21 Sep 2020 09:48

Economic Insights: Crisis responses and restart package provide record stimulus

Håkan Frisén and Daniel Bergvall

On Monday, September 21, the Swedish government will submit its 2021 budget bill to Parliament. COVID-19 crisis responses are now being supplemented with a recovery package including proposals worth at least SEK 100 billion, according to the finance minister. Restrictions normally imposed by official budget rules are temporarily being set aside. After years of fiscal rectitude, it is the right time for expansionary policies. Meanwhile everyone wants a piece of the action, as usual. For reforms that are not directly crisis-related, it again looks as if the government’s two budget partners are prioritising enactment of their own signature issues instead of tackling tougher issues related to the functioning of the labour market, the housing market and the tax system.

A shift from crisis responses to recovery measures.

Early next week, when Finance Minister Magdalena Andersson submits the 2021 government budget, along with another amending budget for 2020, the overall package will include a sizeable economic stimulus. After the crisis packages of this past spring and summer, the focus is now shifting towards restarting the economy and more traditional stimulus measures. Sweden’s strong initial fiscal position will allow ample manoeuvring room for restart packages. Now that the official fiscal surplus target has temporarily been set aside, it will be possible to push through policies that were difficult to finance in early 2020. 

Fiscal stimulus measures are important as central banks run short of ammunition.

In most countries, the predominant view is that fiscal policy makers must now assume greater responsibility for stabilisation policy. This is reflected especially clearly in the European Union’s recovery plan and the agenda of the American presidential election campaign. Given the drawbacks of both negative key interest rates and excessive market interventions in the form of central bank asset purchases, governments possess the most suitable and effective tools. In Sweden, the Riksbank needs burden-sharing by government as it struggles to achieve its 2 per cent inflation target in an environment of low pay increases and a stronger krona. Large-scale asset purchases by the Riksbank and other central banks, in turn, are easing the burden on governments by pushing down interest rates and bond yields. In the prevailing macroeconomic situation, despite their divergent roles, it is certainly true that governments and central banks have an unusually high degree of coinciding interests.

High but “cheap” debts.

Public sector debt has surged in many countries this year. Governments have launched major relief programmes, while debt as a percentage of GDP is also being pushed upward by shrinking nominal GDP (the denominator effect). Once GDP growth rebounds in 2021, the denominator effect will instead work in a favourable direction. Despite continued relatively large budget deficits in most countries, the debt-to-GDP ratio will remain about the same as in 2020. The upturn in Swedish government debt is relatively moderate compared to most other countries, reinforcing Sweden’s image of enjoying strong public sector finances in an international perspective. Because of low interest rates, the interest payment burden in most countries has gradually fallen in recent decades. Interest expenditures on government debt as a percentage of GDP are at record lows. In Sweden’s case, they are now below 0.5 per cent of GDP, compared to more than 5 per cent in the wake of the 1990s crisis. Discussion about what debt level is acceptable is likely to reappear, but during the foreseeable future the focus of attention will be on the task of restarting economies − not on large debts.

Public sector finances are showing some resilience.

Although the Swedish government’s budget deficit is now rapidly increasing, fiscal deterioration has not been as severe as expected. This will also increase future manoeuvring room. Compared to the May forecast of the National Debt Office (NDO), the deficit during the past four months (May-August) was SEK 100 billion lower than expected. This is partly because the economic downturn was not as deep as analysts had feared last spring. For example, SEB’s forecast of Sweden’s full-year GDP growth was revised from -6.5 per cent in May to -3.8 per cent in our latest update (Nordic Outlook, September 2020; read it here). Recent developments also indicate that it may be necessary to adjust our forecast further upward. In addition, crisis relief programmes were not utilised at anywhere near the budgeted amounts. This, too, is partly because the economic downturn was milder than feared. The government also probably overdid things a bit when unveiling its crisis responses last spring, in order to reinforce the confidence-building effect by showing that it was taking the situation seriously. Such a pattern is also discernible in other countries, probably inspired by European Central Bank (ECB) President Mario Draghi’s famous “whatever it takes” statement in 2012, when he tried to break with the initially clumsy handling of the euro crisis. In an uncertain situation, the Swedish government also chose to present the broadest conceivable range of reforms in response to an unprecedented crisis. Last spring there was also little knowledge of how effective the various crisis responses might be.

Broad array of initiatives on both the expenditure and revenue side.

