This Selected Issues paper on Sweden examines developments in the government structural balance. The paper identifies the respective contributions of cyclical and structural factors in the present fiscal consolidation phase. It reviews recent developments and the medium-term fiscal outlook. The paper presents estimates of the structural and cyclical components of the government financial balance. The factors responsible for the fiscal improvement anticipated over the medium term are analyzed. The paper also analyzes the medium-term outlook for public debt, with particular attention to the sensitivity of debt dynamics to different macroeconomic conditions.

Abstract

This Selected Issues paper on Sweden examines developments in the government structural balance. The paper identifies the respective contributions of cyclical and structural factors in the present fiscal consolidation phase. It reviews recent developments and the medium-term fiscal outlook. The paper presents estimates of the structural and cyclical components of the government financial balance. The factors responsible for the fiscal improvement anticipated over the medium term are analyzed. The paper also analyzes the medium-term outlook for public debt, with particular attention to the sensitivity of debt dynamics to different macroeconomic conditions.

Sweden: Basic Data

article image
article image
Sources: Data provided by the Swedish authorities; and staff calculations.

National income data.

Excluding capital transfers.

Change in ratio of real effective exchange rate based on manufacturing export unit values to real effective exchange rate based on unit labor costs.

I. DEVELOPMENTS IN THE GOVERNMENT STRUCTURAL BALANCE 1

A. Introduction

1. Following the fiscal crisis of the early 1990s, Sweden embarked on a strong consolidation of its public finances. The reduction of the general government deficit, from 12.3 percent of GDP in 1993 to 2.5 percent in 1996, has been remarkable.2 With further improvement expected in the coming years, the government intends to balance the budget in 1998 and achieve growing surpluses in the medium term.

2. The purpose of this chapter is to identify the respective contributions of cyclical and structural factors in the present fiscal consolidation phase. The chapter is organized as follows. Section B reviews recent developments and the medium-term fiscal outlook. Section C presents estimates of the structural and cyclical components of the government financial balance. Section D discusses the factors responsible for the fiscal improvement anticipated over the medium term.

B. Recent Fiscal Developments and Outlook

3. The magnitude and speed with which Sweden’s fiscal finances deteriorated in 1990–93 was exceptional.3 But the subsequent reduction in the general government deficit of about 10 percent of GDP in a span of only three years has also been impressive (Chart 1). After a modest improvement in 1994, which was mostly due to the termination of financial support to the banking sector, the net primary balance (i.e., the actual balance corrected for net interest payments) improved from a deficit of 8.3 percent of GDP in 1994 to a surplus of 0.7 percent of GDP in 1996. This strengthening, which proved faster than expected initially, reflected primarily the front-loading of the government’s consolidation program.

Chart 1.
Chart 1.

Sweden: Public Sector Finances, 1980–2000

(In percent of GDP)

Citation: IMF Staff Country Reports 1997, 096; 10.5089/9781451835847.002.A001

Sources: Ministry of Finance; and staff calculations.1/ Financial balance excluding net interest payments.

4. Government primary revenues grew from 54.8 percent of GDP in 1994 to 59.6 percent in 1996 (Table 1). Revenue-enhancing measures including increased contributions for sickness insurance and higher income and property taxes, as well as rapid wage growth contributed importantly to this upturn. Another important (but temporary) factor was the change in the timing of the collection of VAT, with revenues exceptionally based on 13 months in 1996 after only 11 months in 1995.

Table 1.

Sweden: Public Sector Finances, 1989–96

article image
Sources: Konjunktur Instituted, and Ministry of Finance.

Fixed investment, stock changes and net purchases and sales of real estati

Financial balance excluding net interest payments.

5. Primary expenditures also declined markedly during the period, from 63.2 percent of GDP in 1994 to 58.9 percent of GDP in 1996. Public transfers, to households in particular, were substantially reduced and government consumption declined significantly despite strong growth in public wages. The lower spending resulted primarily from the consolidation measures adopted in 1994–96 and additional savings at the local government level.

