Economic policy in the past few years has responded to the COVID-19 pandemic and then Russia’s war in Ukraine. These crisis years have demonstrated the importance of maintaining sufficient room to manoeuvre in fiscal policy. The swift and robust monetary and fiscal policy measures taken smoothed out larger economic fluctuations. The downside is that the general government debt ratio has grown significantly.

Unlike the other Nordic countries, the general government debt ratio in Finland has grown almost without interruption for the past 14 years. This trend will continue unless corrective action is taken. “In Finland, economic policy now has to focus simultaneously on both the short-term inflation problem and longer term structural problem”, says Bank of Finland Governor Olli Rehn.

According to preliminary data, the annual inflation rate in November in the euro area was 10.0% and in Finland 9.1%. Higher energy prices are the main factor behind the surge in inflation, but the rise in prices has broadened out to almost all goods and services. The outlook is marked by uncertainty.

“Monetary policy is aimed at efficiently reducing inflationary pressures and keeping inflation expectations anchored,” says Olli Rehn. The Governing Council of the European Central Bank raised key interest rates by a further 0.5 percentage points in December. The deposit facility rate is currently at 2%. “Interest rates will still have to rise significantly to reach levels that are sufficiently restrictive to ensure a timely return of inflation to the 2% medium-term target. Raising interest rates to restrictive levels will over time reduce inflation by dampening demand and will also guard against the risk of a persistent upward shift in inflation expectations,” says Rehn. The expanded asset purchase programme portfolio will decline at a measured and predictable pace from the beginning of March 2023 onwards. The principal payments from maturing securities will no longer be reinvested in full.

“Fiscal policy can support the achievement of the inflation target if it refrains from fiscal measures that would boost aggregate demand. The near term is shrouded in uncertainty, but when supply factors constrain the economy, expansionary fiscal policy does not support economic growth or employment but, rather, will lead to a rise in prices and costs,” says Olli Rehn.

The public finances must be strengthened to ensure the financing of increasing levels of age-related expenditure. “Halting the accumulation of further debt in the immediate years ahead would give sufficient room for action in future crises and for the next generations,” adds Rehn. The aim should be longer term debt sustainability, and to achieve this, a coherent economic adjustment programme should be drawn up stretching over several government terms. “It is vital to build a strong political commitment to fiscal sustainability and to the resolute implementation of the measures this calls for, ” says Rehn. “These goals would be enhanced by a reform of the EU’s economic governance framework, which should be decided on without undue delay.”

The most efficient way to balance the public finances would be a combination of fiscal consolidation and structural reforms that support economic growth and employment. Long-term growth prospects must be strengthened by investing in education, by supporting new innovations, and by improving the scope for work-based and education-based immigration.