The budget initiatives that have been unveiled so far are relatively evenly divided between social spending and green investments, on the one hand, and tax cuts on the other. This means that all four parties that signed the January Agreement of 2019 on budget cooperation – the minority Social Democratic-Green Party government and the opposition Liberal and Centre Parties – all have room to promote their own signature issues. Our interpretation is that more than half of the programmes that have been unveiled are temporary, covering only 2021. But we should keep in mind that even under normal circumstances, appropriations that are not based on legal entitlements require yearly approval. It is thus likely that some of the measures now being presented will be extended.

Proposals in the Swedish government budget for 2021  

General grants to local government

10.0

Other health and welfare spending

12.0

Green recovery

  9.7

Education and research

  5.0

Temporary income tax reduction

5.0

Tax reduction on earned income

8.5

Lower employer-financed social insurance fees for younger employees


7.5

Lower corporate tax and R&D deduction

10.0

Other items

12.3

Total reforms

80

Source: Swedish government, SEB

The impact of stimulus measures is hard to interpret.

Because of the ongoing shift from crisis responses to restart packages, it will not be entirely easy to estimate the impact of stimulus measures during calendar 2020 and 2021, respectively. As for international comparisons, the most common way of defining this impact is as the change in structural, cyclically adjusted net lending. If net lending deteriorates more than can be ascribed to cyclical effects on the budget balance, such a policy is interpreted as being expansionary. Government policy is defined instead as contractionary when the shift in the budget balance is stronger than can be ascribed to the economic cycle. Since the change in structural saving is affected by GDP growth, estimates by different forecasters provide slightly different outcomes. Estimates for 2020 are also made difficult by uncertainty about the degree to which crisis response programmes have been utilised. According to the Swedish government’s own Harpsund forecast in August 2020, its stimulus measures will be equivalent to 3 per cent of GDP, while the latest update from the Swedish National Financial Management Authority (Ekonomistyrningsverket, ESV) shows a smaller effect, equivalent to 1.5 per cent of GDP. Our estimate is that the dose of stimulus in 2020 amounts to approximately 2.5 per cent of GDP.

Ketchup effect in 2021.

Since the dose of stimulus is measured as a change from one year to the next, a sizeable new injection will be required to ensure that fiscal policy will not be contractionary in 2021 when crisis response expenditures shrink in size. The desire to avoid such a tightening has undoubtedly played an important part now that the government and its two budget partners have ended up with reforms totalling about SEK 100 billion in the 2021 budget bill. Despite thus historically large reform package, we thus reach the conclusion that stimulus measures – measured in the above-mentioned standardised way – will be fairly neutral in 2021. But as for the actual effect of fiscal stimulus on GDP growth, there is reason to expand the discussion. The large-scale crisis programme for 2020 had less impact than normal, since economic activity by households and businesses has been hampered by various restrictions. With consumption and capital spending being held back, private sector saving has instead soared. As restrictions are gradually withdrawn, this high savings ratio represents extra potential for consumption and capital spending. With a time lag, the 2020 relief measures will thus have positive effects on economic activity during 2021 as well.
Decent effectiveness in the restart programme. Economists are now busy examining whether the measures included in the government’s restart package are well designed to get the economy moving again. It is of course possible to find examples of measures that will have a greater short-term effect on demand. But economists must respect the fact that the political parties behind the budget also really want to focus on their respective priority areas in a longer perspective as well. In addition, it is obviously important to concentrate on vital areas that have been neglected for a long time. In this situation, giving larger grants to municipal and regional governments – which have also been on the front lines in combating the COVID-19 pandemic – is fairly natural. Tax cuts aimed at lower-income households are another measure that will quickly impact consumer demand. But the effectiveness of a general lowering of employer fees for younger employees is more doubtful and will be a topic of debate in the near future. The shift from crisis responses to restart programmes is also important for other reasons. Although certain elements of crisis policies may need to be extended, it is important to try as soon as possible to minimise damage in the form of temptations to cheat and otherwise distort the competitive situation, which are an unavoidable risk when using such solutions.


Public sector finances
Per cent of GDP

 

2019

2020

2021

2022

Net lending

0.5

-5.0

-4.0

-3.0

Borrowing requirement (SEK billion)

-118

260

230

100

General government gross debt

35.2

41.0

43.0

44.0

Source: Statistics Sweden, SEB

The fiscal framework is still there in the background.