6. In the 1997 Spring Budget Bill, the government projects further improvements in the net primary surplus, from 0.7 percent of GDP in 1996 to 2.8 percent in 1998 and up to 3.7 percent of GDP in 2000 (Table 2). This strengthening would reflect the residual impact of the consolidation program in 1997–98 and favorable GDP growth during the period. With net interest payments declining gradually as a result of lower debt and moderate interest rates, the improvement in the actual general government balance would be somewhat larger. The deficit would be eliminated in 1998 and government financial surpluses would emerge, reaching 1.5 percent of GDP by 2000.

Table 2.

Sweden: Medium-Term Fiscal Outlook, 1994–2000

article image
Sources: Konjunktur Institutet; Ministry of Finance; and staff estimates.

Projections by the Ministry of Finance for 1997–2000 (Sweden’s Economy, Apri1997).

Financial balance excluding net interest expenditure.

Based on a cyclical adjustment of main categories of tax revenue and unemployment-related expenditures. The elasticities with regard to nominal GDP of direct household and corporate taxes, indirect taxes and social security contributions are assumed to be equal to 1.4,2.4,1.0 and 1.2 as in Giomo and others (1995). The trend unemployment rate used for adjusting unemployment benefits is the non-accelerating rate of unemployment (NAWRU) estimated as in Elmcskov (1993).

Standard fiscal impulse indicators based on total or primary revenue and expenditure net of unemployment benefits (see Heller and others, 1986), with 1985 as the base year with an estimated output gap close to zero.

Consistent with the Maastricht definition.

Staff estimates derived from the Hodrick-Prescott filter applied with a detrending parameter equal to 400 on 1960–2004, with official GDP growth projections for 1997-2000 and growth assumed at 2.5 percent later on.

C. Developments in the General Government Structural Balance

Methodology

7. The structural balance is defined as the government financial balance that would prevail if the economy were at its full potential. The structural balance Bs can, therefore, be obtained from the actual balance B by adjusting government revenues and expenditures for the impact of cyclical fluctuations:

Bs-B=Σt=0I(Tts-Tt)-Σt=0J(Gjs-Gj)

where Ti and Gj are the categories of revenues and expenditures that depend on the cycle.

8. Estimates of the structural balance were derived here by a simple cyclical adjustment of the main categories of revenues Ti (income tax, corporate tax, social security contributions, and indirect taxes) and unemployment benefits UB (including expenditure on labor market programs):

Bs-B=Σi=04Ti([YpY]α1-1)-UB[usu-1]

with Y and Yp the actual and potential GDP, and u and us the actual and structural unemployment rate, respectively; and αi the elasticity of the different categories of tax with respect to output.

Potential output, structural unemployment and revenue elasticities

9. Measures of potential output and the output gap were obtained by using the Hodrick-Prescott (HP) filter, applied with a detrending parameter X equal to 400. Official medium-term projections were taken into account in order to limit end-point biases (Chart 2). The estimates suggest that the output gap has been significantly reduced in recent years, from more than 5 percent of GDP in 1993 at the trough of the recession to 2½ percent hi 1996. With potential output growth close to 2 percent per year, the output gap would be gradually closed by 2000. This is consistent with the medium-term macroeconomic scenario outlined by the Ministry of Finance (April 1997).

Chart 2.
Chart 2.

Sweden: Output Gap and NAIRU Estimates

Citation: IMF Staff Country Reports 1997, 096; 10.5089/9781451835847.002.A001

Sources: Konjunktur Institute; and staff estimates.1/ Output gap estimates from the HP filter with different detrending parameters λ, the nonparametric method by Coe and McDermott (1996) and a standard production function approach as in Giorno et alii (1995).2/ Trend unemployment estimates for the NAWRU (non-accelerating wage rate of unemployment) and from a flexible Okun and Beveridge curve as in Elmeskov (1993) and Giomo et alii (1995)

10. There is, however, considerable uncertainty concerning output gap measures. In particular, estimates from the HP filter with a lower detrending parameter, or from other smoothing techniques such as the non-parametric approach of Coe and McDermott (1996), indicate a smaller amount of slack in the economy. A simple production function approach, such as that used by Giomo and others (1995), yields estimates similar to those of the staff, with actual output 2½ percent below its potential in 1996. But these estimates depend on underlying measures of structural unemployment, the degree of utilization of the factors of production, and additional assumptions for trend factor productivity, which are also quite uncertain.4 The uncertainty concerning output gap measures is also underscored by recent estimates by the Riksbank (June 1997) ranging from 0 to 4½4 percent at the end of 1996 (see Apel and others, 1996, and Apel and Jansson, 1997).

