IMF Executive Board Concludes 2010 Article IV Consultation with Sweden

Sweden was among the first to falter in the great recession. The downturn was mitigated by aggressive stabilization policies, led by a sharp relaxation of monetary policy, a slew of emergency financial sector support measures, and actions raising bank capital. The policy actions taken were effective because they occurred against the background of Sweden’s credible inflation targeting, freely floating exchange rate, and budgetary frameworks. The intention to keep policies supportive are appropriate. Fiscal policy anchors this effort, and the monetary stance is highly accommodative.

Abstract

Sweden was among the first to falter in the great recession. The downturn was mitigated by aggressive stabilization policies, led by a sharp relaxation of monetary policy, a slew of emergency financial sector support measures, and actions raising bank capital. The policy actions taken were effective because they occurred against the background of Sweden’s credible inflation targeting, freely floating exchange rate, and budgetary frameworks. The intention to keep policies supportive are appropriate. Fiscal policy anchors this effort, and the monetary stance is highly accommodative.

On July 14, 2010 the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Sweden.1

Background

Sweden was hard hit by the great recession, but aggressive stabilization policies have attenuated the downturn. Output contracted—by over 6 percent from peak to trough—on the back of a sharp decline in exports and gross fixed capital formation; unemployment rose to over 9 percent, its highest level since 1998; corporate financial positions—notably of manufacturers—have deteriorated and the economy’s spare capacity is considerably high. The policy response to the downturn was led by a sharp relaxation of monetary policy bringing policy rates to their effective floors and a package of emergency financial sector support measures. On the fiscal side, automatic stabilizers were allowed to operate fully and discretionary fiscal policy focused on supporting labor market participation, resulting in a fiscal relaxation of 3 percentage points of gross domestic product (GDP) in 2009. Alongside, a 15 percent real effective depreciation of the krona provided support to exporters and firms competing against imports.

These steps have supported the economy and helped address downside tail risks. As globally, earlier financial strains have eased and exit from financial sector support measures has begun. Credit to households remained buoyant, and concerns with a deflationary spiral have been erased with core inflation and inflation expectations remaining close to the target. Moreover, personal consumption held up firmly and firms hoarded labor to a greater extent than in the 1990s, preventing an even sharper increase in unemployment. In this context output began to rise from mid-2009—led by domestic demand—with the recovery becoming broader based in the first quarter of 2010 as exports picked up and inventories rose.

Nonetheless near term prospects for growth remain uncertain. They are very much dependent on global demand for Sweden’s particular output bundle—investment and intermediate goods and consumer durables—which is likely to lag in the recovery, as well as market stress in Europe which has dented both growth prospects in a key export market and reversed much of the earlier krona depreciation. Staff projects the economy to grow by 3 percent in 2010.

Executive Board Assessment

Directors noted that the Swedish economy had been hit hard by the global recession, and commended the authorities for their aggressive stabilization policies, which were made possible by sound pre-crisis macroeconomic management. A sharp easing of monetary policy, financial sector support measures and significant fiscal loosening have cushioned the downturn in output and employment.

Directors noted that these policies have yielded fruit. Credit to households has remained buoyant and personal consumption held up firmly, while concerns with a deflationary spiral have abated. Output began to rise from mid-2009. Financial sector strains have eased and exit from emergency financial sector support measures has begun.

Directors agreed that, despite the ongoing healthy recovery, near-term prospects for growth remain uncertain. While the global growth outlook has improved, risks remain, including from market stresses in Europe and the resulting “search for strong sovereigns,” which has reversed much of the earlier krona depreciation attenuating prospects for net exports and growth. Accordingly, Directors supported the authorities’ intentions to keep domestic policies supportive and encouraged them to respond flexibly to evolving economic circumstances.

Directors welcomed the additional fiscal support to activity in the 2010 budget and envisaged for 2011, notably via full operation of the large automatic stabilizers and the planned discretionary stimulus. This responds to output concerns and is consistent with fiscal sustainability. Moreover, the composition of the discretionary component will continue to boost supply-side efficiencies. Directors encouraged the authorities to stand ready to reconsider the fiscal stance for 2011 if the outlook for growth turns out stronger than expected. They noted the central role of the Council for Fiscal Policy in ensuring the credibility of the fiscal framework.

Directors noted that the recent policy rate increase by 25 basis points still leaves the stance of monetary policy appropriately accommodative. Given the large output gap and recent krona strength, the tightening cycle should be gradual and cautious.

Directors encouraged continued efforts to secure financial sector stability. Recent stress tests indicated that regulatory capital requirements continue to be comfortably met by all institutions. Moreover, the recent Financial Supervisory Authority’s proposal to cap loan-to-value ratios should help to address vulnerabilities. Nevertheless, risks remain, including from banking operations abroad and from liquidity operations in euro and dollar markets, which should be adequately reflected in capital and liquidity requirements in line with forthcoming global agreements. Directors also encouraged continued efforts to strengthen cross-border resolution frameworks in line with EU proposals.

Directors welcomed the initiative to undertake a review of the current toolkit of supervisory intervention as part of contingency planning. Key issues to be addressed include verifying the adequacy of the level of international reserves, establishing a special resolution regime to manage troubled institutions, and increasing the Financial Supervisory Agency’s capacity.

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case. The staff report (use the free Adobe Acrobat Reader to view this pdf file) for the 2010 Article IV Consultation with Sweden is also available.

Sweden: Selected Economic and Social Indicators

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Sources: OECD; World Development Indicators; Statistics Sweden; Riksbank; Ministry of Finance; Datastream; INS; and IMF staff estimates.

Based on relative unit labor costs in manufacturing.

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. An explanation of any qualifiers used in summings up can be found here: http://www.imf.org/external/np/sec/misc/qualifiers.htm.

Sweden: 2010 Article IV Consultation: Staff Report; Staff Supplement; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Sweden.
Author: International Monetary Fund