The Swedish Economy

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					The Swedish
Economy
August 2003




Published by
The National Institute of Economic Research (NIER)
Stockholm 2003
The National Institute of Economic Research (NIER) prepares analy-
ses and forecasts of the Swedish and international economy and
conducts related research. The NIER is a government agency
accountable to the Ministry of Finance and is financed largely by
Swedish government funds. Like other government agencies, the
NIER has an independent status and is responsible for the as-
sessments that it publishes.

The Swedish Economy contains analyses and forecasts of the Swed-
ish and international economy. The report is published four
times a year, in March, June, August and December. The Statisti-
cal Appendix is issued together with The Swedish Economy (only on
the NIER’s home page in June) and provides a comprehensive
set of supporting numerical data in table form. The Swedish Econ-
omy and Statistical Appendix are English translations of the corre-
sponding reports in Swedish, Konjunkturläget and Analysunderlag,
respectively.

The report titled Wage Formation – Economic Conditions in Sweden
provides analyses of the economic conditions for wage forma-
tion in Sweden. It is the English translation of the report in
Swedish, Lönebildningen – Samhällsekonomiska förutsättningar i
Sverige, which is published annually.

In the Special Studies series, the NIER publishes reports based on
studies or other assignments commissioned by outside parties.
Research findings are published in the Working Paper series.
Some of these working papers are published in international
scholarly journals and then reissued under the heading of Re-
prints. Reports in these three series can be ordered at no charge.
Most publications can also be downloaded directly from the
NIER’s home page, www.konj.se.



NIER
Kungsgatan 12–14
Box 3116
SE-103 62 Stockholm
Sweden
Phone: 46-8-453 59 00, Fax: 46-8-453 59 80
E-mail: ki@konj.se, Home page: www.konj.se

ISSN 0023-3463
ISBN 91-89226-43-7
Preface
The Swedish Economy - August 2003 presents economic forecasts
for the years 2003–2005. The forecasts are for both the Swedish
and international economies. In a special section, the current
forecast is compared with the assessment presented in June
2003.
    The work of preparing The Swedish Economy was led by Hans
Lindberg, Director of Forecasting. The calculations were com-
pleted on August 20, 2003.




Ingemar Hansson
Director General
Summary
There are increasing signs that the international economy is on
the road to recovery. The downturn in manufacturing this spring
has levelled out, and there is much to indicate that there will be
an improvement in the second half of this year. In the United
States, domestic demand surged in the second quarter, and busi-
ness sentiment throughout the world has begun to brighten. The
tendency on financial markets, with rising stock prices and fal-
ling credit-risk premiums, also suggests that recovery is on the
way.
    Supported by a strongly expansive economic policy, particu-
larly in the US, global resource utilization is expected to begin
rising around year-end. But recovery will be slow. The repercus-
sions of the ICT collapse are still holding back activity in certain
industries. Household consumption is being fuelled by low in-
terest rates, and in some countries by tax cuts. But the weak
labour market in large areas of the world economy, and modest
                                                                       Diagram 1 GDP – US and Euro Zone
pent-up consumption, mean that growth in consumption will be           Percentage change, seasonally adjusted quarterly
                                                                       values
rather slow to gain momentum. In recent years, firms have
                                                                       1.5                                           1.5
raised profits by cutting costs; this factor, together with low
interest rates, will encourage investment as demand rises. How-
ever, investment will not pick up substantially until after year-      1.0                                           1.0

end, when demand and capacity utilization will be higher.
   The economic recovery is being led by the US (see Diagram           0.5                                           0.5
1). In the euro zone, growth is more subdued, and there are
large question marks about the future tendency of the economy.
                                                                       0.0                                           0.0
Consequently, further reduction of the ECB’s official interest
will be required to support the recovery. In Asia, the sars epi-
demic is now under control, and growth is on its way to increas-       -0.5
                                                                               00              02         04
                                                                                                                     -0.5

