2002 Article IV Consultation-Staff Report; Staff Statement; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Sweden

This 2002 Article IV Consultation highlights that a cyclical slowdown in domestic demand coupled with global economic weakness led to slower growth of Sweden in 2001. Private consumption stagnated despite rising disposable income, owing to adverse confidence and wealth effects from the continued plunge in stock prices. Exports suffered their weakest year in a quarter century, as telecom exports—the driving force behind the recent rapid growth—fell by about one-third. The weak krona and supportive fiscal and monetary policies, however, helped contain the severity of the slowdown.


This 2002 Article IV Consultation highlights that a cyclical slowdown in domestic demand coupled with global economic weakness led to slower growth of Sweden in 2001. Private consumption stagnated despite rising disposable income, owing to adverse confidence and wealth effects from the continued plunge in stock prices. Exports suffered their weakest year in a quarter century, as telecom exports—the driving force behind the recent rapid growth—fell by about one-third. The weak krona and supportive fiscal and monetary policies, however, helped contain the severity of the slowdown.

I. Introduction and Background

1. Sweden’s strong performance of the past five years is rooted in a credible, rule-based macroeconomic policy framework (Table 1). The Riksbank’s inflation targeting regime coupled with the authorities’ steadfast implementation of a medium-term fiscal framework aimed at a general government surplus of 2 percent of GDP over the cycle has restored policy credibility and financial stability following the crisis of the early 1990s. Strong public finances have enabled a process of gradual reduction in the high tax burden to begin. Structural reforms reinforced by EU membership have helped raise efficiency and mitigated distortions associated with Sweden’s large welfare state.1 These policies paved the way for growth averaging over 4 percent per annum during 1998-2000 driven by large productivity gains, especially in the technology sector. The authorities also made substantial progress in addressing the coming demographic challenge by implementing a pension reform that restored actuarial balance to the public pension scheme.

2. The global economic weakness and slumping domestic demand led to a slowdown in 2001. Following impressive growth in 2000, exports suffered their weakest year in a quarter century, as telecom exports—the driving force behind the recent rapid growth—fell by about 35 percent. Private consumption stagnated under the weight of adverse confidence and wealth effects from the continued plunge in stock prices, despite rising disposable income. The weak krona and supportive fiscal and monetary policies, however, helped contain the severity of the slowdown (Figure 1).

3. Despite the slowdown, resource utilization remained high and sectoral labor shortages persisted. Participation rates remained among the highest in the world, notably for women and older people. With continued low unemployment (Figure 2), wage growth accelerated to 4¼ percent, reflecting strains, particularly in the services, construction and local government sectors. Wages grew by more than in the main trading partners, exacerbating the adverse impact of the cyclical slowdown in productivity growth on unit labor costs. With a sharp but brief slowdown in activity following a prolonged period of rapid growth, the size of the output gap was more than usually uncertain.2

Figure 1.
Figure 1.

Sweden: Output Developments and Prospects

(Annual percentage change)

Citation: IMF Staff Country Reports 2002, 159; 10.5089/9781451835892.002.A001

Sources: Statistics Sweden; and staff projections
Figure 2.
Figure 2.

Sweden: Labour Market Developments

Citation: IMF Staff Country Reports 2002, 159; 10.5089/9781451835892.002.A001

Sources: Statistics Sweden; and OECD1/ Open unemployment plus participants in active labor market programs that are excluded from open unemployment (e.g., retraining, and youth employment schemes).

4. Inflation persisted well above the Riksbank’s target of 2 percent, reflecting transitory influences as well as the high degree of resource use (Figure 3). Four years of falling unemployment and rapid growth intensified resource pressures as output overtook potential in 2000. While demand pressures eased as growth slowed down, structural rigidities combined with a sequence of relative price shocks contributed to the persistence of wage and price inflation. At the same time, the fading of the beneficial effects of earlier deregulation in telecom and electricity sectors, together with one-off factors such as animal disease and higher oil prices added to inflation pressures. Headline inflation remained at the upper edge of the Riksbank’s tolerance band of ±1 percent around its target, before falling to 2 percent in May 2002. Domestic underlying inflation peaked at 5 percent in January 2002, but imported inflation remained low, mitigated by a lower-than-expected pass through of the depreciation, which was widely seen as temporary.


Sweden: Headline and Underlying Inflation 1/

(Percentage change over 12 months)

Citation: IMF Staff Country Reports 2002, 159; 10.5089/9781451835892.002.A001

1/ The underlying index is the CPI excluding changes in indirect takes and subsides and interest costs for owner occupied housing the domestic component also excludes changes in import prices.

