The recession will be short – new government financial measures are coming at the right time

Finland’s economy will shrink by 0.3 per cent this year and will experience growth of less than one per cent next year, predicts ETLA Economic Research. The situation for households will ease towards the end of the year, when inflation has already slowed down, salary increases have come into force and pension index revisions have been made. Inflation in Finland should drop below two per cent next year. The Eurozone economy will also grow next year. Due to these promising signs, Etla considers that the coming changes to Finland’s public spending are timely. The government’s new financial measures and the development of work incentives are necessary to reverse the trend of Finland’s indebtedness.


  • Finland’s economy will shrink by 0.3 per cent this year. At the beginning of the year, GDP was still growing, but by the end of the year, the economic situation will weaken. Next year, Finland’s GDP growth will remain at 0.8 per cent.
  • Growth will be slowed by inflation and the tightening of monetary policy in Finland and the export market.
  • This year, the economy will shrink as investments decrease and inventories are unloaded, but private consumption is also falling. Housing construction and public investments will shrink sharply. Public consumption, on the other hand, is increasing. Weak international demand is reducing exports. However, imports will decrease more, so the impact of net exports will be positive in the forecast period 2023–2025.
  • Next year, domestic demand will increase, but inventories will continue to shrink. Private consumption will increase gradually as purchasing power improves, and public consumption will no longer support growth. Other investments will partly compensate for the weakness of residential construction.
  • The biggest risks are related to changes in inflation and monetary policy.
  • The unemployment rate will rise to 7.2 per cent this year, but will fall next year. A drop in the employment rate will be temporary.
  • Construction will continue to fall from the high level of recent years due to the rapid tightening of monetary policy. The construction industry will start to recover next year, when monetary policy starts to relax. Unemployment in this sector is increasing, but overall, employment should not suffer much, because the availability of work in repair, industrial and land construction is not as restricted as in residential construction.
  • Consumer price inflation will slow down significantly during the forecast period and will be 1.9 per cent next year.
  • Changes in government spending will start to reduce the public deficit next year, but it will take longer to stabilise the debt ratio.

Almost the entire developed world has been fighting inflation this year, and there have been widespread fears that the global economy will sink into recession. Now it seems that the fight against inflation is paying off and a global recession is unlikely.

Unfortunately, positive developments in the world economy do not predict the direction of Finland’s export market. Growth in the world economy is currently driven by developing countries – primarily China, whose economy will grow by 4.5% this year. On the other hand, the economic growth of Germany and Sweden, the most important trading partners for Finnish exports, will remain negative this year. Goods exports will decrease temporarily, and service exports will not improve significantly until next year. Russian and Asian tourists will not be returning any time soon, and the chronic current account deficit will continue.

The situation for households will ease towards the end of the year, when inflation has already slowed down, salary increases have come into force and pension index revisions have been made. Next year, consumer demand for goods and services will grow across the board.

The fierce pace of price increases has already stopped in Finland and the rest of the euro area. Inflation in Finland will fall below the 2 per cent target for next year specified by the European Central Bank (ECB). The whole euro area will not reach that goal until 2025. Interest rate hikes from the ECB are therefore likely to continue, not to mention the effects that the interest rate, which remains higher than it has been for a decade, has on the economy.

Unlike in the United States, the fight against inflation in the Eurozone means a temporary slowdown in production. In particular, German industry has time to shrink rapidly before the demand for services, and thus inflation in the euro area, has been curbed. Despite this, the unemployment rate in the euro area was still at a record low in July. So any recession would not be long or deep, and next year the economy of the euro area will grow again.

Interest rate hikes do not have the same effect everywhere. The industries that invest the most, manufacturing and construction, suffer from high interest rates more than service industries, whose wage increases have maintained upward pressure on prices. The demand for apartments in Finland has decreased significantly, further deepening the downturn in residential construction. The green transition and the government’s infrastructure investment program will improve the situation over the next few years.

The ECB raises interest rates more than is needed for Finland or any individual industry. Due to differences in the structures of production and the mortgage and housing markets, interest rate increases affect different euro countries at different speeds. For example, although France and Germany together are responsible for about half of the consumer price index in the Eurozone, monetary policy affects these countries more slowly than in Finland or the euro area on average. For effects to be felt throughout the entire euro area, common monetary policy must be tightened more than would be necessary for an individual member country.

Until now, the ECB has mostly relied on interest rates to tighten monetary policy, and its securities holdings have not been significantly reduced. The sale of government bonds would have a strong effect on the interest rates of such bonds in euro countries, the differences between which have remained stable until now. It seems that the ECB will not get very far in reducing its balance sheet before it is already time for interest rates to fall again.

Timely changes to government finances

Finnish Prime Minister Petteri Orpo’s new government started preparations for changes in public spending this autumn. The government did not wait for new EU fiscal policy rules, but will make its own decisions in the recovery and management of Finnish public finances. The government’s financial position target – -1% in relation to GDP at the end of 2027 – is more ambitious than what other EU countries would require of Finland, just like the other Nordic countries. The rules of the EU are a compromise between 27 member states, which is inevitably influenced by the fact that others are not required to do more than they themselves are ready for.

The new public finances program and the improvement of work incentives are necessary to make public expenditures better reflect the current income generation capacity of the national economy and curb indebtedness. Increasing R&D spending, on the other hand, is necessary in the long term in order to improve productivity and the economy’s ability to generate income.

Since there is a lot of debt and the general interest rate is expected to remain well above that of the previous decade, the amount of interest payable with public funds will increase throughout the government’s term. At the end of the forecast period in 2025, interest expenses will have more than doubled since 2022. In other words, even though less money will be spent on public services and income transfers due to the government program, the deficit will slowly decrease as interest on old debts continues to grow. This can be seen in the fact that the difference between the basic balance and the financial position is increasing. Although the basic balance – the public financial position from which interest expenses have been deducted – will only be -0.5 per cent in relation to GDP in 2025, the deficit will be 1.2 percentage points higher. Stabilising the debt ratio requires at least the full implementation of savings planned in the government program, not to mention a reduction in the debt ratio.

The combination of indebtedness and slow economic growth thus already has tangible effects. By 2025, the savings accrued by the new government program will already be 2.4 billion euros when compared with 2023. At the same time, the increase in interest expenses by one billion euros eats up almost half of the adjustment. The combination of a large amount of debt and high interest rates means that other expenses must be cut more so that the debt ratio starts to decrease or even stabilise.

We are living in a new normal where debt has a price again. The interest payments of an indebted country increase while the money available for public services and income transfers decrease.