Bank of Finland: Money, stability and growth
The Bank of Finland: money, stability and growth
Good morning, and a very warm welcome to the Bank of Finland Museum.
It is particularly nice to welcome your group here, because there is already a long connection between the Bank of Finland and the work of the Dzikwa Trust in Zimbabwe.
And there is also a personal connection. Oili and I go back quite a long way. When I joined the Bank of Finland’s training programme in 1995, Oili was responsible for the Bank’s investment activities. So it is particularly nice for me to see Oili here today, and to see how fruitfully she has put her energy and talent to work over these past thirty years.
I understand that your visit to Finland is part of an Erasmus+ project between BUSE, Laurea University of Applied Sciences and the Dzikwa Trust, with a particular focus on the Sustainable Development Goals.
So rather than simply telling you what the Bank of Finland is, I would like to use the next fifteen minutes to discuss a broader question: what does a central bank contribute to economic development?
And I would like to start with an even simpler question.
What do we need from money?
What do we actually need from money?
Of course, we need it to buy things. Economists would say that money is a means of payment, a unit of account and a store of value.
But underneath all of these functions there is something more fundamental: trust.
When I receive money today, I need to trust that someone else will accept it tomorrow. And I need some confidence that its value will not change dramatically and unpredictably.
So, in a sense, central banking is very much about maintaining trust in money and in the financial system around it.
The Bank of Finland is Finland’s central bank
The Bank of Finland is Finland’s central bank. We were founded in 1811, so we are actually one of the oldest central banks in the world. The fourth oldest, to be precise.
Our primary objective is price stability. In simple terms, that means keeping inflation low and stable. We aim for inflation of 2% over the medium term.
We also work to promote financial stability, making sure that the financial system can continue performing its essential functions even when the economy is hit by shocks.
These may sound like rather abstract concepts. But both are ultimately about creating an environment in which households, businesses and governments can make decisions with reasonable confidence about the future.
21 countries share one currency – and one monetary policy
Finland does not conduct monetary policy on its own.
We are one of the 21 countries that use the euro. Together, the national central banks of these countries and the European Central Bank in Frankfurt form the Eurosystem.
We share one currency, and we also share one monetary policy.
The key monetary policy decisions are made by the Governing Council of the European Central Bank (ECB). The governors of the national central banks sit around the same table with the members of the ECB’s Executive Board.
In practice, decisions are normally reached by consensus. The important point is that we do not represent national interests, instead, we look at the euro area economy as a whole.
There is one more important feature of this system: central bank independence.
The ECB and the national central banks do not take instructions from governments. This protects monetary policy from short-term political interests. But independence is not a licence to decide everything. Quite the opposite. Because monetary policy has been delegated to an independent institution, its mandate has to be clearly defined and limited.
Our primary objective is set for us in the European Treaties: price stability. We are independent in choosing how to pursue that objective, not in choosing our own objectives. And independence must always be accompanied by transparency and accountability.
For example, we are not allowed to finance government spending directly by creating central bank money.
Together, we make decisions that influence the stability of the euro area economy
This all means our decisions affect a very large economy.
The euro area has 358 million people. The euro is the world’s second most important international currency, after the US dollar. And around 1.6 trillion euros in banknotes are in circulation.
So even though the Bank of Finland is a relatively small institution in a relatively small country, we are part of a monetary system of considerable global importance.
But scale is not the main point. The key question is: what kind of stability are we trying to provide?
What does stability mean in everyday life?
I would divide it into two parts.
The first is price stability.
Price stability does not mean that every individual price stays unchanged. Some prices rise, some fall, and relative prices need to change in a functioning market economy.
What matters is that the general price level develops gradually and predictably.
If you are a household saving for a car, a home or an education, it is much easier to plan if you can have reasonable confidence in the future purchasing power of your money.
The same is true for a company considering a ten-year investment.
The second part is financial stability.
Banks, financial markets and payment systems must continue to function also when the economy is under stress. A financial crisis can destroy otherwise healthy companies, jobs and investments very quickly.
So both forms of stability have a very practical purpose: they allow people to plan ahead and economic activity to continue even when conditions become difficult.
Price stability cannot be taken for granted
And price stability is not something that happens automatically.
This chart shows inflation in the euro area countries over a long period of time.
You can see that in general euro area inflation has been close to the 2% target. For almost ten years, we were actually concerned that inflation was too low. Over that period interest rates were close to zero or even negative in Finland.
The large spike a few years ago followed a sequence of exceptional shocks: the COVID pandemic, bottlenecks in global trade and most importantly the sharp rise in energy and other commodity prices after Russia’s brutal and illegal invasion of Ukraine.
