Sweden
Staff Report for the 2000 Article IV Consultation
Author:
International Monetary Fund
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Publication Date:
07 Sep 2000
eISBN:
9781451835878
Language:
English
Keywords:
ISCR; CR; core rate of inflation; IMF staff projection; consumer price inflation; core rate; wage inflation; formation process; staff estimate; structural surplus; wage differentiation; inflation target range; Wages; Inflation
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In Sweden, the authorities have indicated that their medium-term fiscal strategy is based on restraining expenditures through nominal ceilings and maintaining a fiscal surplus target of 2 percent of gross domestic product (GDP), measured as an average over the cycle. The mission has praised the authorities’ medium-term fiscal strategy but argued that assuming that a structural surplus of 2 percent is maintained and that policy slippages on expenditures are avoided, the room for tax cuts is about 4 percent of GDP over the 2001–03 period, considerably more than envisaged by the authorities.

Abstract

In Sweden, the authorities have indicated that their medium-term fiscal strategy is based on restraining expenditures through nominal ceilings and maintaining a fiscal surplus target of 2 percent of gross domestic product (GDP), measured as an average over the cycle. The mission has praised the authorities’ medium-term fiscal strategy but argued that assuming that a structural surplus of 2 percent is maintained and that policy slippages on expenditures are avoided, the room for tax cuts is about 4 percent of GDP over the 2001–03 period, considerably more than envisaged by the authorities.

I. Economic background

1. Sweden is currently enjoying a robust economic recovery with low inflation. Real GDP growth accelerated to 3.8 percent in 1999, as a result of a strengthening of private consumption and a firming in net exports (Figure 1 and Table 1). Since early 1999, employment has increased by over 4 percent with the open unemployment rate (which excludes labor market programs) falling to 4.1 percent in May 2000. Consumer price inflation has been exceptionally low in Sweden since early 1996, invariably below the EU average and within the lower part of the Riksbank’s inflation target of 2 percent plus or minus 1 percent (Figure 2). The core rate of inflation (which excludes the effects of interest rates, indirect taxes, and petroleum prices) has fallen in recent months to 0.4 percent year-on-year in June. Stock prices have risen rapidly over the past year by over 50 percent, but house price inflation remains moderate at 7 percent.

Figure 1.
Figure 1.

Sweden: Output Developments and Prospects

(Annual percentage change)

Citation: IMF Staff Country Reports 2000, 118; 10.5089/9781451835878.002.A001

Source: Statistics Sweden and National Institute of Economic Research.1/ Contribution to GDP growth.
Table 1.

Sweden: Selected Economic and Financial Indicators

(Percent change, unless otherwise noted)

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Sources: Ministry of Finance; Statistics Sweden; the Riksbank; and staff estimates. Sources: Ministry of Finance; the Riksbank; and IFS.

Contribution to GDP growth.

Percent of GDP.

May 2000.

June 2000.

Figure 2.
Figure 2.

Sweden: Inflation Developments

(Percent change from a year ago)

Citation: IMF Staff Country Reports 2000, 118; 10.5089/9781451835878.002.A001

Sources: Statistics Sweden and the Riksbank.1/ UND1 = CPI excluding changes in indirect taxes and subsidies and interest costs for owner-occupied housing; UNDIXP also excludes changes in petroleum prices; the horizontal lines indicate the inflation target range, centered at 2%.2/ Inflation expected one year ahead.

2. While output growth is strong, the economy is not particularly advanced in the cycle. The recent period of growth still reflects the rebound from the severe recession of the early 1990s when output fell by 5 percent. Moreover, one of the main drivers of economic growth is the high-tech sector, which has contributed about ½ percentage point to output growth over the past five years. This sector is not an intensive user of labor resources; growth in labor productivity has contributed most of the output increase of this sector over this period, averaging over 30 percent per annum. Thus some economic slack remains. In particular, while the ratio of employment to the working age population (aged between 16 and 64) has increased over the past few years it is still 10 percentage points below its previous cyclical peak. Moreover, although the open unemployment rate is low, a broader measure of unutilized labor including those on labor market programs and education initiatives totals over 8 percent of the labor force compared to 3 percent prior to the recession of the early 1990s. Unfilled vacancies are only slightly above half of their previous cyclical peak and labor shortages are only visible in specific areas such as high-tech engineers and construction workers in the main urban centers. Wage pressures are largely absent.

