The renewed escalation of the financial crisis threatens to halt the recovery of the world economy. Uncertainties related to political decision-making and the outlook for public finances have exacerbated problems in the financial system and overall economic activity. ‘It seems probable that world economic growth at the end of 2011 and at the beginning of 2012 will remain weaker than was still widely expected in the early summer,’ noted Governor Liikanen in the public hearing of the Finnish Parliament’s Commerce Committee.
Despite a global increase in the uncertainty surrounding the economic outlook, Europe now takes centre stage in the crisis. ‘Euro area economic growth is also slowing in the latter part of this year. The uncertainty related to growth prospects is high, and a substantial weakening in economic activity cannot be ruled out,’ said Governor Liikanen.
With sovereign debt problems continuing, it has become more difficult for European banks to access finance and the price of financing has risen. The markets require that banks put higher capital buffers in place. Accordingly, the adequacy of banks’ own funds needs to be ensured. Banks should seek to raise additional capital from private sources in the first place. Capital injections possibly made by governments must take place in exchange for stock or ownership.
Restoring stability in European economic performance also requires safeguarding fiscal sustainability in all euro area countries. Governments grappling with the worst problems are expected to adhere to their programmes, and the sufficient capacity of bail-out schemes needs to be ensured. In addition, closer coordination of economic-policy decision-making is necessary.
The euro area inflation rate shows signs of remaining at more than 2% over the next few months, but may decline thereafter. Over the policy-relevant medium-term horizon, there are equally strong upside and downside risks to the inflation outlook. Upside risks stem from, for example, potential increases in indirect taxes. On the other hand, disappointing economic growth may lead to lower inflation than currently expected.
The Eurosystem has responded to the financial market disruptions experienced since 2007, in addition to normal interest-rate settings, by implementing non-standard monetary policy measures. These include the covered bonds purchase programme and the Securities Markets Programme. The aim of these programmes is to ensure the functioning of the transmission mechanism of monetary policy.
Central banking is always also associated with risks which the Bank prepares for by strengthening its balance sheet. This also applies to the Bank of Finland. In recent years, it has pursued a systematic strengthening of its buffers. The Bank of Finland takes management of risk into account in its investment activities, and, among other things, the risks associated with non-standard monetary policy measures. ‘The Bank of Finland’s balance sheet buffers are adequate to cover current risks,’ states Governor Liikanen.