and financial mediation into macroeconomic analysis is still in its infancy, and the relevant approaches are not yet established. this presents a definite challenge for economics in the coming years. the second major economic policy challenge is the repair of the crisis damages to public finances. following the financial crisis and resultant economic crisis, public finances have generally deteriorated and unemployment has increased, in some countries quite sharply. the weakening of general government finances partly reflects the effects of financial system support, automatic stabilisers and various stimulus measures, but perhaps even more the fact that the collapse of gdp levels has led to a marked erosion of the public revenue base. the revenue base is expected to remain smaller than previously envisaged in many countries, as the crisis is estimated to have reduced their output potential. the condition of public finances has rapidly deteriorated, in finland as elsewhere. according to the bank of finland ’ s forecast in september last year, finland ’ s budget balance is weakening considerably, by almost 10 percentage points relative to gdp in the period 2008 – 2011. the budget balance is projected to be about 5 % of gdp in 2010 – 2011. meanwhile, general government debt will grow by about 20 percentage points relative to gdp, to more than 55 % in 2011. the pronounced and rapid weakening of our general government finances is a tough challenge for economic policy. the situation is made increasingly difficult by population ageing, the effects of which begin to be gradually felt more broadly in pension expenditure, demand for publicly subsidised health and care services and in the labour supply. accordingly, the present trend in public finances and the adjustment required cannot be reviewed in isolation from the ageing issue. long - term plans have been put in place in finland to deal with the expenditure pressures of population ageing. this has been reflected not only in public expenditure planning, but also in the pension reform and public - sector productivity programmes. the aim has been to reduce central government indebtedness and thereby to provide room for the short - term costs of structural reforms and for the long - term upward pressures of expenditures. other goals have been to extend the number of years people spend in working life and to raise productivity in the provision of basic public services. the ongoing deep recession, however, is forcing a rethink of the present strategy for ensuring the sustainability of general government finances in the future. in the context of increasing indebtedness, expenditure growth and a decline in the output level, the capacity of general government finances to meet the expenditure and

erkki liikanen : eurosystem ’ s monetary policy and its transmission speech by mr erkki liikanen, governor of the bank of finland, at the rotman icpm forum, helsinki, 5 october 2015. * * * accompanying slides ( pdf ) can be found on the bank of finland ’ s website. [ slide 1 : title page ] welcome [ slide 2 : agenda ] [ slide 3 : i – eurosystem ’ s expanded asset purchase programme ( eapp ) : background ] [ slide 4 : decisive action by the eurosystem stabilised financial markets ] the financial crisis created great uncertainty and increased challenges from the monetary policy - making. not just the eurosystem but central banks around the world reacted by cutting policy rates, increasing their banking system ’ s liquidity and adopting so - called non - standard measures of monetary policy. in july 2012 the president of the ecb, mario draghi, committed to do “ whatever it takes to preserve euro ”. this came to mark a turning point for the crisis : markets calmed down and fears of euro area breaking down were removed. during the same month, in its monetary policy meeting, the ecb ’ s governing council cut the main policy rate to below 1 percent, and the deposit rate to zero. by mid - 2014 all crisis countries apart from greece were again able to borrow from private markets. [ side 5 : traditional monetary policy restricted by the zlb ] despite stabilisation of the financial markets, the operating environment of monetary policy remained challenging. inflation and expected inflation continued to slow down and short term money market rates increased, which meant that further monetary policy easing was needed to maintain price stability over the medium term. the policy rate is, indeed, the most straightforward tool the central bank has to steer market interest rates. by 2014 we, the governing council, had cut the policy rates almost to zero. the deposit rate was cut to negative in the june 2014 policy meeting. the sheer existence of a lower bound for policy rates complicates monetary policy decision making as it creates asymmetry : a central bank can always increase its policy rate to control inflation but the policy rate cut is limited by the zero bound even if inflation drops to very low levels. [ slide 6 : real interest rates increase if inflation expectations fall ] the zero lower bound creates a challenge, as falling inflation puts upward pressure on real interest rates. it is the real interest rates, and expectations of them – not the central bank ’