3. In 2000 and 2001, the rate of economic growth is expected to remain firm with subdued inflationary pressures. The staff project that the economy will grow by about 4½ percent this year, and 3½ percent in 2001, with contributions from all demand components (Table 1). Employment growth should sustain its recent momentum, with the open unemployment rate dropping below 4 percent. The core inflation rate should rise only gradually to 1½ percent in 2001 with real wages remaining at or below productivity growth. This forecast, comparable to the Riksbank’s projection, is more optimistic than the Ministry of Finance’s forecast which estimates growth at 3¾ percent this year, falling to 3 percent in 2001. The main risks to the forecast would include a sizeable wage increase during the new wage round next year, a large drop in equity prices, and a hard landing in the United States. While a drop in equity prices would have macroeconomic effects through the wealth channel, simulations of such a scenario undertaken by the major banks indicate that they would not be seriously affected because of their current strong capital position.

II. Report on the discussions

4. Against the backdrop of strong economic growth, the mission focused on medium-term structural issues-including tax policy, the wage formation process, and the unemployment insurance system-where changes were needed to expand the supply side of the economy and prevent the current economic expansion from ending prematurely.

A. Fiscal Policy

5. The authorities indicated that their medium-term fiscal strategy was based on restraining expenditures through nominal ceilings and maintaining a fiscal surplus target of 2 percent of GDP, measured as an average over the cycle. These policies, adopted in 1997 followed an ambitious fiscal consolidation program containing both deficit reducing expenditure and revenue measures. As a result of adopting these policies Sweden achieved a sizeable structural fiscal surplus of 3¾ percent of GDP in 1999 which set the stage for tax cuts over the medium term (Table 2). The authorities took a first step in this direction in the 2000 budget by raising the threshold of the highest tax brackets and offsetting ¼ of the employee pension contribution through income tax credits. Based on the Spring Budget Bill and assuming no further tax cuts, the authorities estimate that the structural surplus would reach 3½ percent in 2001 and 4½ percent of GDP by 2003, implying room for tax cuts of about 2½ percent of GDP over the medium term.

Table 2.

Sweden: General Government Fiscal Operations 1/

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Sources: Ministry of Finance, and Staff estimates.

Projections for 2001–2003 are before tax cuts.

6. The mission praised the authorities’ medium term fiscal strategy but argued that, assuming that a structural surplus of 2 percent was maintained and that policy slippages on expenditures were avoided, the room for tax cuts was about 4 percent of GDP over the 2001–03 period, considerably more than envisaged by the authorities. The revenue forecasts of the authorities were considerably below those of the IMF staff on account of their lower growth forecast for this year and next and mainly, their lower level of potential growth (2 percent). The staff’s growth forecasts for 2000 and 2001 were comparable to the consensus forecasts. Moreover, the staff considered that with the continued high growth rate of productivity in the high technology sector and with the gradual recovery of the ratio of employment to the working-age population, the growth rate of potential output was at least 2½ percent (within the range projected by the Riksbank).

7. Given the extremely high tax burden in Sweden, the highest in the OECD, the IMF staff urged the authorities to seize the opportunity to strengthen the incentives to work, save, and invest, through launching an ambitious tax reform program encompassing labor and capital taxes. The staff endorsed the authorities’ strategy of offsetting the pension fees paid by employees through income tax credits (which would stimulate work incentives at the lower end of the income scale) and suggested supplementing it with lower marginal income taxes, in particular, through replacing the two state income tax rates of 20 and 25 percent with a single rate of 15 percent. On capital incomes, the staff suggested lowering the capital income tax rate (currently at 30 percent) and raising the threshold on wealth taxation to stimulate entrepreneurship, saving, and investment. The staff tried to dissuade the authorities from maintaining the freeze on the tax valuation of housing, especially since this sector was already heavily favored from a fiscal standpoint.

8. Beyond the difference in views on the medium-term prospects for the structural budget surplus, the authorities indicated that they were not inclined to adopt a comprehensive program of tax cuts because this could lead to overheating. The staff believed that the stimulative effects of a large tax cut would be partially mitigated by the simultaneous reduction in expenditure which had a stronger demand impact—the staff projected a decline in cyclically adjusted primary expenditure of 2 percentage points of GDP during the period 2001–2003. Moreover, the automatic stabilizers were much more powerful in Sweden than in other countries and therefore these would also provide some restraint on aggregate demand. The nature of the tax cuts recommended by the staff would also expand the supply of resources in the economy because of their incentive effects. All combined, the staff did not think that the tax cuts would be a source of inflationary risk. Nonetheless, the mission recommended a cautious approach of smoothing tax cuts over time, dividing the available resources evenly over the 2001–03 period. Moreover, if next year’s wage round resulted in a sharp increase in wages, tax cuts for 2002–03 that could be expansionary (mainly, the increase in income tax credits to offset the pension fees) should be put on hold.