5. The krona has turned around, reversing a trend of prolonged weakness (Figure 4). In the fifteen months through September 2001, the krona depreciated by16 percent against the euro. Relatively low Swedish interest rates (Figure 5), the bursting of the bubble on Sweden’s technology-centered equity market, as well as the relaxation of investment rules for pension funds from 2001 led to sizable portfolio outflows, contributing to this weakening. The Riksbank intervened in June 2001 to stem the krona’s slide and followed it up with a rise in the policy interest rate. In the event, the krona continued its fall through September 2001 before appreciating by 4½ percent against the euro through May 2002—prompted in part by political signals about the possible adoption of the euro. Competitiveness, nevertheless, remained adequate as suggested by the continued healthy growth of exports other than those of information technology products, and large current account surpluses. Relative unit labor costs have declined by about 10 percent vis-á-vis the main trading partner countries in the past three years.


Sweden: Trade weighted and Euro Exchange Rate

Citation: IMF Staff Country Reports 2002, 159; 10.5089/9781451835892.002.A001

Figure 3.
Figure 3.

Sweden: Inflation Developments

(Percent change from a year ago)

Citation: IMF Staff Country Reports 2002, 159; 10.5089/9781451835892.002.A001

Sources: Statistics Sweden and the Risksbank1/ UNDIX = CPI excluding changes in indirect taxes and subsidies and interest costs for owner-occupied housing; UNDINHX also excludes changes in import prices; the horizontal lines indicate a 1 percent range around the 2 percent inflation target.2/ Inflation expected one year ahead.
Figure 4.
Figure 4.

Sweden: Exchange Rate Developments

Citation: IMF Staff Country Reports 2002, 159; 10.5089/9781451835892.002.A001

Source: IMF, International Financial Statics
Figure 5.
Figure 5.

Sweden: Asset Price and Interest Rate Developments

Citation: IMF Staff Country Reports 2002, 159; 10.5089/9781451835892.002.A001

Sources: Statistics Sweden; Risk bank; IMF International Financial Statistics, and INS1/ Repo rate was 63 percent in September 1992.

II. The Policy setting and the Short-term outlook

6. The weak krona and low interest rates made for accommodating monetary conditions in 2001. The krona’s weakness, especially during a period of high resource use, led to concerns on the part of the Riksbank about growing inflation risks. However, it refrained from raising rates, except for the 25 basis point increase in July 2001 to back up its intervention. Indeed, in the aftermath of the uncertainty following September 11 and in concert with the world wide move toward policy easing, interest rates were cut by 50 basis points. As uncertainty subsided, this easing was fully reversed in March-April 2002 to rein in persistent inflation pressures, contributing—together with the strengthening krona—to some tightening of monetary conditions. Although subsequently policy rates were kept unchanged, a tightening bias was maintained.


Sweden, US, and ECB: Policy Interest Rates

(In percent 1996–2002)

Citation: IMF Staff Country Reports 2002, 159; 10.5089/9781451835892.002.A001

7. Public finances remain strong, with fiscal policy firmly anchored in the medium-term framework (Table 2 and Figure 6). The framework is based on three elements: (i) a general government surplus target of 2 percent of GDP over the cycle, (ii) nominal ceilings on central government primary expenditure and old-age pension spending; and (iii) an ex ante balanced budget requirement for local governments. In 2001, the general government surplus rose to about 5 percent of GDP, benefiting from large dividend distributions and exceptionally high revenues from capital gains taxes. The fiscal stance—calculated as the change in the structural balance—was nevertheless expansionary to the tune of 1 percent of GDP.3

Sweden: General Government Finances, 2000-04

(In percent of GDP unless otherwise indicated)

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Source: Ministry of Finance.

Cyclically adjusted balance corrected for timing of tax receipts.

Figure 6.
Figure 6.

Sweden: Fiscal Developments and Prospects

(In percent of GDP)

Citation: IMF Staff Country Reports 2002, 159; 10.5089/9781451835892.002.A001

Sources: Statistics Sweden; and Ministry of Finance1/ Excluding interest expenditure and income.

8. The 2002 budget continued the authorities’ reform strategy. The third phase of the income tax reform—which gradually offsets earlier increases in social security contributions by income tax credits—was implemented, and the threshold for the state income tax was raised, lowering the marginal tax on labor. A number of other taxes were also reduced, with estimated tax cuts amounting to about 1 percent of GDP4. On the expenditure side, several benefits were raised with the intention of raising labor supply and improving education and health. With some offsetting cuts, expenditures rose by about ½ percent of GDP. With the fading out of one-off factors and a strong cyclical impact, the general government surplus is projected at 1.8 percent of GDP, which would be consistent with the medium-term surplus target.

