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Finland 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.
Data as of December 1988
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