pentti hakkarainen : the growth outlook and the challenge of financial stability presentation by mr pentti hakkarainen, deputy governor of the bank of finland, at the financial times group ’ s investment series 2012, helsinki, 26 april 2012. * * * dear friends and colleagues, ladies and gentlemen. i want to thank the organizers for giving me this opportunity to speak to you on what i think is one of the most important issues in the european and the global economy today, the question of debt and deleveraging, and its relationship to growth. the question is how the economies of europe and the other advanced countries can revive and start growing again, when they are still suffering from high debt levels, extreme hoarding of liquidity, and an extraordinary degree of risk aversion. how do we get out of the problems we are in? the economic situation of today reminds me of a tourist who on his trip to ireland stopped a local old man to ask for the way. how do i get to galway, he asked. the irishman replied : well, sir, if i was going to galway i would not start from here! but we have to start from where we are, and the obstacles on the way must be analyzed and overcome. i will argue that the present mood in the markets is partly an overreaction, a sort of mirror image of the irrational exuberance of the first years of the 21st century. the tasks of financial consolidation and reregulation are real and unavoidable. however, we need growth too, and growth will require something else as well : a revival of confidence in real productive investment and a reversal of the negative psychology which has been perpetuating the state of gloom. recent experience ( slide 2 ) the global economic outlook continues to be dominated by shadows of the 2008 – 2009 economic crisis. recovery from the “ great recession ” has been much slower than was expected and there have been repeated disappointments. this has to do with debt. economic history shows that economic recoveries are especially slow after slumps which have involved financial crises. this is precisely because financial crises leave the economy burdened with high levels of debt, and it has often taken a long time to digest that debt. one recent disappointment on the way to normal was experienced towards the end of last year, when economic activity suddenly turned down, especially in europe and japan. there were several reasons, but the difficult debt situation of the southern european countries was a key

management are being developed. the goal is that the supervisors could intervene in a loss - making bank well before the equity is exhausted. this should reduce the risk borne by taxpayers in rescue operations. the possibility of early intervention by the supervisors can also improve the incentives of the managers and equity holders to avoid excessive risk taking. regulation vs. growth the new regulatory measures have financial stability as their main aim. at the same time they would limit risk - taking by banks. this raises an interesting and very important question : is there a conflict between these safety - oriented reforms on the other hand, and growth and investment on the other? is there a danger that the new regulations perpetuate the present tendencies of excessive risk aversion and liquidity hoarding? if that is the case, the consequences would be negative for an economic recovery in the short run and for growth in the long run. these questions cannot be passed over lightly. how can the long - run goal of a more resilient financial system be reconciled with the need to have more investment and a more growth - friendly business environment? will the quest for a safer banking system lead to scarcity of credit and finance for real investment? it is only realistic to admit that this problem may be relevant in the short run. but we should not overstate the conflict. in the long run, the conflict between stability and the availability of finance should disappear, because in the long term, the focus is by definition on sustainable profits and returns. so, more a stable financial system should provide a better environment for investment as well. the european banking authority is presently assessing banks ’ recapitalization plans which they have submitted as responses to the eba ’ s recommendation on recapitalization. the bis central bankers ’ speeches first results suggest, fortunately, that european banks expect to be able to meet most, by far, of their recapitalization needs by far by raising new capital, retaining earnings or conversion of hybrid liabilities. one observation related to that is that when the banking system is re - engineered and becomes safer and better capitalized, the cost of equity capital for banks should also fall. investors in bank stock will be satisfied with a lower rate of return when the capital structure of banks is improved. because of this effect, the cost of new regulations to the banks and their negative impact on growth is likely to be less than in has been claimed by some critics. the way ahead ( slide 9 ) in the future recovery, finance will