Risk assessment: impact on Finland’s GDP


-1,2

-1

-0,8

-0,6

-0,4

-0,2

0

0,2

t + 1 t + 2 t + 3

Source: Bank of Finland.28124 Suomi

Difference in growth rate, % points

Shock in year t

Julkinen

Bank of Finland forecast for the global economy

GDP 2013 2014e 2015e 2016eUnited States 2,2 2,1 3,1 3,1

2,8 3,1 3,1

EU21 0,0 1,1 1,6 1,9

1,4 1,6 1,7

Japan 1,5 1,1 1,2 1,2

1,3 1,2 1,1

China 7,7 7,0 7,0 6,0

7,0 7,0 6,0

Russia 1,3 0,0 0,5 1,5

0,5 1,0 2,0

World 3,1 3,2 3,7 3,7

3,5 3,7 3,7

World trade 3,2 3,9 5,1 5,4 4,8 5,4 5,5% change from previous year. Previous forecast underneath.EU21 = Euro area, Sweden, Denmark and United Kingdom.


Julkinen

Thank you!


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

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