Another good video here with Tom Chitty from CNBC – outlines why the cost of living is so high in Scandinavia – Norway, Sweden and Denmark. These countries on average have some of the highest tax rates (see graph) in order to fund a large welfare state. Expenditure in social welfare is one of the highest as a % of GDP and eventhough it is very expensive to live in these countries they rank as some of the happiest.
To boost spending in any economy you would assume that the central bank would reduce interest rates – encourages borrowing and reduces saving. But very low interest rates could encourage people to hold cash rather than keep the money in the bank – this could slow economic activity in the economy.
Sweden’s central bank – Riksbank – has gone negative with interest rates. Sweden has the third highest savings rate in the developed world but there is a significant positive output gap. With inflation at 0.2% it remains well below the central bank’s 2% target but the mandate from the Swedish government encourages radical measures to rectify the threats of deflation.
But with lower rates in the eurozone to stimulate growth this has weakened the Euro against the Swedish krona making Swedish imports cheaper and putting further deflation pressure on the economy. Therefore the Riksbank has had to cut its own rates in response in an attempt to avoid deep deflation. Switzerland has also go the negative way with a rate of -0.75%.
Championed as an economy which has effectively weathered the GFC, Sweden’s output is now starting to slow. Like Germany their economy is very export dependent and specialises in high-value manufacturing and therefore has been affected by the slowdown in both Europe and China.
50% of GDP is export related and because of the global downturn industrial production is down 5% this year although the strong Swedish Krona hasn’t helped matters. The Swedes have some concerning debt issues in that households have a debt-to-income ration of 149% – the Dutch rate is even higher 250% and the Danes are at 267% – see graph below. However the public sector debt is low and gross national debt is 37% of GDP. For the private sector the house prices have increased relative to incomes and rents and this is in a country with so much land and so little population ought to be a worry for policymakers. With unemployment on the rise households will find it harder to to pay off their debts and the banks might have to take some big losses.
Gross debt-to-income ratio of households % Source: http://epp.eurostat.ec.europa.eu
From reading the October 2012 IMF Fiscal Monitor I came across a page on the Swedish model of managing its public finances. Obviously the IMF see this as a good example for other economies to follow. At the bottom of the recession in 2009 the fiscal deficit in Sweden was only 1% of GDP and by 2011 it was at pre-crisis levels. The IMF publication identified four main points that other countries could learn from.
1. The building up of fiscal buffers during good times, together with credible fiscal institutions, provides room to maneuver during bad times.
Before the GFC Sweden enjoyed a fiscal surplus of 3.5 percent of GDP, compared with an average deficit of 1.1 percent of GDP among advanced economies. When the recession hit the government had enough fiscal space to allow automatic stabilizers to operate fully and to implement stimulus measures without jeopardizing fiscal sustainability. The fiscal balance went from a surplus of 3.5 percent of GDP in 2007 to a relatively small deficit of 1 percent of GDP in 2009. The authorities’ expansionary policy was not called into question by markets because of the low level of the deficit and the credibility of Sweden’s comprehensive fiscal policy framework—including a top-down budget process, a fiscal surplus target of 1 percent of GDP over the output cycle, a ceiling for central government expenditure set three years in advance, a balanced-budget requirement for local governments, and an independent fiscal council.
2. Central bank credibility allows monetary policy to be used aggressively.
During the crisis, the Riksbank lowered its target short-term interest rate nearly to zero and implemented sweeping liquidity measures, including long-term repurchase agreement operations and the provision of dollar liquidity.
3. A flexible exchange rate can help absorb the shock.
During the crisis, the krona fell in value against both the dollar and the euro as investors flocked to reserve currencies. It depreciated by 15 percent in real effective terms from mid-2008 to early 2009, supporting net exports and helping prop up economic activity.
4. Decisive action to ensure financial sector soundness is crucial.
Swedish banks were badly hurt by the financial crisis, despite their negligible exposure to U.S. sub- prime assets. Bank profitability fell sharply in 2008– 09, and two of the largest banks — both increasingly funded on wholesale markets and exposed to the Baltics — saw their loan losses spike and their share prices and ratings decline accordingly. The authorities took fast action to calm depositors and inter- bank markets, including a doubling and extension of the deposit guarantee and introduction of new bank recapitalization and debt guarantee schemes.