6.2 The COVID-19 crisis drove the Finnish economy into a deep recession in 2020

The Finnish economy contracted exceptionally sharply in 2020. Economic forecasts were dominated by the COVID-19 pandemic and the related remarkably high degree of uncertainty. Forecasting is particularly challenging because the recession and economic recovery are dependent on the evolution of the epidemic. To demonstrate this uncertainty, the Bank of Finland published several alternative economic scenarios in addition to the actual forecast.

The COVID-19 pandemic has caused great uncertainty about economic developments and has dominated the preparation of forecasts for both the Finnish economy and the Eurosystem as a whole. The coronavirus crisis has further highlighted the importance of economic forecasts.

Monetary policy preparation necessitates economic forecasts

Monetary policy measures often affect inflation and other macroeconomic phenomena with a time lag. For this reason, monetary policy decision-makers need an informed view of the economic situation prevailing in months’ or even years’ time, which will be impacted by the decisions taken now.

Therefore, the preparation of euro area monetary policy and assessment of the related effects necessitate independent analysis of economic developments in the immediate years ahead.

The Bank of Finland draws up forecasts primarily to support preparation of the single monetary policy and related decision-making. The forecast for the Finnish economy is produced as part of the Eurosystem’s projections in cooperation with the ECB and the rest of the Eurosystem.

The macroeconomic forecast is also closely linked to the forecast for the public finances and the short-term inflation forecast.

The Bank of Finland began to produce interim forecasts

In 2020, in addition to macroeconomic forecasts, the Bank of Finland began publishing interim forecasts for the Finnish economy twice a year, in March and September. The interim forecasts are more limited than the forecasts prepared as part of the Eurosystem’s projections.

The interim forecast contains the outlook for GDP, inflation and the employment rate. The assessments are based on the ECB’s assumptions on, for example, Finnish export market developments and interest rates.

The March interim forecast was coloured by COVID-19

According to the interim forecast published in March, the Finnish economy was expected to contract by 1.5–4% in 2020. The pandemic was assumed to remain short-lived, and the Finnish economy was anticipated to begin recovery in the latter part of 2020.

The Bank of Finland emphasised in the interim forecast that the economic impacts of the pandemic depended essentially on the extent and speed of the policy measures implemented. The Bank also pointed out that unemployment and bankruptcies could begin to rise, should the pandemic and its containment measures drag on.

Opting for the strategy of suppression or mitigation of the virus?

As the COVID-19 crisis worsened during the spring, the Bank of Finland published exceptionally two alternative scenarios for the Finnish economy for the immediate years ahead. The names of the scenarios – the suppression strategy and the mitigation strategy – refer to alternative ways of treating the coronavirus epidemic.

In the suppression strategy, strict restrictions were assumed to be in force for two months. The economy would contract sharply, but recovery would be faster than in the mitigation strategy.

Overall, economic output losses, such as bankruptcies and rising unemployment, would remain smaller in this scenario, and there would be no permanent scars on the economy. GDP would decline by 5% in 2020 and would fully recover already in 2021, when it would be growing at a rate of 7%.

In the mitigation strategy, containment measures would be less stringent but would remain in place much longer. Output losses would be significantly greater than in the suppression strategy.

In the mitigation strategy, the COVID-19 crisis would also leave permanent scars on the economy, and output would remain permanently below pre-crisis levels. GDP would shrink by as much as 13% in 2020. Recovery would be slow and unemployment would be high, should the number of bankruptcies increase. In 2021, GDP would only grow at a rate of 4%.

The Bank of Finland stressed that the scenarios were subject to uncertainty. The economic ramifications of the pandemic would depend on how rapidly the virus could be contained and restrictions could be lifted in Finland and other countries.

The Bank of Finland’s calculations suggested that the suppression strategy would be significantly less harmful to the economy than the mitigation strategy.

According to the calculations, a swift economic recovery would still be possible if restrictions did not remain in place for very long and if corporate bankruptcies and mass unemployment could be avoided through economic policy measures.

The impacts of COVID-19 were reflected in economic statistics with a time lag

The impacts of the coronavirus crisis were genuinely reflected in the various Finnish indicators only at the end of the spring; in export market figures they were reflected slightly earlier, however.

The pandemic highlighted the slow pace of producing economic statistics. For its own part, the Bank of Finland began to closely monitor certain high-frequency indicators, such as consumer card payments and road transport data.

In spring 2020, almost all indicators signalled a very deep contraction in the economy.

The June Eurosystem forecast increasingly pointed to a slow recovery

In the June macroeconomic forecast, the Bank of Finland stated that Finland would gradually recover from the sudden shutdown. The economy was projected to shrink by 7% in 2020. Recovery from the COVID-19 crisis would be relatively slow and the economy would grow by 3% per annum in 2021 and 2022.

The June forecast assumed that the acute phase of the crisis would pass in 2021, when a viable treatment would be found for the virus. The economy would begin to recover slowly, led by private consumption, once households were willing to spend again and unemployment eased.

