‘Hopeless’ Flaw in Swedish Budget Policy Gets a Prominent Critic

(Bloomberg) -- Sweden was behind the curve when it revamped its fiscal policy a few years back, and is now stuck with a flawed budget framework, a prominent former policy maker said.

The country’s fiscal-surplus target is a “hopeless” construction that’s the result of “hysteria” from opposition politicians, according to Karolina Ekholm, who’s both a former central bank deputy governor and, until last year, a top adviser to Finance Minister Magdalena Andersson.

The target is a relic from Sweden’s 1990s financial meltdown. After a parliamentary review, it was this year lowered to 0.33% of gross domestic product from 1%. It was also combined with a so-called debt anchor, as part of a compromise deal reached by Andersson’s Social Democrats, who had been aiming for a balanced budget target.

Sweden is now saving so much that government debt risks sinking below the lower tolerance level set by the anchor.

“What I am most critical of when it comes to the new framework is that it’s evaluated based on structural savings, which is a pretty hopeless measure since it’s hard to gauge,” Ekholm said in an interview. “It would have been better for the government to go over to a balanced budget target and keep everything else unchanged.”

The list of detractors anxious about the direction of fiscal policy in Sweden is long and growing. Economists, investors and labor unions are all questioning the need for ever bigger surpluses at a time when huge investments are needed and debt levels are at a 40-year low.

A more expansionary fiscal policy would ease pressure on the central bank, which is struggling to lift interest rates above zero after years of extreme monetary stimulus. Sweden’s ultra low rates have weighed on the currency -- the krona is trading at its weakest level against the euro in almost a decade.

Since there are costs associated with deviating from the fiscal framework, the government needs to follow the rules it has set for itself, Ekholm said. On the other hand, the lower debt levels will provide a lot of scope for future spending, should a crisis hit.

Sweden will probably need to use its fiscal levers during the next downturn to compensate for the Riksbank’s limited leeway, according to Ekholm.

“You need a preparedness to use fiscal policy stimulus considering that monetary policy is in a situation where there are limits to how much more you can stimulate on that front,” Ekholm said. “We have plenty of room to handle both normal economic cycles and an outright crisis.”

Ekholm left the Riksbank in 2014 to join the Social Democratic-led government as a state secretary for Andersson, but has now resumed her professorship at Stockholm University. In 2017, opposition lawmakers blocked her from becoming the new Riksbank governor due to her political position, handing Stefan Ingves another term.

During her nearly four years as state secretary, Ekholm studied which fiscal policy options would be most effective in a downturn. Her own assessment is that fast transfers to local governments and increasing funding for education would work best. Research shows that tax cuts may not be as effective since people tend to save rather than spend extra income during a downturn, according to Ekholm. She also says that large infrastructure projects aren’t fast enough.

“Before I started working at the Finance Ministry I thought infrastructure investment would be a good tool,” she said. “But the timing is hopeless, it takes too long to plan.”

She says the best stimulus is to bring forward measures that are already in the planning stage, since any changes tend to become permanent.

As deputy governor at the Riksbank, Ekholm together with Lars EO Svensson (who later left the board) were consistent critics of the tighter policy at the time. The bank’s decision to raise its main rate by a quarter point to minus 0.25% in December can always be reversed, if the board members “feel very uncomfortable,” she said.

“I wouldn’t see that as a very big backlash for monetary policy,” she said. “Then you can always ask yourself what you’d accomplish with such a cut?”

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