9. An economic recovery has begun and is expected to gather speed in the second half of the year. National accounts estimates for the first quarter of 2002 suggest that private consumption has begun to pick up, buoyed by large gains in disposable income and continued strong employment. Rising foreign demand is likely to sustain net exports even with some further krona appreciation. Assuming a healthy pick-up in the world economy, activity is projected to strengthen further in 2003. The key downside risks to growth are possible adverse confidence effects from the continuing difficulties of the world telecom sector—Ericsson, the leading Swedish telecom company, continues to suffer from large losses and declines in its share price—and a weaker than-expected global recovery. A shrinking effective labor supply and continuing product and labor market rigidities could also undermine the supply response. The baseline projection is for inflation to recede toward the Riksbank’s two percent target over the two-year horizon, albeit still remaining somewhat above it. The negative output gap emerging in 2002 (on staff estimates) is expected to close in 2003. Upside risks to inflation include wage pressures stemming from increasing resource utilization and a possible adverse impact of higher recent inflation on expectations.

Sweden: Demand and Output

(Annual percent change)

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Source: Staff estimates and projections.

10. Despite structural reforms in recent years, product and labor market rigidities could hold back growth in the medium-term. The Swedish price level substantially exceeds the EU average in part due to market imperfections, notably in construction and retail trade. A compressed wage scale and relatively high marginal effective tax rates also contribute to work disincentives. In recent years, a surge in sickness absenteeism and continued high levels of disability retirement have led to diminishing effective labor supply. Finally, de facto rent control and employment protection regulations limit labor market flexibility. These factors could constrain potential growth in the coming years.


Sweden: Absence from the Work place in Percent of Labor Force

Citation: IMF Staff Country Reports 2002, 159; 10.5089/9781451835892.002.A001

III. The Policy Discussions

11. The discussions centered on the following main themes:

  • The appropriate stance of macroeconomic policy in the light of the incipient but still fragile recovery, the uncertainty about the output gap and the persistence of inflation pressures;

  • The medium-term fiscal framework and the ongoing debate on the implications for stabilization policy if Sweden were to decide to adopt the euro;

  • The need to refocus on the structural policy agenda—particularly in the areas of competition and deregulation, labor and housing market policies, and the growing problem of absenteeism–to raise potential growth.

A. Monetary Policy

12. Persistent inflation concerns made the recent monetary tightening inevitable. The authorities explained that unabated inflation pressures and upside risks to inflation prompted the decision to raise the policy rate by ½ percent earlier this year. There was agreement that this tightening should go some way toward containing inflation and wage pressures, and had underlined the Riksbank’s commitment to safeguarding the inflation target. Following a period in which Swedish policy interest rates were among the lowest in Europe, they now were above those in the euro area and the United States. As to the question of whether the tightening should have taken place earlier, officials noted the uncertainties clouding the world economic outlook as well as prospects for the Swedish economy around the turn of the year. In hindsight, however, it seemed clear that the degree of resource use in the economy had been underestimated.

13. The authorities argued that following the recent interest rate hike, a policy of wait-and-see was appropriate. There was reason to hope that the cyclical recovery in productivity combined with the projected moderate rise in unemployment and easing resource strains should contain unit labor costs to a level consistent with the inflation target. The mission agreed with the authorities that given the fragility of the prospective recovery, a wait-and-see approach with a tightening bias was appropriate. However, it emphasized that risks to the inflation target remained. If productivity failed to rebound or wage growth remained high, pressures on inflation—which is already above target—could accentuate as the recovery gathers pace. The authorities acknowledged these risks and stated their readiness to take prompt policy action if necessary.

14. The authorities expressed confidence that in the event of a decision to adopt the euro, Sweden’s sound macroeconomic fundamentals should ensure a smooth transition. Recent opinion polls suggested an incipient shift in public opinion in favor of the euro. An official decision to join would depend on the outcome of a referendum which the government has publicly signaled would be held in 2003. Sweden’s fiscal position was strong, public debt was below 60 percent of GDP and macroeconomic fundamentals were satisfactory. In view of Sweden’s recent inflation record and the fact that its inflation target was in line with that of the euro area with which it conducts most of its trade, the possibility of a conflict between the inflation and exchange rate objectives was viewed as remote. Thus, officials were confident that the transition from the inflation-targeting regime to exchange rate stability under ERM2 would be smooth. The mission saw little reason to disagree with this assessment.

15. The soundness of the financial system was confirmed by the FSSA assessment. The authorities expressed broad agreement with the conclusions of the recent FSAP exercise. Noting the potential sources of vulnerability—concentration of exposure to a few counterparties and residual risks in the securities settlement system, officials expressed their intention to strengthen further regulatory and supervisory arrangements and crisis management capabilities (Box 1).

B. Fiscal Policy

16. The authorities and the staff agreed that the fiscal policy stance for 2002-03 was appropriate and in line with the medium-term fiscal framework. The planned moderate stimulus in 2002 and the return to a broadly neutral stance in 2003 were viewed as consistent with the expected cyclical evolution. The stance for 2003 would, of course, be reassessed at budget time as the outlook becomes clearer. The mission welcomed the government’s commitment to keep expenditures within the expenditure ceiling despite mounting pressures from escalating sickness and disability payments, but expressed some concern that no specific contingency measures had yet been identified. Staff also saw expenditure restraint as critical for continued achievement of the general government surplus target.