11. The indicator of trend unemployment used in the structural balance calculations is based on estimates of the non-accelerating wage rate of unemployment (NAWRU), obtained as in Giorno and others (1995). It suggests that the recent increase in the actual open unemployment rate reflects an important rise in its structural component, from about 2 percent in the early 1980s to nearly 7 percent more recently (Chart 2). Other indicators, derived from a flexible Okun curve or from unfilled vacancies and a flexible Beveridge curve, would point to a similar increase, albeit of a somewhat smaller magnitude.5

12. The revenue elasticities used for the different categories of tax αi were drawn from Giorno and others (1995): 1.4 for personal income tax, 2.4 for corporate tax, 1.0 for indirect taxes and 1.2 for social security contributions.

Cyclical and structural balance

13. The staff’s estimates of the cyclical and structural components of the government financial and primary balances are presented in Table 2 and Chart 3. They confirm the conclusions of Arnason (1996) and Fall (1996), who have shown that structural factors contributed significantly to the fiscal crisis of the early 1990s: the structural primary balance deteriorated from a surplus of 2 percent of GDP in 1989 to a deficit of 6½ percent of GDP in 1993, accounting for about half of the decline in the actual primary balance. Conversely, the estimates show a considerable structural strengthening in recent years, the primary balance rebounding from a structural deficit of 5 percent of GDP in 1994 to a structural surplus of 3 percent of GDP in 1996, accounting for most of the 10 percent increase in the actual primary balance. Based on official projections, the structural primary surplus would further strengthen to 4 percent in 1998, before easing slightly to 3½ percent of GDP in 1999–2000.

Chart 3.
Chart 3.

Sweden: Structural Fiscal Balance and Impulse

(In percent of GDP or potential GDP)

Citation: IMF Staff Country Reports 1997, 096; 10.5089/9781451835847.002.A001

Sources: Konjunktur Institute; Ministry of Finance; and staff calculations.1/ Staff estimates. See Table 2 and Giorno and others (1995) for methodology.2/ Staff estimates. See Table 2 and Heller and others (1986) for methodology.

14. The results also suggest a cyclical sensitivity of 0.9 for Sweden’s public finances; with a 1 percent increase in the output gap inducing an automatic deterioration of 0.9 percent of GDP in the government financial balance. This value is consistent with the results of Ribe (1995) and Fall (1996) who identify a cyclical sensitivity of 1 and 0.9, respectively, with a contribution of 0.6–0.8 due to revenues and 0.2–0.3 due to expenditures, and falls well within the range of ¾to 1 found by most other studies.

15. Such a cyclical sensitivity appears relatively high by international standards (see, for instance, Jaeger, 1993; Giorno and others, 1995; and Ribe, 1995). This feature reflects: (i) the high tax share; (ii) higher-than-average revenue elasticities for some categories of tax; and (iii) the rather generous unemployment benefit system and the relatively high share of such expenditures in GDP. Recent changes in the Swedish tax and transfer system should have helped, however, to reduce the size of these automatic stabilizers; and recent estimates from simulations on microeconomic data by the Ministry of Finance suggest a lower budget sensitivity of ¾.

D. Accounting for the Improvement in the Structural Balance

16. The target to balance the budget in 1998 implies an improvement of the financial balance of 10¼ percent of GDP between 1994 and 1998, with a slightly larger improvement of 11 percent of GDP of the primary balance (Table 3). With the output gap projected to decline to 1½ percent from 3½ percent in 1994, cyclical factors would account for only 2 percentage points of GDP of the fiscal improvement with structural factors accounting for the remaining 9 percentage points of GDP.

Table 3.

Sweden: Improvement in the General Government Structural Balance, 1995–98

article image
Sources: Ministry of Finance; and staff calculations.

Projections by the Ministry of Finance (Sweden’s Economy, April 1997).

Staff estimates.

