Finland's general government debt ratio rose almost without interruption for 14 years, Bank of Finland Governor Olli Rehn warned, and must be brought under control to preserve fiscal room. Rehn cited high inflation, an energy-driven shock and the European Central Bank's late-2022 rate increases as immediate headwinds that complicate policy choices. He said fiscal policy should avoid moves that boost demand while public finances are strengthened to cover rising age-related spending. That mix, he argued, calls for a multi-term plan and clear political commitment to restore sustainability.

Debt path and the warning

Finland's public debt trend has been moving upward for more than a decade. Bank of Finland statements in 2022 said the general government debt ratio had grown almost without interruption for 14 years. That pattern sets the context for Rehn's message to lawmakers and markets.

Rehn, Governor of the Bank of Finland, told parliamentary audiences that the country faces two simultaneous challenges. One is short-term inflation. The other is longer-term structural pressures on public spending. He said both must be handled at the same time.

He argued that halting further debt accumulation in the immediate years ahead would give Finland more room to act in future crises. He said the aim should be longer term debt sustainability and that a coherent adjustment programme should stretch over several government terms.

He called for a strong political commitment to those goals.

Inflation, energy and the ECB response

Rehn tied the short-term problem to a global energy shock and broad price increases. The man noted that in October 2022 headline inflation in the euro area reached 10.6 percent, with underlying inflation at about 5.0 percent.

He also cited preliminary November 2022 data showing euro-area inflation near 10.0 percent and Finnish inflation around 9.1 percent.

Higher energy costs pushed headline inflation up. They also fed into food and other prices. Rehn said energy accounted for a large share of the rise in headline inflation and made the outlook more uncertain.

The European Central Bank reacted in late 2022 by raising key rates. The ECB Governing Council increased rates by 0.5 percentage points in December 2022 and the deposit facility rate stood at 2 percent at that time. Rehn said interest rates would still have to rise further to reach enoughly restrictive levels so that inflation could be brought back to the 2.0 percent medium-term target.

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Why fiscal consolidation now

Rehn set out a narrow role for fiscal policy during the high-inflation episode. He said fiscal authorities should avoid measures that would boost aggregate demand. The point was simple: when supply factors are constraining output, expansionary spending or tax cuts tend to raise prices rather than lift employment or growth.

At the same time, Rehn stressed long-term pressures on public finances. He said rising age-related expenditure will increase financing needs over time. Without corrective action, he argued, the debt ratio will continue on its upward path and diminish the government's room to act in future downturns.

To address that, Rehn proposed a coherent adjustment programme. He didn't set out a single package. But he said adjustment should be planned over several government terms so that choices are spread in time and politically credible.

Energy shock, recession risks and fiscal limits

Rehn assessed the broader European outlook as gloomy in late 2022. He warned that Russia's war in Ukraine had weaponised energy and made Europe vulnerable. He said joint European decisions and national solutions had helped moderate the immediate impact. The man also noted the private sector was adapting and accelerating a green transition away from fossil fuels.

But he flagged the recession risk. He said the ECB's September 2022 forecast pointed to around 1.0 percent euro-area GDP growth in 2023 while a downside scenario showed a contraction of nearly 1.0 percent. Rehn judged the probability of the downside scenario as significant. That raised the bar for fiscal policy: governments need to avoid actions that would stoke inflation yet also must be mindful of downturn risks.

Rehn explained how monetary policy was being tightened in 2022 to deal with high inflation. He said that raising policy rates to restrictive levels would dampen demand and help return inflation to 2.0 percent over time. He also noted that the ECB planned to let its expanded asset purchase portfolio decline at a measured pace from March 2023, with principal payments from maturing securities no longer being fully reinvested.

The combination of higher interest rates and shrinking reinvestment was meant to remove excess stimulus from financial conditions. Rehn framed this as necessary even if it raised borrowing costs for governments and households soon.

Rehn put political will at the centre of the challenge. He said fiscal consolidation requires sustained commitment across electoral cycles. That, he warned, is hard to achieve without a clear plan covering several terms.

He also said that the timing of consolidation matters. Tightening public finances while inflation is driven by supply constraints risks depressing activity without lowering prices. At the same time, delaying consolidation risks locking in higher debt and raising future interest costs.

Rehn didn't prescribe specific tax or spending measures in his public remarks. He focused instead on the principles: avoid demand-boosting measures now, plan for ageing costs, and build a long-run adjustment path with political credibility.

Finland is a modern EU member economy with open trade links and exposure to European energy markets.

That exposure helped transmit the energy shock into domestic inflation in 2022, Rehn said. He argued that the country's fiscal position and its demographic trends make the need for consolidation more urgent than in some neighbouring countries.

Unlike other Nordic economies, Rehn noted, Finland had seen a steady rise in its debt ratio over many years. That relative position shapes the options available to policymakers when external shocks hit.

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"Halting the accumulation of further debt in the immediate years ahead would give enough room for action in future crises and for the next generations," Olli Rehn, Governor of the Bank of Finland, said.

This article was created with AI assistance.