9. On this matter, however, it should also be noted that the government depends on the support of its coalition partners in Parliament—the Green and the Left parties—that are opposed to lowering state income tax rates and taxes on wealth and capital. These parties consider that cutting taxes could ultimately endanger the development of the welfare state. Against the backdrop of a strong budgetary position, the Left party is putting pressure on the government to raise the expenditure ceilings and reestablish some of the expenditures that were cut during the crisis. Raising the expenditure ceiling is also motivated by the fact that sickness and disability expenditures are running far ahead of projections—related to the recent strong upturn but still largely unexplained—so that cuts are being made elsewhere to satisfy the target. The staff stressed that the existing expenditure ceilings, set through 2003, should be maintained and that any overruns in individual categories should be offset elsewhere in the budget. Moreover, savings resulting from lower than expected unemployment benefits should not be spent on other expenditure items.

B. Monetary Policy

10. The mission welcomed the Riksbank’s cautious interest rate increases since last autumn. The Riksbank raised the repo rate by 85 basis points between November and February as it continued to implement monetary policy in a forward-looking inflation targeting framework (Figure 3). Riksbank officials indicated that they had kept the repo rate at 3.75 percent in recent months in light of a moderate inflation forecast and lower than expected inflation outcomes (core inflation dropped below 1 percent). The mission agreed that there was not a pressing need for further rate hikes in the absence of resource pressures or signs of an upward trend to inflation.

Figure 3.
Figure 3.

Sweden: Interest Rate Developments

(In percent)

Citation: IMF Staff Country Reports 2000, 118; 10.5089/9781451835878.002.A001

Sources: IMF, International Financial Statistics, and INS.

11. There was agreement between the monetary authorities and the staff that a less accommodative stance was likely to be needed later this year. Although two-year ahead inflation prospects are on target at current interest rates, both the staff and the Riksbank saw an increased likelihood that as the business cycle continues to mature, a return to a cyclically neutral level of interest rates would be required. Indeed, the authorities did not rule out rate hikes later this year, especially if they saw some wage momentum ahead of the major wage negotiation round next spring.

12. The monetary authorities broadly concurred with the mission’s view that the combination of tax cuts and somewhat higher interest rates would not threaten the economic expansion. If tax cuts were to inject a slightly expansionary impulse to the economy that caused the inflation forecast to rise above 2 percent, the monetary authorities acknowledged that an increase in interest rates could be used to offset the stimulus. They agreed with the mission that Sweden’s external sector has been competitive at current exchange rates with room for some moderate appreciation over the medium-term (Figure 4 and Table 3). Nonetheless, the staff argued that it would be important to keep in mind the need to avoid an excessive appreciation of the exchange rate vis-à-vis the euro to facilitate a smooth entry into the euro area if Sweden chooses to adopt the single currency.

Figure 4.
Figure 4.

Sweden: Exchange Rate Developments

Citation: IMF Staff Country Reports 2000, 118; 10.5089/9781451835878.002.A001

Source: IMF, International Financial Statistics
Table 3.

Sweden: Balance of Payments

(In billions of US Dollars)

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Source: Riksbank

Capital and financial accounts are defined as in IFS except that reserve assets here are included in the financial account instead of being a separate item.

Staff projections.

C. Structural Policies

13. Since the mid-1970s Sweden’s wage formation system has been criticized for its lack of wage differentiation and periodic excessive wage demands which required large exchange rate adjustments to maintain competitiveness. While in recent years aggregate wage agreements have been quite modest, concerns remain that as the effects of the crisis of the early 1990s wane, the wage formation process could once again become a source of inflation and low productivity growth. To avoid this outcome a government commission presented concrete guidelines for improving the wage formation process.1 Even though the recommendations of the commission were not fully implemented and some sectors (industry and government) contracted out of the government’s new mediation process through setting their own procedures, the need for wage agreement guidelines was now generally recognized. Moreover, increasing emphasis was being placed on individual wage agreements at the local level at the expense of the centrally negotiated minimum increases, which could help to contain wage pressures through avoiding the cumulation of the wage hikes at the central and local levels. The test of course would come in the new wage round set to commence next Spring against the backdrop of a lower unemployment rate.

