According to Governor Erkki Liikanen of the Bank of Finland, the financial crisis and the economic crisis that followed it have forced economists and economic policymakers to reconsider some basic issues. Speaking at the annual meeting of the Finnish Economic Association in Tampere, Liikanen identified three key challenges: 1) preventing the causes of the financial crisis being repeated in the future, 2) repairing the damage the crisis has caused to the public finances and 3) drawing the right conclusions for economic theory.
‘Before the crisis, understanding of systemic risks to the financial system as a whole was inadequate. Supervision of individual financial institutions is not enough; the financial system and financial markets must also be supervised and regulated at the macro level. The establishment of the European Systemic Risk Board represents an important step in this direction.’
Liikanen identified two distinct attitudes towards the role of central banks in macro supervision. On one hand there is an acceptance that monetary policy should take greater account of strong rises in asset prices and the credit stock as well as the pricing of risk. On the other hand there is concern that monetary policy is being burdened with responsibilities it is unable to bear given the policy tools currently available.
‘This presents a clear challenge for economics in the immediate years ahead. While the traditional toolkit of monetary policy, namely interest rate policy and money supply analysis, is firmly entrenched at the core of economics as a discipline, the integration of financial markets and financial mediation into macroeconomic analysis is still in its infancy,’ according to Liikanen.
Unemployment has increased and the condition of the public finances rapidly deteriorated, in Finland as elsewhere. Although long-term plans have been put in place to deal with the expenditure pressures brought by population ageing, Liikanen believes the recession forces a rethink of the present strategy for ensuring the sustainability of general government finances in the future.
‘Calculations of the long-term trend in public finances carried out at the Bank of Finland reinforce the outcome of the Ministry of Finance’s analysis: there is now a pressing need to readjust the public finances. The extent of the adjustment required will depend to a large extent on the type of policy measures taken to reduce the deficit. Of the various possible alternatives, policies that undermine employment will be particularly expensive,’ continued Liikanen.
In addition to improving productivity in public services, and extending the number of years people spend in working life, other measures are also likely to be needed to bring about the necessary adjustment. It will probably be impossible to avoid higher taxes and a reassessment of public expenditure.
Attitudes have also become increasingly critical towards economics as a discipline. It has been claimed that the fascination for analytical elegance and mathematical acrobatics locked economics into an ivory tower of frictionless markets and rational economic agents while marginalising attempts to understand the economy as it actually is in reality.
‘It could be that economists and economic policymakers need a more humble approach to their own expertise. It could also be that achieving a balance between mathematical elegance and understanding real economic phenomena will indeed require reconsideration,’ concluded Liikanen.
Read more: Talouspolitiikkaan ja talouspoliittiseen ajatteluun kohdistuvat haasteet finanssikriisin jälkeen