‘Slower growth elsewhere in Europe and in the United States will impact negatively on Finnish exports. Higher prices for oil and other commodities will reduce households’ real purchasing power and push up corporate costs. Fading investment will slow output. The long-sustained cyclical high in construction will come to an end at the same time as the rising trend in housing prices. One exceptional factor is the contraction of forest industry output, partly because of declining supplies of roundwood due to the export duties on roundwood imposed by Russia,’ declared Bank of Finland Governor Erkki Liikanen today when he published the Bank’s latest economic forecast.
As economic growth slows, employment growth will come to a halt and unemployment become stuck at a full 6%. Inflation has reached record figures on the back of rising prices for energy and other commodities. Inflation will, however, slow again fairly rapidly, provided commodity prices do not begin to rise again and the pace of wages growth slows substantially as economic growth wanes.
The foundations of the Finnish economy remain rather strong. The general government balance is sound. The banks are solid. If, as forecast, the waves generated by the financial crisis begin to gradually die down around the world, economic activity in Finland’s most important export markets will begin to pick up again next year, providing a stimulus for the Finnish economy. The forecast for 2010 is for a return to growth of over 2%.
‘However, the unexpectedly rapid rise in prices during the present year increases the risk of a wage and prices spiral. The rise in fuel prices is due to external factors. It means a transfer of income from Finland to the oil-producing countries. The higher fuel prices cannot be compensated by higher incomes, because there has been no corresponding value added to the Finnish economy. It is therefore absolutely essential to ensure that medium and long-term inflation expectations remain firmly anchored to a rate of inflation that accords with the definition of price stability. It is essential to avoid extensive second-round effects on prices and pay from rising energy and food prices,’ Governor Liikanen continued.
The basic picture presented by the forecast is relatively reassuring despite the slower pace of growth. The underlying assumption is that the financial market turbulence will be short-lived and there will not be a global credit slump.
In terms of economic growth, however, the most serious risk relates specifically to the financial market uncertainty. Finland would be unable to avoid the negative consequences if the United States and Europe were to drift into a clear recession with the consequent slowdown in growth in Russia and China.
Finland’s resistance is weakened by the level of household debt and the rise in wage-related costs in the corporate sector. Falling housing prices and the weaker employment outlook could encourage households to save, in which case consumption growth would be weaker than forecast. The negative impact on employment would start to be seen fairly soon, particularly if export demand was believed to be weakened on a long-term basis.
The general government surplus will begin to decline rapidly after the end of 2008 due to the termination of the cyclical upswing, cuts in taxation and the growth in expenditure pressures that can be expected to begin in a couple of years as a consequence of demographic ageing.
Tax cuts are the largest single factor that will eat into the central government surplus during the forecast period. Tax cuts on earned income are well founded in a situation where there is a tight labour market and problems in accessing raw materials.
The cutting of tax on earned income is, however, dependent on its not endangering the sustainability of public finances. This will require control of expenditure and a broad tax base.
Economic outlook 2/2008