6.1 The Bank of Finland and domestic economic policy in 2021

In 2021, the Bank of Finland’s statements focused especially on the long-term conditions for economic growth and on the public finances. The COVID-19 crisis fuelled public debt and reinforced the need to strengthen fiscal sustainability and the conditions for long-term economic growth.

In 2021, as in previous years, the Bank of Finland analysed economic developments and participated in economic policy debate in Finland.

The Bank of Finland’s statements on domestic economic policy are based on the objectives set for the Bank by law and in the EU Treaty and also on its independent status.

Statements focus on the identification of problems and assessment of alternatives for action

The Bank of Finland’s primary objective is price stability. The secondary objectives include balanced economic growth and the stability of the financial system.

The sustainability of the public finances and stable evolution of domestic costs are key to the attainment of the Bank’s objectives.

The Bank of Finland’s statements are based on expert knowledge and focus on the identification of problems and assessment of the effects of alternatives for action.

However, setting the ultimate economic policy goals and decision-making in this area is the task of elected representatives.

The COVID-19 crisis reinforced the need to strengthen the public finances

As the pandemic continued in 2021, the Bank of Finland emphasised that measures to combat the crisis effectively were also pivotal for the economy. Vaccination coverage played an important role in this.

The Finnish economy has weathered the difficulties caused by the COVID-19 crisis better than expected during the worst days of the pandemic. The crisis was not forecast to have a similar long-lasting impact on total output as usually follows a deep economic crisis.

After the most severe phase of the pandemic, however, the general government debt-to-GDP ratio was around 10 percentage points higher than before the crisis.

In the early phase of the COVID-19 crisis, the extensive and rapid economic policy response succeeded in preventing mass unemployment and a wave of bankruptcies. Growth in public debt was well justified at that time.

At the end of 2021, however, the situation had already changed. With the economy standing on a firmer ground, there is good reason to change the direction of fiscal policy in order to make provision for the effects of ageing population and future crises.

In the management of the public finances, it is also worth noting that at some point the general level of interest rates will rise from the exceptional lows of recent years.

Strengthening the public finances was deemed particularly important in Finland, as the proportion of elderly people in the population is growing exceptionally rapidly and, at the end of 2021, the Finnish economy was already entering a more favourable cyclical phase.

During an upswing, an expansionary fiscal policy does not support growth and employment effectively. It could instead lead to an increase in public procurement costs and to a general rise in costs and prices, in addition to increasing the level of public debt.

Sustainable management of the public finances can be supported in various ways

International experience suggests that rules-based fiscal policy contributes to the sustainable management of the public finances. The central government spending limits procedure used in Finland has been a workable model in this respect.

There may well be reason to deviate from the spending limits in a crisis situation, but if such expectations become the rule, the benefits of the spending limits procedure for fiscal sustainability will be lost.

In 2021, the Bank of Finland highlighted that Finland should return as soon as possible to such central government spending limits that lead public finances closer to balance.

The Bank also emphasised the need to consider strengthening the national fiscal governance framework, for example in accordance with the Swedish model.

The Swedish system includes clear numerical targets for the general government budget balance and debt, and a reporting obligation on the Government regarding achievement of these targets.

As expenditure related to an ageing population continues to grow, it would be beneficial in bringing Finland’s public finances onto a sustainable footing to explore in detail where it is possible to cut public expenditure.

In 2021, the Bank of Finland noted that, in this task, decision-makers could be supported by a comprehensive, regularly prepared spending review that critically examines each expenditure item.

Such a review would best be prepared centrally under the direction of the Ministry of Finance or an independent expert body. A spending review would be most meaningful if linked into the decision-making process and if it has the support of decision-makers and is commissioned by them.

The Finnish economy has gradually fallen behind the other Nordic countries

The upward trend in public debt during the COVID-19 crisis reinforced the need to improve Finland’s economic performance.

During the 15 years preceding the crisis, the Finnish economy fell behind the pace of the other Nordic countries. Labour productivity growth was almost stationary, the employment rate was notably lower than in the other Nordic countries and the working-age population started to contract.

In terms of economic prospects, one worrying trend during the past 15 years has been that the average educational attainment of young adults has begun to decline in Finland.

This has been exceptional by international standards. In fact, it is projected that the rise in the average educational level of the Finnish population will come to a halt in the coming decades.

The Bank of Finland stressed in 2021 that Finland’s growth potential and fiscal sustainability can be supported with various reform measures. We can invest in education and training, improve opportunities for work-based immigration, seek to increase research and development activities and reform innovation policy on a broader basis.

Strengthening incentives for employment is vital, especially with regard to the outlook for the public finances.

Labour market plays a key role

In 2021, as in previous years, the Bank of Finland highlighted the great importance of the labour market for economic growth and employment.

Labour market changes in recent years reflect the importance of increasing bargaining at local level. At the same time, it is important that bargaining on the terms and conditions of employment is well coordinated in Finland.

The Bank of Finland underlined the need to monitor changes in labour costs relative to other countries and in relation to labour productivity. The related assessments were surrounded by a high degree of uncertainty during the COVID-19 crisis.

From the perspective of employment developments, it is important that Finland’s cost-competitiveness does not materially deteriorate.

Strengthening economic coordination in the EU is important for Finland, too

In 2021, the Bank of Finland contributed to the discussions on developing the Monetary Union and economic coordination in the EU. The Bank emphasised that it was important to continue strengthening the Monetary Union, for example by taking the next steps towards the establishment of a Banking Union and a Capital Markets Union.

The Bank of Finland also considered it necessary that the EU fiscal policy framework be reformed. The fiscal rules should be more simple and support countercyclical fiscal policies in good times, too.

This way the rules could more strongly support the sustainable management of the public finances and allow room for expansionary fiscal policies during economic recessions.

A proposal of the European Fiscal Board provides one good starting point for the reform of the EU fiscal rules framework.