Financial Sector Stability Assessment and Recommendations1/

Sweden’s Financial sector is sound, efficient, and well supervised. Four major financial groups—active in insurance, securities and cross-border banking, with extensive operations throughout the Nordic area—dominate the sector. Supervision and regulation conform with the relevant standards and codes, and best transparency practices were observed in all areas. Financial sector resilience was documented by financial soundness indicators (Table 3) and validated by sophisticated stress tests.

Stress tests showed Sweden’s financial system to be resilient to potential severe shocks. Stress tests covered large shocks to: (a) equity and real estate prices; (b) exchange rates and interest rates; and (c) prolonged economic stagnation. Significant vulnerabilities appeared only in the presence of contagion effects in the event of these shocks. Such effects can be amplified by the complex nature of the largest Swedish financial groups, which operate—and are systemically important—in several neighboring countries, with activities spanning various, closely related business areas. The insurance sector had minimal reinsurance exposures, and life insurance was protected by rules allowing lower payouts if its net capital position deteriorated. The Swedish financial sector was also found to be resilient to further distress in the telecoms sector.

Bank supervision showed a high degree of compliance with Basel standards. It is evolving toward a more pro-active, risk-focused approach emphasizing effective consolidated supervision in collaboration with other supervisors. The FSAP mission recommended increasing staffing of the financial supervisor (FI), broadening its range of available corrective measures, increasing the cross-border harmonization of approaches to emergency liquidity assistance, and enhancing the credibility of the regime for winding-up large financial institutions.

Insurance, securities regulation and supervision, and the payment system were compliant with core principles. The mission recommended enhancing the supervisor’s capacity to conduct fit and proper tests for insurance companies, improving oversight of the exchanges, and strengthening rules regarding issuers and mutual fund companies, especially those owned by financial groups.

The mission found that the central securities settlement system did not comply with all applicable recommendations. It recommended improving the supervision of clearing and settlement, and implementing risk management measures to prevent unwinding and to contain the present systemic risk in the clearing system.

Sweden demonstrated a high degree of compliance with the IMF Code on Monetary and Financial Transparency. The mission recommended clarifying the respective responsibilities of the Riksbank and FI, notably concerning the supervision of the payment system.

Sweden’s regime for anti-money laundering and combating terrorist financing was found to comply with the relevant guidelines.

1/ See the accompanying FSSA document for further details.

17. The fiscal framework is well designed and would serve Sweden well over the medium-term. The discussion of the potential modification of the fiscal framework was partly triggered by proposals recently put forth by the government-appointed Johansson Commission on the implications for stabilization policy in case Sweden decides to join the euro area. The Commission’s suggestions—which will be debated over the next several months—include an increase in the surplus target to 2½-3 percent of GDP and the introduction of designated cyclical margins under the expenditure ceilings. The mission argued against raising the surplus target which, inter alia, would impose a strong bias against much-needed further tax reductions; however, some modifications of the expenditure ceiling may be warranted (see Box 2 and the Selected Issues paper). The authorities expect to formally react to the Commission’s proposals by the end of this year.

18. The agenda for income tax reform remained to be completed. The authorities were doubtful whether the envisaged fourth and final phase of the income tax reform—estimated to cost around 0.7 percent of GDP—could be implemented in 2003. They saw insufficient headroom to absorb the associated revenue decline, and were concerned that the resulting discretionary stimulus could be cyclically ill timed. The mission underlined the adverse supply-side effects of a delay coupled with the envisaged rise in social insurance replacement rates. It argued for completing the income tax reform and implementing offsetting expenditure cuts, consistent with the authorities’ strategy of continued balanced reductions in taxation and spending. More broadly, the staff reiterated that a further streamlining of the extensive welfare state would be desirable in order to address the emerging challenges of globalization, European integration, and demography.5

19. The authorities seek to rein in escalating expenditures on sick leave, disability and early retirement through measures for better occupational health. Long-term sickness absence climbed dramatically since 1998, more than doubling spending on sickness insurance. Almost a quarter million workers were absent from work for over 60 days in 2001. The government has prepared an 11-point program focusing on improving the work environment and treatment for patients, and on helping re-integrate the long-term sick into work. Some changes in eligibility rules may also be considered. See paragraph 22 for further details.

20. The authorities’ medium-term goal is a balanced reduction in taxes and spending, but no concrete proposals are on the agenda. Sweden’s tax burden remains among the highest in the world. The authorities argued that this was partly due to Sweden’s practice of taxing benefits, though they agreed that accounting for this effect did not alter the ranking. Noting that the tax burden is concentrated on labor, the mission argued that the tax wedge on labor income—combined with generous benefits—created strong disincentives to work. While the phased income tax reform has reduced somewhat the marginal tax on labor, scope for further reduction remained. Other aspects of the tax system which merited changes included the wealth tax that in practice did not apply to the wealthiest. On the expenditure side, the mission advocated further outsourcing of the provision of some public services to realize efficiency gains; some outsourcing has already occurred in areas such as childcare and elderly care. Finally, the mission urged an early refocusing on reform efforts after the forthcoming elections.

