Economic development

• The authorities broadly share staff’s assessment of the economic developments in Sweden and internationally. After the slowdown in the economy during 2012, there are some positive signs in the Swedish economy. While GDP growth in the second quarter of 2013 amounted to -0.1 percent (q/q), indicators suggest increasing growth for the third quarter and GDP growth is expected to pick up further in 2014 as the international environment improves.

• The Consumer confidence indicator is at a historically normal level and consumption is expected to grow at a normal rate whilst domestic investment remains subdued in the coming quarters. The development in the labor market is stable with slight increases in both employment and participation rates, implying roughly unchanged unemployment rates over the recent past. Compared to pre-crisis levels, however, unemployment has increased by about two percentage points. Resource utilization and the labor market are expected to improve in 2014. Inflation is below target at 1.2 percent mainly as a result of reduced price markups and a strong krona. Inflation is expected to increase gradually to 2 percent over the next few years. The repo rate is at 1 percent and the Riksbank’s repo rate path indicates that it will remain at this low level for around a year.

• The authorities also agree with staff that the current policy mix is appropriate given the economic development and that there is room for additional monetary and fiscal stimulus, should downside risks to the economy materialize.

Monetary policy

• The Riksbank agrees with staff that considerable uncertainties about the outlook remain. The situation in the euro area is fragile and a re-intensification of the crisis could have spillover effects on Sweden both through exports and through the banking system. In such a situation, the repo rate path may need to be lowered. At the same time, if household credit growth were to increase to unsustainable levels the repo rate path might have to be increased beyond what macroeconomic and inflationary considerations would warrant in the short run.

• Staff raises the issue of house prices and household debt in monetary policy decisions. As noted by staff, the Riksbank’s monetary policy is currently accommodative. With inflation around one percentage point below target and the real economy recovering slowly, further repo-rate cuts could in principle be contemplated. However, high debt levels and high house prices may jeopardize macroeconomic stability in the longer term and could also have long lasting negative effects on inflation. The Executive Board of the Riksbank therefore needs to take such longer-term risks into account when making the repo-rate decisions. Having said this, the Riksbank agrees with staff that macroprudential policy should be the first line of defense for preventing imbalances in house prices and indebtedness.

Financial stability, macroprudential policy and financial reforms

• The authorities share staff’s view that ensuring financial stability is key. Important steps have already been taken and further strengthening of financial stability will be on top of the agenda in the coming years.

• The authorities emphasize their commitment to make further progress on an appropriate macroprudential policy system.

• The authorities agree with staff’s assessment that Sweden’s large banking system remains a potential vulnerability for financial stability, especially in combination with the high levels of household debt. The Swedish banking sector is dependent on international wholesale funding markets, and therefore, a re-intensification of the euro area crisis remains a risk that could spill over to banks particularly in the form of a shortage of foreign currency liquidity. Because of the high levels of household debt, a fall in domestic house prices could lead to negative effects on the real economy, particularly through a negative effect on consumption. As stated in the assessment, such developments could also possibly push up bank funding costs and non-performing loans. In this context it should be noted that the Swedish banks are well capitalized on a risk-weighted basis, giving them a buffer if risks were to materialize. Swedish authorities have also strengthened the capital requirements for Swedish banks. First, by accelerating the implementation of the Basel III capital requirements, and later by establishing minimum requirements for risk weights on Swedish mortgages.

• The authorities agree with staff’s view that the high level of household debt is a cause for concern. Recently the FSA increased risk weights on mortgages and, going forward, further increasing risk weights for mortgages could be one way to temper growth in household debt.

• The authorities agree with staff’s assessment that the liquidity risks should be reduced. Important steps have, however, already been taken in this direction in the form of the early implementation of LCR by the FSA both in aggregate as well as separately in euro and US dollar, applicable from January 2013. To further push banks in the right direction, the Riksbank introduced a recommendation in its latest financial stability report that the Swedish banks should publish their NSFR at least every quarter.

• The authorities agree with the staff’s assessment that a robust bank resolution framework could help to reduce potential spillovers in case of financial crises. Developments in the Nordea Crisis Management Group as well as in the Bank Recovery and Resolution Directive are important improvements. As regards a potential Banking Union membership, Sweden participates actively in the discussions, but there are fundamental issues that remain to be agreed upon. Consideration of a potential membership can take place when all the rules are in place.

• The authorities agree with staff that a clear allocation of responsibility and mechanisms for coordination between the relevant authorities would be needed to ensure an effective macroprudential policy framework. Moreover, the authorities are of the view that any institutional arrangement should be designed in a way that takes into account the need for adequate democratic accountability. In this spirit, with a view to ensure a well-functioning coordination of macroprudential policy, the Government has recently announced a proposal on the establishment of a Financial Stability Council with representatives from the Ministry of Finance, the FSA, the Swedish National Debt Office and the Riksbank. Further, the government has proposed that the FSA be equipped with the primary responsibility for the implementation of macroprudential tools. Regarding the implementation of macroprudential tools, the authorities share staff’s view that the approach should be gradual and take due account of the effects on the real economy.

Fiscal development and structural reforms

Fiscal stance

• Sweden’s sound public finances have made it possible to meet the international downturn with expansionary measures, while preserving confidence and safeguarding the surplus target.

