By The Bloomberg Editors
Sweden faces a difficult year, like every other European economy, but unlike the rest of the European Union, it’s equipped to cope. There are lessons here, especially for the EU’s other non-euro countries.
Scandinavia’s biggest economy will see growth slow to less than 1 percent in 2012, down from an impressive 4.5 percent in 2011, according to the National Institute of Economic Research. Sweden relies heavily on exports to the rest of Europe, and the EU’s protracted economic crisis will set it back.
Shortly before Christmas, the Riksbank cut its benchmark rate for the first time since 2009 to 1.75 percent. The NIER predicts further reductions this year in response to a weaker economy and slower inflation. This prospect underscores the seriousness of the situation -- and how valuable it is at such times to have an interest rate to change.
The value of monetary independence is the first and most important Swedish lesson. Sweden stayed out of the euro system when the currency was introduced in 1999, and in the past several years, the government has used this monetary flexibility to the full.
Firm Fiscal Hand
With most of the EU bound by the European Central Bank’s excessive monetary caution, the Riksbank cut interest rates more sharply than the ECB and (in real terms) the U.S. Federal Reserve from 2007 to 2009. Its inflation-adjusted interest rate fell from 2.25 percent to minus 1.5 percent. The central bank also devised new credit facilities and other unconventional measures to support the Swedish financial system.
Fiscal policy played a smaller role in steadying the economy. This, too, was a legacy of the 1990s, when budget deficits widened and a national consensus formed around the need to curbgovernment spending and stabilize the public finances. Sweden’s subsequent success in doing that is nothing less than remarkable.
Hence Sweden’s second lesson: Fiscal stimulus isn’t a necessary condition for economic recovery. Through the course of the recent recession, the government’s cyclically adjusted budget stayed in surplus. As a result, Swedish government debt stands at less than 40 percent of gross domestic product, among the lowest of any rich country.
Fiscal policy still helped to cushion the recession and support a recovery -- not with discretionary stimulus, but through so-called automatic stabilizers, which are relatively strong in Sweden. (Measures such as consumption taxes and generous unemployment benefits relax fiscal policy in recessions and tighten it in booms, even if policy stands pat.)
In Sweden’s case, a firm fiscal hand, far from stifling the recovery, probably helped it along. Keeping the budget under control buoyed consumer and investor confidence. Surging demand for Swedish debt drove bond prices higher last year; indeed, Sweden’s government pays less to borrow than Germany’s.
Should others follow its example? For one group, the answer is plainly yes. Members of the EU that have not yet adopted the euro are nonetheless committed in principle to doing so. (This includes Sweden; the U.K. and Denmark are two exceptions.) Sweden proves, if further proof were needed, that euro membership is a mistake.
Lacking a currency to devalue and interest rates to cut, members of the euro system would only worsen their recessions if they squeezed fiscal policy as tightly as Sweden did. Beyond the EU, though, Sweden does suggest that sufficiently powerful monetary easing can carry most, if not all, of the burden of economic stabilization.
New Swedish Model
Models have their limits. Every country has to cope with its own special circumstances. It helped Sweden that the most recent slump, unlike that of the 1990s, was export-led: Its exports are capital-intensive, so a drop in foreign demand raises unemployment by less than a decline in demand at home. It also helped that since coming to power in 2006, the country’s center-right coalition government has made private-sector job creation a priority.
Note, therefore, that this isn’t the old Swedish model. Taxes on labor have been cut and the country’s once-lavish welfare state is being squeezed.
What do Sweden’s voters, who once elected left-wing Social Democrats by default, make of that? Their economic concerns have increased lately, but few blame Prime Minister Fredrik Reinfeldt and his government, and the Social Democrats have failed to recover.
This suggests a third lesson, political rather than economic: Fiscal conservatism can be popular. Sweden is reluctant to put its hard-won fiscal strength at risk. Rightly so. Sweden is better placed than most to deal with the further economic setbacks the EU seems determined to dispense. More interest-rate cuts and a shift to budget stimulus, if needed, are options that few other rich economies have.
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