The Medium-Term Fiscal Framework1/

Sweden has a well-established fiscal framework that has served the authorities well. The surplus target is set to ensure fiscal sustainability in the face of the demographic transition. The expenditure ceilings have prevented overruns that otherwise may well have occurred over the last years during which the surplus target was often exceeded by a sizable margin. The experience so far also suggests some room for improvement in the framework, particularly regarding the design of the expenditure ceilings.

A government-appointed commission has recently proposed several changes to Sweden’s fiscal framework, in the context of the possibility of Sweden joining the euro area. The commission suggested raising the general government surplus target to 2½-3 percent of GDP and introducing dedicated cyclical margins under the expenditure ceilings. The commission argued that raising the surplus target would be necessary to provide sufficient room for stabilization policy once the Stability and Growth Pact (SGP) framework, and thereby the deficit ceiling of 3 percent of GDP becomes binding and an independent monetary policy is no longer possible. Expenditures are currently set below the expenditure ceilings with a margin to provide some room for new policies and a safety cushion for cyclical overspending. So far, the margins have all too often been completely used up for discretionary expenditure increases. Dedicated cyclical margins would address this problem.

The surplus target of 2 percent of GDP is designed to prepare public finances for the adverse effects of ageing over the coming decades. On current projections, (see Appendix I to the Spring Budget, 2001) therefore, there is no need to raise the surplus target on sustainability grounds. The surplus target would also offer considerable room for stabilization policy (5 percent of GDP) if Sweden joins the euro area and the SGP ceiling becomes binding. For example, with a negative output gap of around 4 percent, automatic stabilizers would lead to a worsening of the overall balance of around 3 percent of GDP, leaving 2 percent of GDP for discretionary measures. Only at a negative output gap of 6 percent would automatic stabilizers use up the entire margin for stabilization. However, in such a case of very severe recession, the SGP deficit ceiling would likely not apply, and there would be additional scope for discretionary measures. The EU Commission’s (2002) minimum benchmark for the structural deficit is 0.8 percent which would allow automatic stabilizers to work during typical downturns without threatening the deficit ceiling. Taken together, in the staffs view, the reasons for increasing the surplus target are not compelling. Moreover, increasing the surplus target would come at the cost of reduced scope for much-needed tax cuts.

The expenditure ceilings have been instrumental in keeping a tight rein on spending in the face of large budget surpluses. However, three related weaknesses have emerged. First, the ceilings are not explicitly linked to the surplus target. Second, the margins under the ceilings that are in part set to allow for cyclical overspending have all too often been used up for discretionary increases. Third, the ceilings are not designed to induce symmetric expenditure fluctuations over the cycle. Thus, the expenditure ceilings do not guarantee that the surplus target is achieved, nor do they ensure that expenditures do not become pro-cyclical.

A modified expenditure rule should be clearly linked to the surplus target to ensure that elements of the fiscal framework are consistent. The link should be explained in the budget documents. A cyclically neutral expenditure path could be calculated from structural revenue projections and the surplus target. Actual expenditure would fluctuate around this path over the cycle, with overspending during downturns being offset by under-spending during upturns. The overall balance would fluctuate around the surplus target due to cyclical expenditure and revenue movements. To ensure that common problems associated with estimating structural revenues do not lead to missing the surplus target over the cycle, a cumulative limit could be set on missing the surplus target. In case the overall balance falls systematically short of the surplus target over several years, adjustments would be required.

Nevertheless, given the generally positive experience with expenditure ceilings in Sweden, a ceiling could be set with a margin over the expenditure path. This ceiling would help to control spending pressures that are likely to persist given Sweden’s strong fiscal position. Limiting cyclical overspending during downturns risks making expenditures pro-cyclical. However, the overall fiscal stance is likely to be still counter-cyclical as revenues, which typically have a larger automatic stabilizer element, would still be counter-cyclical.

1/ For a more detailed exposition, see the accompanying Selected Issues Paper.

C. Structural Policies and Other Issues

21. The authorities and staff saw continued structural reforms as critical for raising the potential growth rate. The authorities pointed to substantial progress made in recent years. In 2001, Sweden had achieved the highest degree of implementation of EU internal market directives. Competition rules and their enforcement have been tightened, and legislative changes aimed at enhancing the efficiency of public procurement and improving financial market competition were being finalized. Staff acknowledged this progress, but stressed that the economy was operating close to its capacity limits, leaving little slack to increase output without productivity gains. To ensure such gains—also the key medium-term source of growth—Sweden needed to address several interrelated issues: raising effective labor supply and improving labor market flexibility; reducing housing market rigidities; and enhancing product and services market competition.