Finnish exports were expected to grow slowly, since corporate investment would be very low in an environment of exceptionally high uncertainty.

The COVID-19 pandemic was forecast to cause lasting damage to the Finnish economy, as not all companies were expected to survive the deep recession. Some job losses would also be permanent.

Due to the exceptionally high degree of uncertainty surrounding the June forecast, the Bank of Finland also published two alternative scenarios for the Finnish economy.

According to the alternative scenarios, the economy would contract by just 5% or by as much as 11%, depending on how the epidemic progresses in Finland and how successfully it could be contained. The Bank of Finland underlined that the economic contraction and recovery would depend largely on containment of the epidemic.

The September interim forecast indicated a slow economic recovery

The worst recession fears did not materialise in 2020, but recovery was expected to be slow. In its September forecast, the Bank of Finland expected GDP to decline by 4.7% in 2020.

In 2021 and 2022, GDP would grow at an annual rate of 2–3%. Even though it appeared in September that the recession would be milder than feared in the spring, it would still be deep, and recovery would be slow.

The interim forecast stressed that employment threatened to weaken for a protracted period and that the global recession was overshadowing the outlook for exports. Uncertainty stemming from the pandemic would remain high, both in Finland and in the global economy.

The Bank of Finland also pointed out that the risk of weaker-than-expected developments was still considerable and related, in particular, to failure in preventing the spread of the virus. The longer the concerns prevailed, the more fragile economic growth would be.

The December forecast suggested that the Finnish economy would recover, albeit slowly

The December forecast was revised up and the economy was projected to shrink by 3.8% in 2020. The Bank of Finland stated that the 2020 economic recession looked set to be milder in Finland than elsewhere in the euro area, but with the rapid spread of the second wave of the virus, the coming winter would be difficult.

Economic growth was forecast to pick up to 2.2% in 2021, as the pandemic would gradually be left behind due to the vaccines. In 2022, economic growth would strengthen to 2.5%.

At the end of the forecast period in 2023, the economy would return to a slow 1.5% growth rate. This reflected the subdued conditions for long-term growth which, in turn, mirrored population ageing and low productivity growth.

According to the December forecast, economic growth in the forecast years will largely hinge on private consumption. Household income will continue to grow steadily and consumer confidence will strengthen as the threat from the pandemic recedes.

The recovery of Finland’s external operating environment will take time, and investments in Finland’s export markets, in particular, will remain well below pre-pandemic forecasts.

Finnish exports will begin to gradually recover from the collapse in 2020, once the export markets take a turn for the better. The growth contribution of net exports, i.e. the difference between exports and imports, will be negligible during the forecast years.

Private investment will also remain weak in the next few years, as uncertainty over economic developments has led companies in Finland to postpone or cancel fixed investments.

While the recession caused by the COVID-19 pandemic has remained milder than feared, it has weakened the conditions for economic growth. In the December forecast, the labour market was expected to recover slowly from the pandemic and related containment measures. Inflation was also anticipated to remain low.

The key messages of the December forecast are crystallised in Chart 25, which was also published in connection with the forecast. The chart summarises the factors contributing to the economic recovery.

Uncertainty about economic developments was still high in December, and the forecast highlighted both upside and downside risks.

The risks were particularly related to how the pandemic will be brought under control. Uncertainty associated with the forecast was assessed in two alternative scenarios.

A positive scenario was that a medical solution, i.e. vaccine, would be available and efficiently distributed among the population already in the first half of 2021. In this case, economic growth would pick up notably more than forecast.

A negative scenario was the possibility that the epidemic would spread in winter 2020–2021 and the public would have to be protected by a wide-ranging shutdown of the economy.

Should the epidemic drag on, the economy would contract further in 2021.

Analyses to support forecasting and monitoring of the Finnish economy

In support of the forecast, the Bank of Finland regularly publishes a report on recent developments in the Finnish economy.

In 2020, the Bank also published topical articles supporting forecasting and economic monitoring. The articles were largely related to the analysis of the impacts of the COVID-19 pandemic.

In addition to the forecasts, during 2020, the Bank of Finland actively provided information on the Finnish economy to different media, including social media.

There was great interest in the Bank of Finland’s forecasts. During the year, the forecasts were widely discussed in both the national media and social media.

The several presentations on the Finnish economy given to the various domestic and foreign stakeholders in 2020 were also important in sharing information on the economy and increasing the Bank of Finland’s media visibility.

The Bank of Finland draws up its macroeconomic forecasts using the dynamic general equilibrium model Aino.

Aino is a stochastic general equilibrium model that simulates the Finnish economy. It is built on economic theory and is estimated based on Finland’s national accounts data. The model consists of a group of mathematical equations that are implemented in a computer code. The equations illustrate interdependencies between the key Finnish economic variables.

The Bank of Finland also uses several short-term indicator models for nowcasting GDP developments in the current and next quarter.