14. On wage differentiation, the authorities indicated that much greater attention was being placed on properly rewarding differences in work effort. However, differentiating wages based on varying profit developments within industrial sectors or investments in education was much less evident. Historically, wage equality had been an explicit policy choice of successive Swedish governments with the lack of wage differentiation among industrial groups forcing the least productive firms out of business. In the current environment, where productivity enhancements depended on the availability of a highly skilled mobile workforce, the authorities acknowledged that a lack of wage differentiation could delay the speed of economic adjustment and hamper growth prospects.

15. The authorities argued that their strategy of improving training and education, implemented during the past decade, was beginning to bear fruit. This was evidenced by the achievement of a sharp increase in employment over the past two years without noticeable wage pressures. Individuals were finding it easier to switch from active labor market programs into regular employment—this development was partly responsible for the sharp decline in active labor market programs since last summer. While recent evaluations of these programs during the early 1990s were critical (the majority of those on wage subsidies had returned to unemployment soon after the subsidies expired and those on youth programs had a lower probability of becoming unemployed relative to a control group with similar characteristics), the authorities argued that these evaluations had been conducted over a period when economic activity was low in Sweden. It was not clear whether similar results would hold true in the current strong upswing.

16. A committee set up to review the functioning of the unemployment insurance (UI) system had presented proposals to enhance job search through lowering the unemployment benefit over time. While the proposals implied that those not actively searching for jobs would receive lower benefits, the staff argued that the suggested changes were unlikely to achieve the desired results: the current system already contained a fairly strict search clause; the problem with the clause was that it was not being implemented properly. The authorities acknowledged that in many tightly-knit communities the close ties between the unemployment benefit recipient and the official of the employment agency had led to the weak implementation of rules. To address this problem, the UI proposals suggested transferring the authority for deciding on benefit eligibility to a central agency to release the local employment official from taking the decision.

17. The reform of the pension system was now being completed and was expected to be fully implemented in 2001. The rationale for the reform was to link benefits more closely to contributions, allow a portion of funds to be privately invested, ensure the long-run solvency of the system, and introduce additional flexibility into retirement options. While future pension benefits could be adversely affected by upward revisions to demographic projections and downward revisions to the projected rate of income growth or the return on investment, the solvency of the system was secure because a trigger mechanism (lowering the rate of indexation) would be adopted under such circumstances. However, to limit the likelihood that such a trigger mechanism would need to be introduced, the staff recommended that the authorities enhance their efforts in raising the effective retirement age. Raising or eliminating the statutory retirement age, currently at 65, would be a possibility.

III. Staff appraisal

18. Sound macroeconomic management has made significant contributions to the rebound in the Swedish economy from the deep recession of the early 1990s. Although the economy is not yet particularly advanced in the cycle and economic growth is strong, more structural reform is needed to sustain the expansion. Notwithstanding the sharp reduction in the ratio of government expenditures to GDP in recent years, the role of government remains large in comparison with other industrial countries. This level of government is financed by numerous taxes which considerably weaken and distort the supply side. Other prominent rigidities include the limited amount of wage differentiation and weak job search incentives. These rigidities may partially explain Sweden’s decline into the lower half of the income-per-capita league among industrial countries and why the benefits of new technologies in terms of higher productivity growth are yet to be evident outside the telecommunications industry.

19. On fiscal policy the authorities must resist mounting pressures to use the existing budgetary room for increased spending. Sustaining the expansion will require, at a minimum, maintaining the current expenditure ceilings to provide room for tax cuts. Indeed, the authorities should go further and take account of the rapid decline in unemployment compensation by staying below the expenditure ceilings by a corresponding amount. Measures should also be taken to correct policy slippages, including those currently taking place in sickness and disability benefits. Net budgeting (the practice of recording expenditures as negative revenues) masks the problems and should cease.

20. A broad-based reduction in the tax burden should be implemented to foster incentives to work, save, and invest. Provided that the existing expenditure ceilings are respected and the authorities maintain their 2 percent structural surplus target, the staff estimate that there should be room for tax cuts cumulating to 4 percent of GDP over the 2001–03 period to finance this reform. To err on the side of caution, the tax cuts should be spread uniformly over this period with updates for 2002 and 2003 made on the basis of economic and fiscal developments in 2001. A comprehensive tax reform package could include offsetting employee pension fees through income tax credits, lowering state income tax rates and the capital tax rate, and raising the wealth tax threshold. The tax cuts would coincide with a corresponding decline in cyclically adjusted expenditures and would expand the supply of resources because of their incentive effects. Taking these factors into account, the fiscal impulse would be quite limited and could easily be offset through a slight tightening in the monetary policy stance.