22. There was agreement on the need to address the mounting erosion of labor supply due to escalating absenteeism as well as early and disability retirement. The authorities expressed concerns about this trend—keeping a fifth of the labor force away from the workplace in 2001—and agreed that, if not reversed, it would adversely impact the labor market, growth prospects, and public finances. However, they argued that the issue was complex and that the increase could not be attributed primarily to disincentives from the tax benefit system. Cuts in public spending, particularly in health and education in recent years may have raised stress in the workplace, while the share of older workers, who are more prone to sickness, had risen. Moreover, current levels of absenteeism were not unprecedented in Swedish experience: similar high levels in the early 1990s were reversed, suggesting that the current rise may level off The officials also underlined the overriding objective of maintaining generous sickness benefits for those in need. Staff noted that while the authorities’ program to address the many dimensions of occupational health was a useful step, large work disincentives for low-wage workers and the lack of incentives for employers to limit long-term sickness were important components of the problem that needed to be addressed. In addition, eligibility criteria would need to be tightened. Easing employment protection rules, and further focusing active labor market policies on the long-term unemployed and on supporting job search could also bring employment gains.

23. The authorities agreed that de facto rent control depressed housing investment and impeded labor mobility, but had no plans for significant deregulation of rental housing. Rents in Sweden reacted sluggishly to market conditions owing partly to the dominance of municipal housing companies in the rental market. Together with the limited availability of building permits, this contributed to housing investment languishing at a third of the average for the advanced economies during the past 5 years. As a result, large cities with rapid job growth experienced housing shortages. Thus, workers found it hard to move, resulting in regional labor shortages that contributed to wage pressures. Staff suggested freely negotiated rents at least for new contracts, and raising housing supply through enhanced competition in construction. However, citing institutional and legal constraints, the authorities favored improving the flexibility of rent setting in the framework of the current system, which they saw as critical to safeguarding distributional objectives.

24. A persistent 20 percent excess of the Swedish price level over the EU average highlights the need for further product and services market deregulation. While about half of the differential is explained by tax differences, the remainder reflects weak competition, especially in the construction and building materials sectors, transportation, and retail trade. The authorities emphasized progress in deregulation, and their stepped-up enforcement of EU rules against concerted anti-competitive practices and the abuse of dominant market positions. They also pointed to ongoing work to raise the efficiency of public procurement and to open up the gas market—the only remaining sheltered network industry—to competition in 2003. Staff noted that divestment of public ownership—including enterprises owned by municipalities—in competitive sectors would further raise competition and help streamline the public sector. However, the authorities saw no urgent need for action in this regard.

25. Sweden has signed all international conventions against money laundering, including the international convention for the suppression of the Financing of Terrorism, with enabling legislation coming into force in July 2002. Legislation also conforms to the standards of the OECD’s Anti-Bribery Convention, to which Sweden is a signatory.

IV. Staff Appraisal

26. The Swedish economy displayed considerable resilience in the face of the worldwide slowdown in economic growth in 2001. This resilience was rooted in sound macroeconomic policies and structural reforms implemented over the past decade. Looking ahead, the challenge is to create the basis for sustainable high growth in the medium-term by shifting the focus of the policy agenda toward enhancing productivity and labor supply.

27. Economic activity is projected to pick up in the second half of this year and to gather pace into 2003. However, the incipient recovery is still somewhat fragile, vulnerable to the continued weakness of the telecom sector, and adverse confidence effects from declining asset markets. Moreover, large wage increases, low productivity growth, and rigidities in product and labor markets could undermine the economy’s supply response.

28. The persistence of high headline and underlying inflation has become a cause for concern. Several transitory factors related to weather, animal diseases and energy prices accounted for part of the rise in inflation. Nevertheless, indicators of underlying inflation have risen sharply as well. The rise in inflation reflects the high degree of resource utilization and wage inertia, particularly in the service sector.

29. The gradual tightening of the monetary stance by the Riksbank in recent months underlines its commitment to meeting the inflation target. The cyclical recovery in productivity combined with the projected moderate rise in unemployment and the easing of labor shortages should contain unit labor costs to a level consistent with the inflation target. The recent increases in the policy interest rate should help restrain wage and price pressures stemming from a rise in inflation expectations. However, there are risks. Unemployment is low and there are scant signs of a slowdown in the growth of labor costs. As the recovery gathers pace with inflation already high, demand pressures, combined with labor and product market distortions, could push inflation above the target. All in all, a wait-and-see approach is appropriate in light of the uncertain outlook, but the Riksbank should stand ready for further monetary tightening if inflation pressures do not decline.

