Sweden´s loss of ‘faith’

Per Bylund argues for fiscal consolidation but forgets the important role of monetary policy:

Since 1992, Sweden has, across the board, seen consistent government cutbacks while increasing restrictions on welfare policies, deregulating markets, and privatizing former government monopolies. The country has instituted an overall new incentive structure in society making it more favorable to work. The national debt tumbled from almost 80 percent of GDP in 1995 to only 35 percent in 2010.

In other words, Sweden successfully rolled back its unsustainable but world-renowned welfare state. Despite Krugman’s wishful thinking, this is the real reason for Sweden’s success in riding out the present financial crisis.

Sweden surely got its act together in the early 1990s. The IMF numbers are a bit different but there´s no doubt a significant fiscal consolidation took place. The charts for the Government Debt/GDP and Government Balance/GDP ratios attest.

But it was a good monetary policy, one that kept NGDP evolving along a stable level path that allowed fiscal consolidation to take place without negative effects on growth. The chart illustrates the real reason for Sweden´s success.

Unfortunately, after a good reaction to the international crisis, the Riksbank savants soon got cold feet, worrying about inflation and real estate bubbles. So much so that after dissenting for many months Lars Svensson gave up and resigned. The chart shows that by early 2011 the Riksbank changed direction and stopped vying for the trend level of NGDP.

Unemployment stopped falling and began to gently rise while inflation dropped far below target. Despite very low interest rates, monetary policy remains tight!