21. The Riksbank is to be congratulated for not having raised interest rates too aggressively early in the business cycle. However a less accommodative stance will likely be required by Fall 2000 to keep inflation on target through 2002. As long as moderation persists in the coming wage round, and even with the suggested tax cut, a gradual return to a cyclically neutral level of interest rates in the first half of 2001 should probably be sufficient to keep inflation prospects for the next two years in line with the 2 percent target.

22. The wage formation process is changing through increased emphasis on mediation procedures and increased differentiation based on effort. The real test will come during the new wage round set against the backdrop of a lower unemployment rate. To avoid returning to the wage inflation of the 1970s and 1980s, the authorities will have to remain vigilant and, if necessary, implement more fully the recommendations of the Oberg commission. While wage differentiation is present in the high-tech sector, it needs to become more widespread. Increased wage flexibility could be accomplished through offering more wage variation with sectors and across skill levels while maintaining an aggregate ceiling for the wage bill.

23. The rationale for reforming the unemployment insurance system is commendable but tightening the relationship between the benefit level and the intensity of job search is unlikely to succeed because of the difficulty in assessing whether an individual is actively searching. Instead, the staff recommend offering a generous level of unemployment benefit for the first few months of unemployment but significant cuts later on, say after 6 and 12 months of unemployment. Sweden’s new pension system is laudable but would benefit from an increase in the current statutory retirement age so that the enhanced retirement options embodied in the reform could be fully utilized.

24. It is proposed that the next Article IV consultation with Sweden be held on the standard twelve month cycle.

Figure 5.
Figure 5.

Sweden: Labor Market Developments

Citation: IMF Staff Country Reports 2000, 118; 10.5089/9781451835878.002.A001

Sources: Statistics Sweden and OECD.1/ Open unemployment plus labor market measures.2/ Source is OECD.

APPENDIX I

Sweden: Core Statistical Indicators

as of July 14, 2000

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APPENDIX II Sweden: Fund Relations

As of June 30, 2000

I. Membership Status: Joined: 08/31/1951; Article VIII

II. General Resources Account:

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III. SDR Department:

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IV. Outstanding Purchases and Loans:None

V. Financial Arrangements:None

VI. Projected Obligations to Fund:None

VII. Exchange Rate Arrangements: The Krona has been floating since November 19, 1992.

Under Decision 144-(52/51), Sweden has notified the Fund that it has lifted exchange restrictions vis-à-vis: the Socialist People’s Libyan Arab Jamahiriya and areas of the Republic of Bosnia and Herzegovina under the control of the Bosnian Serb forces. Sweden has amended restrictions vis-à-vis the Federal Republic of Yugoslavia (Serbia and Montenegro) and maintains restrictions vis-à-vis Angola (EBD/96/91, 7/12/96) and Iraq (EBD/90/286, 9/10/90).

VIII. Article IV Consultation: Discussions for the 1999 Article IV consultation were held in Stockholm, May 19-26, 1999, and concluded by the Executive Board on August 25, 1999.

IX. The Article IV consultations with Sweden are on the standard twelve-month cycle.
1

The Öberg commission proposed the establishment of a new Mediation Authority with the right to intervene to coordinate wage agreements, delay industrial action, send disputes to compulsory arbitration, make unions pay the cost of industrial action, and prohibit industrial action against self-employed and family enterprises. After facing stiff resistance from unions, the last two proposals were dropped.

1

Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country’s economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country’s authorities. In this PIN, the main features of the Board’s discussion are described.

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Cover IMF Staff Country Reports
Sweden: Staff Report for the 2000 Article IV Consultation
Author:
International Monetary Fund
Volume/Issue:
Volume 2000: Issue 118
Publisher:
International Monetary Fund
ISBN:
9781451835878
ISSN:
1934-7685
Pages:
25
DOI:
https://doi.org/10.5089/9781451835878.002
Figure 1.

Sweden: Output Developments and Prospects

(Annual percentage change)
Figure 2.

Sweden: Inflation Developments

(Percent change from a year ago)
Figure 3.

Sweden: Interest Rate Developments

(In percent)
Figure 4.

Sweden: Exchange Rate Developments
Figure 5.

Sweden: Labor Market Developments