17. This substantial structural improvement results in large part from the budget reinforcements adopted in 1994–96. The different fiscal packages of the original consolidation program of 1994–95 and the supplementary measures adopted in the spring of 1996 were intended to yield net savings of about SEK 125.5 billion, or 8 percent of GDP, during 1995–98, with revenue reinforcements and expenditures cuts contributing similar amounts (Table 4). The effect of the measures, however, appears to have been felt more strongly already in the first two years than estimated initially. In particular, both public consumption and investment were weaker than expected in 1996, with the deficit of 2.5 percent of GDP only about half the level initially budgeted. The estimated strengthening of the government structural balance and common indicators of the fiscal impulse, such as those proposed by Heller and others (1986), also show that the withdrawal of fiscal stimulus in 1996 was exceptionally high, reaching some 6 percent of GDP.

Table 4.

Sweden: Fiscal Consolidation Program

article image
Source: Ministry of Finance; and staff calculations.

Net of reductions in revenue induced by expenditure cuts.

Since presentation of the original proposals, minor adjustments have been made in the distribution of revenue and expenditure.

REFERENCES

  • Apel M., J. Hansen and H. Lindberg, 1996, “Potential Output and Output Gap,” Sveriges Riksbank Quarterly Review, 1996:3 (Stockholm: Sveriges Riksbank).

    • Search Google Scholar
    • Export Citation
  • Apel M., J. and P. Jansson, 1997, “System Estimates of Potential Output and the NAIRU,” mimeo (Stockholm: Sveriges Riksbank).

  • Arnason, B., 1996, “The Deterioration in the Fiscal Position in the Early Nineties,” in Sweden -Selected Issues, IMF Staff Country Report No 96/226, (Washington: International Monetary Fund).

    • Search Google Scholar
    • Export Citation
  • Coe D., and C.J. McDermott (1996), “Does the Gap Model Work in Asia,” IMF Working Paper 96/69 (Washington: International Monetary Fund).

    • Search Google Scholar
    • Export Citation
  • Elmeskov, 1993, “High and Persistent Unemployment: Assessment of the Problem and its Causes,” OECD Economic Department Working Paper No. 132, (Paris: Organization for Economic Cooperation and Development).

    • Search Google Scholar
    • Export Citation
  • Fall J., 1996, “Government Finance in a Structural Perspective,” Sveriges Riksbank Quarterly Review, No 1996:4, (Stockholm: Sveriges Riksbank).

    • Search Google Scholar
    • Export Citation
  • Giorno C., P. Richardson, D. Roseveare and P. van der Noord, 1995, “Estimating Potential Output, Output Gaps and Structural Budget Balances,” OECD Economic Department Working Paper No. 152, (Paris: Organization for Economic Cooperation and Development).

    • Search Google Scholar
    • Export Citation
  • Heller P.S., R. D. Haas, and A. S. Mansur, 1986, A Review of the Fiscal Impulse Measure, IMF Occasional Paper No. 44, (Washington: International Monetary Fund).

    • Search Google Scholar
    • Export Citation
  • Jaeger A., 1993, “Structural Budget Indicators for the Major Industrial Countries,” in World Economic Outlook (October 1993), (Washington: International Monetary Fund).

    • Search Google Scholar
    • Export Citation
  • Ministry of Finance, 1996, 1997, Sweden’s Economy (various issues), (Stockholm, April 1996 and May 1997).

  • Ribe F., 1995, “Structural Fiscal Balance in Smaller Industrial Countries,” in World Economic Outlook (May 1995), (Washington: International Monetary Fund).

    • Search Google Scholar
    • Export Citation
  • Sveriges Riksbank, 1997, The Inflation Report (various issues) (Stockholm, March and June 1997).

1

Prepared by Antoine Magnier.

2

Unless specified otherwise, the figures in this chapter refer to the general government finances as measured in the Swedish National Accounts. The main differences between these figures and those derived from the European System of National Accounts (ESNA), which are used for the Maastricht criteria, reflect the fact that the former are recorded on a cash basis while the latter are on an accruals basis.

3

See Arnason (1996) for a detailed account of the fiscal crisis of 1990–93.

4

In the staffs production function approach, private and public sectors are separated, with the latter assumed to remain at potential; actual labor input is measured by the number of hours worked and measures of trend unemployment are based on NAWRU estimates.

5

The indicator based on the Beveridge curve appears less reliable, since it is subject to strong end-of-sample biases.

Sweden: Selected Issues
Author: International Monetary Fund