For years, Sweden’s official fiscal framework has imposed strict limits on policy makers. Fiscal responsibility is also regarded as a formula for political success, which has further contributed to cautious budget policy. Yet even before the COVID-19 crisis broke out, the surplus target was criticised as too tight, since general government gross debt was already on a par with the “debt anchor”: 35 per cent of GDP. The question now is whether an increased focus on the need for stimulus measures to restart the economy – and the advantages of easing the pressure on monetary policy – will affect the role of the fiscal framework further ahead. Our conclusion is that the issue of formal changes in the framework will probably not become acute for quite a long time. We forecast that the public sector deficit will end up at 3 per cent of GDP in 2022. This is based on the assumption that the government and its two budget partners will proposed some new stimulus measures in next autumn’s budget bill as well, in order to avoid excessively tight fiscal policy during the election year 2022. However, we expect unemployment to remain above its equilibrium level in 2023 as well, which means that the structural budget balance will remain stronger than the actual balance. Due to continued support for cyclical improvements, combined with the gradual phase-out of certain temporary measures, the deficit may continue to shrink without any need to impose active tightening measures. Continuing to bend the budget rules a bit will hardly lead to any major reactions, in an environment where the Riksbank still has a shortage of monetary policy ammunition while the burden of interest expenditures for government debt remains at record-low levels. We thus do not believe that any formal changes in the fiscal framework will materialise, although we cannot rule out that the surplus target will again be adjusted downward in the review scheduled for 2025. As a result of the latest review in 2017, the surplus target was lowered from 1 per cent of GDP to 0.33 per cent.

Structural reforms are being postponed.

lockages between political parties prevented major structural policy initiatives even before the COVID-19 crisis. Under the pressure of crisis responses, it is even harder to look at the big picture and deal with more long-term national challenges. The 73-point January 2019 agreement that forms the basis of four-party budget collaboration includes general declarations about the tax system, housing policy issues and the functioning of the labour market. Given the existing conflicts between the four parties in their budget collaboration and the appointment of commissions of inquiry in various fields – for example tax policy and the rental market – we will probably have to wait a long while before the time is ripe for far-reaching reforms. Economists traditionally assume that structural reforms imply various forms of deregulation, but today’s international discourse also includes various other structural problems such as the dangers of widening economic gaps. Structural problems in the Swedish school system are also increasingly being highlighted by researchers and international organisations. This all means that the discussion of “structural reforms” actually needs to be broadened and that it will thus become more politically complicated than before.

Positioning ahead of the 2022 election has begun.

It is common and natural for the level of conflict to fall and for political parties to declare a truce during periods of acute crisis. The parties find it easier to reach agreement when the challenges are more concrete and less ideological. Meanwhile opposition parties are aware that being confrontational in such situations is usually severely punished in the court of public opinion. Although many companies are still hard-pressed by the pandemic − for example in the hospitality sector − the general situation is changing. What we have seen so far is that the political parties not included in the budget agreement (Moderates, Christian Democrats, Sweden Democrats and the Left Party) have reverted to a more normal opposition role. Their positioning ahead of the September 2022 election has begun to be reflected in tough rhetoric. But so far there are few indications that the Left Party and the three opposition parties on the right will reach agreement on any common issues that could block the budget. It is also clear that the three opposition parties on the right want to shift the debate to other areas besides economic policy, for example law and order, where the potential for creating a majority together with the Left Party is nearly non-existent. Because the Social Democrats are losing ground in public opinion surveys as the COVID-19 crisis has become less acute, the Moderates in particular can bide their time and focus entirely on trying to create the basis for a government after the election. Today it does not look as if possible future budget collaboration between Christian Democrats and Sweden Democrats would result in general economic policies so very different from those of the current government and its budget partners.

Budget collaboration seems to be holding up after all.

Ever since the Social Democratic-Green Party government reached its cross-bloc budget agreement with the Centre and Liberal parties, there has been speculation about how long it would last. The COVID-19 crisis naturally brought these parties closer to each other during a period when the entire Parliament focused on national unity. Parliament has had generous funding at its disposal in recent months, which has also helped to ease conflicts. But underlying tensions concerning priorities and procedures under the 73-point programme still remain, which will become more evident later this autumn. Both the Green Party and the Liberal Party are struggling desperately to keep the 4 per cent nationwide voter support they need to stay in Parliament, and they must try to find popular signature issues. The most strategically important matter is how the relationship between the Centre Party and Social Democrats will evolve; how the “first hired, last fired” rule and other labour law issues are handled is especially crucial. The Centre Party must show successes on key “economic liberal” issues in order to justify its participation in the current budget collaboration. Yet at the same time, the party also seems to want to tone down its rhetoric somewhat in order not to squeeze the Social Democrats too hard. Although it looks difficult at present, it will not be impossible to find a compromise if the employer organisations and labour unions cannot first achieve a solution. The Centre Party certainly also has a general interest in cultivating a good relationship with the Social Democrats over the next couple of years, in order to show the Moderates (who dominated the four-party Alliance government in 2006-2014) that the Centre enjoys genuine freedom of choice on the issue of forming a government following the 2022 election.