The outlook for the global economy has deteriorated, causing adverse effects on the management of the sovereign debt crisis. Resulting from moderate inflationary pressures and subdued economic growth, key policy rates have been lowered in the euro area. The Governing Council of the ECB has adopted additional non-standard measures to preserve monetary policy transmission and the singleness of monetary policy throughout the euro area.
Money market interest rates have declined markedly, reflecting the monetary policy measures adopted by the Governing Council of the ECB. However the monetary policy stance has not been equally transmitted in the euro area. ‘When the differences in the price and availability of funding are related to factors such as the country’s debt sustainability and the status of the banking system, the risk premia are well-founded. However, unfounded risk premia, for example those related to the reversibility of the euro, are not acceptable’, stressed Governor Erkki Liikanen at the press briefing for the latest issue of the Bank of Finland journal Euro & talous.
At its September meeting, the Governing Council of the ECB decided on the modalities for undertaking Outright Monetary Transactions (OMTs). ‘The aim of the decision is safeguarding monetary policy transmission and the singleness of the monetary policy without changing the division of responsibilities between member states and the ECB’, Governor Liikanen emphasised. A necessary condition for the OMTs is strict and effective conditionality attached to a European Financial Stability Facility/European Stability Mechanism programme.
‘The monetary policy measures adopted are in line with price stability and the mandate of the Governing Council of the ECB’, Governor Liikanen specified. ‘It is important to emphasise that, as a monetary policy measure, the OMTs will be applied in equal terms to all euro area countries’, he added. The Governing Council of the ECB will decide on the implementation of the Outright Monetary Transactions in full discretion and the transactions will be focused on the shorter part of the yield curve.
The Bank of Finland’s forecast for the global economy foresees subdued growth in the world economy in the latter part of 2012. The economic outlook for the euro area for the remainder of the year is weak, while growth rates for emerging economies are projected to be lower than expected. Growth prospects for the world economy will also remain subdued for 2013. Inflation rates in major economic regions are projected to settle around 2% over the forecast horizon.
Restoration of confidence is a long-term process, as signs of recovery of economic growth and debt sustainability will only become visible far into the next year in the financially stressed countries. ‘We are  now seeing the outset of an adjustment process in Europe, and based on previous experience from financial crises, there may be several more years to go’, said Governor Liikanen.  Although the deterioration of the economic outlook has been most marked in the euro area, the forecast for 2013 has been revised down for all major economic regions. The weak confidence and heightened uncertainty is also reflected in a deceleration of world trade growth.
Risks to the forecast are weighted to the downside, relating to the prevalence of the adverse developments in Europe, which will make recovery even slower than forecast.  These risks may be dampened by policy measures.
‘Although the situation in Europe remains fragile, better-than-forecast developments are also possible. If Europe is able to implement a credible crisis management strategy, market confidence may strengthen faster than assumed, which would reduce funding costs for financially stressed countries’, Governor Liikanen continued. From the viewpoint of safeguarding the debt sustainability of the financially stressed countries, it is crucial that the countries themselves are committed to implementing adequate adjustment measures and structural reforms.
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In addition to the article on monetary policy and the global economy, issue 4/2012 of the Bank of Finland journal Euro & talous includes the following contributions:
Hanna Freystätter: Housing price bust and the economic policy challenges for Spain
Juha Kilponen: Fiscal policy cyclicality and government bond risk premia
Heli Simola: The contribution of emerging economies to changing global price trends