Finland Macroeconomic Policy

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Finland - Macroeconomic Policy

Macroeconomic policy

During the 1960s and 1970s, government policy had pursued rapid economic growth and high investment in industry, often to the detriment of price stability. By the mid-1960s, the government, generally in concert with the BOF, which controlled monetary and exchange-rate policy, established a macroeconomic approach with fixed roles for monetary, fiscal, incomes, and exchange-rate policies. In general, monetary policy aimed at keeping interest rates low to favor domestic investment. The BOF imposed strict controls on capital exports, which made possible negative real interest rates, and rationed credit to the commercial banks, which controlled most investment. The perceived need to balance budgets, usually annually, handicapped fiscal policy. The government used incomes policy to influence wage settlements, often offering tax breaks in exchange for concessions from management and labor, but incomes policy was rarely coordinated with the general macroeconomic strategy. Exchange-rate policy was dedicated to safeguarding industrial competitiveness.

Although this policy package favored growth, high employment, and industrial development, the economy suffered from greater inflation and instability than those of other OECD countries. Public spending remained under firm control, but low interest rates and tax cuts fueled domestic inflation. At roughly ten-year intervals, Finland experienced export-led booms followed by major devaluations and severe recessions. Fluctuations in world demand for Finnish exports were largely responsible for the cycles, but economic policies magnified them. Typically, a period of overheating in the economy, occasioned by an upswing in exports and by the relatively inelastic supply of exportable commodities, led to sharp increases in wages and prices in the export sector as well as to greater imports of investment goods. Faced with declining export competitiveness and a worsening external balance, the authorities responded with major currency devaluations (24 percent in 1967; 10 percent in 1977-78) and with tighter macroeconomic policies, which dampened domestic demand but restored competitiveness. Output recovered following each devaluation, only to decline as domestic inflation rocketed higher, further eroding competitiveness in external markets.

Although Finland managed to avoid restructuring traditional policies until several years after the 1973 oil crisis, an especially severe downturn in the second half of the 1970s, caused largely by recession in West European markets, inspired a new policy approach. Starting in 1977, with the adoption of a five-year stabilization program, the government began to give priority to fighting inflation and to overcoming the devaluation cycle, even at the cost of higher unemployment and slower growth in the short run.

The new macroeconomic framework involved changing the traditional assignments for each policy tool. Perhaps the most important innovation was a more active role for fiscal policy. Given the low level of Finnish state debt, policy makers stopped requiring that the budget balance each year, and they aimed instead for a balanced budget over the life of the business cycle. Fiscal policy became consciously countercyclical, and increased spending during the 1982-83 slowdown was followed by tax increases in the 1984-85 upswing. In addition, the authorities adjusted tax rates not only to moderate wage demands but also to affect investments and export competitiveness. The implementation of monetary policy shifted from offering negative interest rates in a protected capital market to using interest rates to dampen inflation and to influence the exchange rate. Monetary policy came to depend even more on market operations by the mid-1980s, as deregulation of financial markets eliminated the earlier system of capital rationing. The tighter monetary stance tended to reduce the volume of investment, but economists expected that the quality of investments would improve. After 1977, the BOF attempted to peg the external value of the Finnish mark to a trade-weighted "basket" of foreign currencies. The new exchange-rate policy was meant to curtail both domestic and imported inflation. Indeed, in 1979 and 1980, the currency was allowed to appreciate for the first time in the postwar period in response to greater export demand. Policy makers hoped that the stable exchange rate would eliminate distortions caused by an undervalued or overvalued currency and would allow market conditions to determine investment decisions.

The new approach to managing the economy still depended on negotiated incomes settlements to restrain wage growth and to dampen inflation. The government continued to try to influence agreements between capital and labor by means of fiscal or other incentives. Implementing such sophisticated policies required extensive coordination and cooperation among government ministers belonging to different parties, the BOF, and leaders in agriculture, industry, and labor. Although differences among interest groups continued to exist and sometimes resulted in serious conflicts, the country enjoyed widespread consensus regarding the desirability of medium-term stabilization. It was this consensus--and the macroeconomic policies it made possible-- that deserved much of the credit for Finland's relatively strong economic growth, low unemployment, and price stability.

You can read more regarding this subject on the following websites:

Finland Economy - GDP, Inflation, CPI and Interest Rate
Finland's current situation: The Macroeconomic Perspective
Finland | European Commission - Finland - Macroeconomic Policy | Finnish

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