30. The fiscal stance in 2002 and 2003 appears consistent with cyclical developments. The moderately expansionary stance this year should help support the still fragile recovery, while the shift to a broadly neutral stance in 2003 corresponds well to the expected rise in resource utilization. By the time the 2003 budget is formulated, a better picture of the cyclical position will be available, based on which the fiscal stance can be adjusted. It would be desirable to implement the announced fourth and final step of the income tax reform in 2003. The government needs to regain control over the rapidly rising budgetary costs of sickness absences, and of early and disability retirement. Otherwise, the expenditure ceilings may well be breached, which could undermine the credibility of the fiscal framework. In this context, the government’s firm commitment to keep expenditures within the ceilings is welcome. Reining in expenditures is also important for continued achievement of the surplus target. While the projected surpluses appear consistent with the 2 percent target over the cycle, any further overspending would likely require fiscal adjustment.

31. The medium-term fiscal framework will serve the Swedish economy well in the coming years. The recent proposals of the Johansson Commission for changes in the fiscal framework in the event of euro area membership will continue to be debated in the period ahead. In broad terms, the staff sees the surplus target of 2 percent on average over the cycle as adequate, offering considerable room for stabilization policy during downturns even under the deficit ceiling of the Stability and Growth Pact. However, a modification of the expenditure rule may be warranted, given that the budget margins—partly intended for cyclical fluctuations—have all too often been used up for discretionary increases in spending. A modified expenditure rule should be explicitly linked to the surplus target and structural revenue projections.

32. The focus of fiscal as well as structural policies—independent of the EMU debate—should be on strengthening the supply side of the Swedish economy. Beyond the current program of tax reform, it is important for the government to follow through on its general intention to pursue further a balanced lowering of taxation and spending aimed at reducing distortions and maximizing growth and welfare. In this context, reducing the high marginal effective tax rates on labor income and a structural reform of the wealth tax would be the key measures.

33. The recent favorable performance of employment should not obscure the need for further reforms to enhance the functioning of the labor market. Wage growth needs to be restrained to reflect gains in productivity. Active labor market policies should continue to shift toward the long-term unemployed, job search support and improvements in the efficiency of programs. Finally, labor mobility should be enhanced by easing employment protection rules and by reducing housing market distortions through liberalizing the rental housing market, and promoting competition in the construction sector.

34. The decline in unemployment has brought moral hazard problems associated with the welfare system to the surface. The sharp rise in absenteeism on account of sickness has emerged as an issue with major implications for public finances and the economy’s supply potential. These developments contribute to higher costs, lower productivity, and a large increase in public spending. It is essential to reform the system of sickness benefits so as to rein in absenteeism while ensuring generous social benefits to those in need. The government’s program of improving occupational health is a step in this direction. However, greater emphasis would need to be placed on changes in the incentive structure and on tightening eligibility criteria.

35. The authorities should give renewed impetus to the process of enhancing competition in the economy. The momentum of deregulation seems to have slowed in recent years. Although notable progress was made in liberalizing product markets, particularly in the utilities and telecom sectors, greater efforts to strengthen competition are needed in retail distribution, pharmaceuticals, air transport, and especially construction and rental housing. Further progress in privatizing public enterprises operating in competitive markets would also be desirable.

36. The staff’s recent assessment of Sweden’s financial system concluded that the system was sound and complied well with international codes and standards. While the economic slowdown has weakened the performance of the four major financial groups, stress tests as well as recent experience indicate that they remain robust to market and credit risks in the event of a downturn. Nevertheless, concentration of their exposures to a relatively small number of counterparties and residual risks in the securities settlement system are potential sources of vulnerability. Regulatory and supervisory arrangements comply well with international standards. In light of the systemic importance of large Swedish banks in several countries, the authorities’ plans to develop further their arrangements for crisis prevention and management in consultation with other relevant jurisdictions are welcome.

37. The Swedish authorities are to be commended for their high level of official development assistance (0.73 percent of GNP), which they intend to raise further.

38. Sweden is expected to remain on the standard 12-month consultation cycle.

Table 1

Selected Economic Indicators

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Sources: Statistics Sweden; Riksbank; IMF, International Financial Statistics; INS; and staff estimates.

Staff projections.

In percent of potential GDP, also adjusted for timing of tax revenues.

Based on relative normalized unit labor cost in manufacturing.

Table 2

Sweden: General Government Financial Accounts, 1997-2003

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Sources: National authorities; and Fund staff calculations.
Table 3

Sweden: Indicators of External and Financial Vulnerability

(In percent of GDP, unless otherwise indicated)

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Sources: Riksbank; Statistics Sweden; National Debt Office; and staff calculations.

End 3rd quarter 2001.

APPENDIX I Sweden: Fund Relations

(As of May 31, 2002)

I. Membership Status: Joined 08/31/51; 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 Arrangements: The Krona has been floating since November 19, 1992. Under Decision 144-(52/51), 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 2001 Article IV consultation were held in Stockholm, June 11-20, 2001 and the staff report (SM/01/257) was issued on August 15, 2001. The consultation was completed by the Executive Board on August 31, 2001.

