Sweden’s lessons for managing the crisis

• The banks. Most of the Swedish banking system ended up in deep crisis. One bank went into liquidation, while the rest of the system was aided by extensive governmental emergency efforts. 
• Asset values. Property values in Sweden fell by approximately 35% over a period of four years. Equities fell by some 55% over a three-year period. 
• Currency. The Swedish krona was pegged to euro’s forerunner, the Ecu in European Currency Unit, before the crisis. The crisis created a large capital outflow, where, despite a 500% (!) central bank interest rate, it was impossible to defend the parity of the krona, which subsequently depreciated by around 25%. This took place in autumn 1992, a year after the start of the crisis. Sweden then changed to a floating exchange rate with an explicit inflation target as the anchor for its monetary policy.
• Real downturn. The crisis triggered a sharp downturn in the economy; GDP fell by 7% over three years and unemployment rose by 7% over five years. 
• Government debt. During a three-year period, Swedish government debt increased by about 50% and the public deficit reached 12% of GDP. Most of the increase could be explained by the crisis and the heavily indebted private sector paying off its loans. Falling GDP led to declining tax revenues and increased unemployment led to an automatic increase in public expenditure.

With the exception of its currency depreciation, the Swedish crisis followed the pattern of other countries’ international financial crises relatively closely. Significantly, the process always takes time. Crises also come in sequences; those in the financial markets are first, and eventually there will be a decline in the real economy with high unemployment as the last part of the crisis.

Although the crisis that began in the United-States has since spread worldwide, the outlook for the U.S. economy is clearly crucial to eventual global recovery. And if we assume that the United States is experiencing a typical financial crisis, as seen internationally, it faces declining GDP both this year and next. Unemployment in about three years is likely to be 12% and gross public debt will have increased by 50%, which corresponds to around 90% of GDP. But if the United States follows the Swedish or international pattern, it will now have the worst of the crisis behind it in terms of the financial sector’s problems. The U.S. will, however, still have almost every feature of the crisis ahead of it, in terms of government fiscal problems and in the decline in the real economy.



MATTERS OF OPINION Yes, EU member states should collaborate on dealing with the crisis   Are national authorities the best placed to address the economic crisis, or would they do better to join forces and coordinate their efforts? When citizens of the 27 EU member states were asked, more than twice as many picked the joint approach over the go-it-alone option: 61% felt they would be better protected against the crisis if their government worked with other EU countries, adopting measures and applying them in a coordinated manner rather than individually (26%). The chart shows that a substantial majority thought that each one of several measures, being discussed by the European institutions, would be effective in combating the crisis. For example, 71% of respondents wanted stronger coordination of economic and financial policies between all EU member states.  http://www.gallupworldpoll.com/  What, then, will be the impact on the world economy if these developments in the United States turn out to be correct? Many other counties have problems of their own, and obviously there is a risk that their problems and those of the Americans could reinforce each other in a downward spiral. In that case we may get an outcome that is far worse than the one I just have sketched out. In Sweden, the decline in GDP lasted for three years and the economy was then lifted by a very sharp increase in Swedish exports. The export boom was itself driven by a sharp depreciation of the krona. The increase in industrial output over two years was on average around 10% a year. An equivalent development for the United States is hardly on the cards. Financial crises and currency crises are often linked, and we have not seen any of this in terms of the dollar. Instead, paradoxically, it has been somewhat strengthened by the crisis. Although the United States is the epicentre of the crisis, its government debt instruments are still regarded as the safest investment in the world. Will the Americans’ financial problems alter this? One can imagine two scenarios for the dollar over the next five years. In the first scenario the dollar retains its position or perhaps even rises slightly. In the second the decline in the U.S. economy and growing fiscal problems lead to a sharp fall in the dollar. Some estimates show that it would take a 40% depreciation of the dollar to bring the United States foreign payments into balance. Neither scenario seems particularly favourable for Europe, or for the economies of the rest of the world. One of the imbalances that have built up in the world economy in recent decades is that the fast-growing Asian economies, as well as EU economies like those of Germany and the Nordic countries, have had export-led growth as their overall economic strategy. This had led to those countries becoming dependent for their own growth on increased American domestic demand. This has also led to the industrial sectors of those countries becoming larger than is compatible with long-term balance. Both these scenarios exclude export growth as a continued success strategy for countries outside the United States. In any case, rich European countries are going to suffer a permanent structural decline in manufacturing: Much of the decline that we now see in European manufacturing industries is not the result of temporary economic movements but part of a long-term adjustment of the industrial sector’s size. Although the bigger EU countries have signalled that they intend to protect their industries against the worst ravages of the crisis, they will doubtless be unsuccessful because no country can ultimately call a halt to structural adjustment through the use of subsidies. Protectionist actions will increase governments’ fiscal problems in any countries where such measures are taken, deepen the international downturn and delay recovery. It is easy enough to sketch out negative scenarios that show the crisis persisting, and it is also easy to talk about what should not be done. But it is much more difficult to talk about what to do other than the monetary policy actions that have already made. And while it is difficult to argue against increased fiscal incentives, it is important to recognise how limited are the available opportunities for lifting the crisis through such measures. For those countries that already have fiscal problems, they can even aggravate them and thus have a negative effect on the real economy. Short of any short-term “miracle” cure, in the medium term the aim should be to renew and strengthen the framework for international economic and trade cooperation. A significant part of the origins of the present crisis lies in the imbalances in international trade and capital flows that built up over the years without anybody taking responsibility for the consequences. Remedial action in Europe should include completing the internal market. It is only when Europe has a dynamic internal market for goods and services that balanced European growth can occur. Furthermore, the whole world does not need to lend money to the American consumer for it to lead the economic recovery. In any case, it will be a good while before the United States can once again take on the role of locomotive for the world economy.




Further articles in this  OVERCOMING THE CRISIS section
Edmond Alphandéry	"It's up to Europe to set a global example of concertation"
Jerzy Buzek	"Let's return to the grassroots and base growth on savings and productivity"
Mark Eyskens	“My 10 point rulebook for the globalised economy”
Franz Fischler	“What we need first and foremost is a change in public consciousness”
Nicole Gnesotto	"We need a new global political deal now the West is no longer master of the world"
Béla Kádár	“To save the market economy and democracy, governance has to step in where corporations ruled and markets failed”
Noëlle Lenoir	"My five courses of action"
John Monks	“The financial markets are where the re-building must start”
Poul Nyrup Rasmussen	"The EU must pull its weight and demonstrate real leadership"
Klaus Regling	“Better regulation and supervision, and the greater legitimacy of international financial institutions”
Onno Ruding	“Implement de Larosière and then consider further reform”
André Sapir	"Restoring the health of banking is no longer a financial problem but a political one"
Tøger Seidenfaden	“We urgently need much stronger international institutions"
Constantine Simitis	“Fiscal stimuli, yes. But social goals are also crucial”
Loukas Tsoukalis	"To be a major player on the new global architecture, Europe must end its IMF over-representation"
Alvaro de Vasconcelos	"Now it's the West that needs the Rest"
George Vassiliou	"How to beat this crisis and head-off another"
Nicolas Véron	“Institutional innovation, not streamlining, is today’s priority”
Stephen Wall	“We need a eurozone regulatory structure, and if Britain wants a role it must manage its eurozone entry”
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