• The Ministry of Finance broadly agrees with staff’s view of Sweden’s fiscal stance, even though the Ministry’s assessment of the structural balance and the output gap in the near term is noticeably higher. As is pointed out by staff, Sweden’s fiscal position is fundamentally strong which allows for continued injections into the economy in the short term without jeopardizing either long-run sustainability or the ability to respond properly, should downside risks materialize.

• As opposed to many other European countries, Sweden’s strong fiscal position has enabled the government to present budgets with expansionary measures in both 2012 and 2013. According to the authorities’ assessment, there is still a clear need to support the economic recovery by taking an expansionary policy stance also in 2014.

• Future reform efforts will continue to focus on structurally warranted reforms that strengthen Sweden’s long-term growth prospects by increasing employment, decreasing structural unemployment and increasing social cohesion. Expansionary fiscal policy in the current juncture is consistent with the fiscal framework. The surplus target allows for active stabilization policy when resource utilization is below normal levels and the return to the target level should, in the absence of any new negative shocks to the economy, be undertaken gradually with the closing of the output gap.

Contingent liabilities, fiscal buffers and a long-term anchor for fiscal policy

• As staff points out, the Swedish fiscal framework has been serving Sweden well in the present down-turn. The surplus target has helped bring down the public debt to low levels and enhance the credibility of fiscal policy.

• The authorities acknowledge staff’s opinion on the importance of retaining appropriately large fiscal buffers and find the discussion on the link between contingent liabilities and fiscal buffers important. However, as is shown by the large range in the staff’s assessment of a possible debt limit, it should be noted that it is always difficult to make a precise estimation ex ante of the potential fiscal costs of a banking crisis. Moreover, there is a risk that explicitly linking fiscal targets to contingent liabilities could lead to moral hazard. Therefore, the authorities agree with staff’s recommendation that strong financial market policies are the first-best response to protect against such fiscal risks.

• The authorities find that the discussion on introducing an explicit long-term anchor for fiscal policy should depart from the premise of preserving the surplus target. The latest evaluation of the surplus target (Ds 2010:4) dissuaded from introducing an explicit debt target, notably since public debt is affected by other factors beyond net lending and would decrease the effectiveness of fiscal policy.

Counter-cyclicality of the fiscal framework

• According to staff there are indications that fiscal policy has become less sensitive to the business cycle since the mid-2000s. It is the authorities’ view that the fiscal policy framework does not give rise to pro-cyclicality and that it gives ample room to counteract downturns with discretionary measures. The construction of the surplus target allows net lending to fall when the economy slows and vice versa. Since it is a forward- looking target, discretionary measures are also consistent with the framework as the surplus target does not demand temporary deviations from the target level to be made up for by running corresponding surpluses, provided that the long-term sustainability of public finances is not threatened. The authorities would also like to underline that the estimates of the discretionary responsiveness of fiscal policy to the cycle from aggregate time-series, especially in the presence of a short sample period and extreme outliers, are associated with large uncertainty.

• In 2008-2009 there were considerable concerns about a protracted and even deeper recession that would imply large deficits. This called for retaining some fiscal room for maneuver. However, the effect on public finances turned out to be much smaller than expected as the fall in GDP mainly depended on a drop in external demand. In addition, output gaps widened to an extent that could not reasonably be fully counteracted by a weakening of net lending. Moreover, during these years there was a substantial downward shift in expenditure due to the reforms of the labor market and the social insurance system that had been undertaken since 2006. This shift on the expenditure side, occurring at the same time as the downturn, upheld the level of net lending and is therefore likely to have concealed the automatic stabilizing effect of public expenditure. Going forward, corresponding benign effects on public finances are not to be expected, which calls for vigilance as regards the relationship between public finances and the cycle. All in all, the factors mentioned above created an ex post impression of a weak relation between discretionary policy and the cycle. The fiscal policy conducted during the 2008-2009 recession is therefore not readily comparable to the period prior to the crisis.

• It should also be noted that while the size of the public sector in relation to GDP has decreased somewhat in recent years, the introduction of the in-work tax credit has increased the progressivity of the tax system. In the Swedish context, it is also important to take into account the extensive use of semi-automatic stabilizers in the form of active labor market policies as an effective stabilization policy instrument. In addition, a proposal to reduce the risk of pro-cyclicality in local governments’ finances was recently passed by Parliament, allowing them to use a portion of their surplus from good times to cover deficits incurred as a result of a recession. Moreover, the government has proposed a system of state support for short-time working schemes that can be deployed swiftly during a particularly serious crisis.

Facilitating structural change

• The authorities agree that further reforms are warranted to boost Sweden’s growth potential. The government is looking closely at developments in the housing market and has taken measures to increase incentives for construction, to foster a more efficient use of the existing housing stock and to make planning and zoning processes more efficient.

• With respect to the labor market, important steps have been taken to increase demand and improve training and education for jobs, in particular for vulnerable groups. Such groups include the young and foreign-born that face the risk of becoming long-term unemployed. Further steps are necessary to increase employment and reduce structural unemployment. Since 2011 the Government has engaged in talks with the social partners about how the labor market could become more inclusive and flexible. These talks are now beginning to yield concrete results. A number of vocational introduction agreements have been signed and a proposal for state support to vocational introduction agreements will be presented in the Budget Bill.