IX. Technical Assistance: None

X. Resident Representative: None

APPENDIX II Sweden: Statistical Issues

National accounts

1. The overall structure of the national accounts follows the System of National Accounts 1993 (1993 SNA) and the ESA 95. The scope of the accounts is consistent with international standards and agreed practices. The data comprise both quarterly and annual accounts, for the latter, a full set of institutional sector accounts, including financial accounts, is compiled. Constant price series are based on Laspeyres chain indices. The delimitation of the economy, the production and asset boundary, and the classifications used are in accordance with internationally recommended systems. Recording is done on an accrual basis taking into account the new EU rules for recording of taxes and social contributions.


2. The Consumer Price Index (CPI) and the Producer Price Index (PPI) follow internationally agreed practices and standards in terms of concepts, definitions and use classifications. The scope of the indices follows international standards concerning both weights and the coverage of prices collected. Thus the CPI covers all resident household consumption of goods and services classified according to the Classification of Individual Consumption by Purpose (COTCOP), and the PPI includes all resident market-enterprise production of goods classified according to the Combined Nomenclature (CN). The CPI weights and prices refer to market prices; the PPI weights refer to basic prices and the prices collected exclude taxes. The prices collected for the CPI are mid-month prices; the PPI prices are based on average monthly prices.

Government finance statistics

3. Statistics Sweden compiles the general government statistics in the context of the national accounts based on the ESA 95, which is broadly consistent with the 1993 SNA. The available data provide a minimum set of variables for fiscal policy. The general government statistics cover the budgetary and extra-budgetary (self-financed) central government, social security funds, and local governments.

4. In documents that accompany the budget, the Ministry of Finance presents an analytical framework showing the previous year’s general (and central) government aggregates for revenue, expenditure, and net lending/borrowing along with annual forecasts.

Monetary statistics

5. With regard to the monetary statistics, monthly balance sheet data for the Riksbank and the credit institutions are disseminated separately on the Riksbank Internet website. The institutional coverage of these data comprises the central bank and the other depository corporations (ODCs) or deposit money banks that are engaged in financial intermediation and issue liabilities included in the definition of broad money used by the Riksbank. The monetary and credit aggregates that are disseminated for these institutions are based on international principles of classification and sectorization.

6. However, monetary statistics are not presented in the form of an analytical framework in which the consolidated monetary liabilities of the Riksbank and the ODCs as a group are linked to the claims of these corporations on the nonresident and resident sectors of the economy. While the building blocks exist to construct a monetary survey in which the intrasectoral claims and liabilities of the depository corporation would be consolidated, the absence of this framework complicates the interpretation of the monetary statistics.

Balance of payments statistics

7. Sweden’s balance of payments statistics are compiled in broad conformity with the conceptual framework of the fifth edition of the IMF’s Balance of Payments Manual (BPM5). Supplementary guidelines issued by Eurostat and the European Central Bank (ECB) also inform the present structure of BOP statistics. Resident institutional units are classified in accord with the BPM5’s concepts of economic territory, residence, and center of economic interest. Classification and sectorization of the BOP are largely consistent with BPM5; recent initiatives on the reclassification of financial derivatives in line with revised international standards represent an important contribution in advancing the methodological soundness of Sweden’s BOP statistics.

APPENDIX III Sweden: Core Statistical Indicators

as of June 20, 2002

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The Selected Issues Paper for the last consultation (Country Report 01/169) provides a detailed survey and assessment of the Swedish welfare state’s achievements and the challenges it faces.


Sweden’s historical potential growth rate of around 2 percent over the past three decades rose to 2¼-2½ percent during 1998-2000, reflecting the impact of structural reforms and the emergence of a thriving technology sector. However, potential growth may have fallen back since then as a result of a fall in effective labor supply and weaker productivity growth as the contribution of the technology sector has diminished. With the resulting uncertainty about potential output levels, the estimates of the output gap for 2001 span a range of –0.7 to 0.8 percent of potential GDP, with the staff estimate around the middle of the range.


The Ministry of Finance calculates the structural balance as the cyclically adjusted balance corrected for the timing of some tax receipts, so as to measure the structural balance on a full accruals basis. Large payments of corporate and capital gains taxes, which accrued in 2000, were received in 2001.


Taxes on pension benefits were marginally reduced and the real estate tax rate was lowered to offset the effects of rising house assessment values on the tax liability. Also, the wealth tax exemption was raised, and the VAT on books and periodicals was reduced from 25 to 6 percent. The green tax swap–raising the burden on greenhouse gas emission while lowering other taxes–was continued.


For a detailed discussion of these issues, see Box 3 of the last staff report (SM701/257) and Country Report 01/169.

Sweden: 2002 Article IV Consultation-Staff Report; Staff Statement; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Sweden
Author: International Monetary Fund