Our two per cent inflation objective is to be reached over the medium term.
Why two per cent rather than zero? Because a small positive rate provides some room for prices and wages to adjust and reduces the risk of deflation.
The important point is that we do not try to keep inflation exactly at two per cent every month. Monetary policy works with lags, so what matters is bringing inflation sustainably towards the target over the medium term.
Monetary policy is therefore forward-looking. What matters greatly for us is that inflation expectations remain firmly anchored around our two per cent target.
How monetary policy affects the economy – one important channel
So how can a central bank actually influence inflation?
This slide shows one important channel, in a deliberately simplified form.
Suppose inflation is too high and the economy is overheating. The ECB can hike its policy interest rates.
That tends to increase market interest rates. Higher market rates are then reflected in the interest rates banks charge households and companies.
Borrowing becomes more expensive. This limits households’ willingness and ability to consume and companies to invest.
As spending and demand weaken, this gradually brings inflation down to our goal.
If inflation is too low, the process works broadly in the opposite direction: we cut interest rates, financing becomes cheaper, demand strengthens and inflationary pressures increase.
But I want to stress the words in the title: one important channel.
The economy is not a machine in which moving one interest rate automatically produces a precise result. Monetary policy works through many channels, under uncertainty, and with substantial time lags. That is why central banks need a great deal of analysis and judgement.
Keeping money and payments working
Central banking is not only about interest rates.
Another very concrete responsibility concerns payments and money itself.
First, cash. Euro banknotes are central bank money. We have a responsibility to make sure that enough cash is available, and that the banknotes in circulation are genuine and fit for use.
Second, payment systems. Much of modern economic activity depends on payments moving safely and reliably between banks and their customers. We work to promote payment systems that are efficient, secure and resilient − so that payments continue to work also when disruptions occur.
And third, the way people actually pay is changing rapidly. Finland is one of the European leaders in electronic payments, and most everyday payments are now made digitally.
So the technology and the forms of money may change. But the basic requirement remains the same: people must be able to trust that money and payments work when they need them.
Evidence, not guesswork
How do we decide what to do?
Hopefully, not by guesswork.
First, forecasts. We produce two main forecasts for the Finnish economy each year. They help us assess where the economy is heading and what risks we need to take into account.
Second, data. The Bank of Finland collects and processes billions of statistical observations every year. Good policy starts with understanding what is actually happening in the economy and the financial system.
And third, research. We have two active research units that study the economy, financial markets and the forces shaping them.
Research is essential because the world keeps changing. Shocks differ from one another, financial structures evolve, technology changes and people change their behaviour.
So good policy requires both data about what is happening now, forecasts about where we may be heading, and research that helps us understand why things happen.
And this brings me to something that connects very naturally to a university audience.
Stability is the foundation – people, skills and ideas create growth
Central banks can contribute to economic prosperity, but there is an important limit to what monetary policy can do.
A central bank can help provide stable money, a stable financial system and reliable payments.
These are essential foundations for economic development.
But central banks cannot themselves generate sustainable long-term economic growth.
Ultimately, growth comes from people becoming more productive: from education, skills, investment, innovation and better ways of doing things.
This is why I particularly wanted to include education in this presentation.
Education increases human capital − the skills and knowledge embodied in people.
Human capital makes it possible to develop new ideas, adopt new technologies and use physical investment more effectively. This raises productivity, and productivity is ultimately what allows living standards to rise sustainably over time.
So there is a useful division of labour here.
Stability creates the conditions for growth. People, skills and ideas ultimately create the growth itself.
And this is also where the work of universities such as yours becomes part of the economic story.
Three key takeaways
Let me finish with three messages.
First, stable money makes economic decisions possible. Without confidence in the value of money, planning for the future becomes much more difficult.
Second, a stable financial and payment system creates trust. Modern economies depend on financial services working reliably every day, including during difficult times.
And third, stability is the foundation, but it is not enough by itself.
Long-term prosperity ultimately depends on education, innovation, investment and human ingenuity.
Central banks have an important role, but economic development is a much broader project involving institutions, businesses, governments, universities and individuals.
Securing stability, in science we trust
That is why our motto at the Bank of Finland captures both sides of what I have talked about today:
“Securing stability, in science we trust.”
We try to provide stability, and we try to base our decisions on evidence and research.
For a group from Bindura University of Science Education, I think that is quite a suitable place to end.
Thank you very much — and I hope you enjoy the rest of your visit here at the Bank of Finland Museum.