ing. The situation in Latin America is continuing to improve,                      US
                                                                                   Euro Zone
one reason being the stabilization of the economic situation in
                                                                       Sources: Bureau of Economic Analysis, Eurostat
Argentina. All factors considered, global growth is forecast to        and NIER.
rise from 3.1 percent this year to 3.8 percent in 2004 and 3.9
percent in 2005, compared to an average growth rate of 3.5 per-
cent in 1985–2002.                                                     Diagram 2 Household Consumption
                                                                       Percentage change, seasonally adjusted quarterly
     The Swedish economy has shown weak growth since the               values
third quarter of last year. During the spring, however, growth         3.0                                           3.0

picked up somewhat despite the uncertainty surrounding the war
in Iraq. Household consumption is now rising rapidly owing to
                                                                       2.0                                           2.0
greater optimism about the tendency of the economy and to
interest-rate cuts by the Riksbank (the Central Bank of Sweden).
It is assumed in the forecast that Sweden will vote ”yes” to the       1.0                                           1.0
euro in the coming referendum and that the Swedish krona will
be linked to the ERM2 later this year at an economically well-
balanced central rate of SEK 9.00 to the euro. This will provide       0.0                                           0.0
an additional stimulus to domestic demand through lower credit-
market interest rates. Household consumption will therefore
pick up more substantially around year-end (see Diagram 2). At         -1.0
                                                                              97         99         01   03     05
                                                                                                                     -1.0

the same time, exports will accelerate as the economy improves         Sources: Statistics Sweden and NIER.
in other countries. It is estimated that investment has now
Diagram 3 Investment, Machinery and Con-               reached bottom and will contribute increasingly to growth in
struction Sector                                       demand during 2004-2005. Both household investment in hous-
Annual percentage change
  15                                            15
                                                       ing and manufacturing investment in machinery and equipment
                                                       will pick up next year, and in 2005 investment in buildings and
  10                                            10     constructions will begin rising (see Diagram 3).
                                                           All factors considered, the forecast is that GDP will grow by
   5                                            5      1.3 percent this year, rising to 2.5 and 2.7 percent, respectively,
                                                       in 2004 and 2005. It is calculated that a greater number of work-
   0                                            0      ing days in 2004 compared to 2003 will raise the rate of GDP
                                                       growth by 0.3 percentage point. Adjusted for calendar effects,
  -5                                            -5
                                                       GDP growth is forecast to be 2.2 percent in 2004. Thus, as in
                                                       other countries, economic recovery will be slow (see Diagram 4).
 -10                                            -10
        97          99      01    03       05              Demand for labour will gradually start to pick up, and em-
             Machinery
             Construction                              ployment will begin rising during the autumn of 2004. The un-
Sources: Statistics Sweden and NIER.
                                                       employment rate is expected to culminate later this year at 4.9
                                                       percent before dropping back to 4.2 percent by the end of 2005.


Diagram 4 GDP at Market Prices                         Table 1 Selected Indicators
Percentage change, seasonally adjusted quarterly
values
                                                       Annual percentage change and percent, respectively
  2.0                                           2.0                                           2001    2002    2003    2004    2005
                                                       GDP at market prices                     1.1     1.9     1.3     2.5     2.7
                                                                               1
  1.5                                           1.5
                                                       Current account                          4.2     4.2     3.8     4.3     4.6
                                                                                   2
                                                       Employment ratio                        78.2    78.1    78.0    77.7    77.5
                                                                           3
                                                       Unemployment                             4.0     4.0     4.7     4.6     4.3
  1.0                                           1.0
                                                       Hourly earnings                          4.3     4.1     3.5     3.5     3.7
                                                       Labour costs in the business sector
  0.5                                           0.5
                                                       (LCI)                                    4.8     3.8     4.3     3.7     3.8
                                                       Productivity in the business sector      0.4     4.1     2.7     2.5     2.6
                                                       CPI, Dec.-Dec.                           2.9     2.3     1.2     1.4     2.3
  0.0                                           0.0
                                                       UND1X, Dec.-Dec.                         3.4     2.2     1.7     1.3     1.9
                                                                                          1
                                                       General-government net lending           4.6     1.1     0.4     1.2     1.9
                                                                   4
 -0.5                                           -0.5   Repo rate                               3.75    3.75    2.50    2.75    3.50
        97           99     01    03      05
                                                       Interest rate, 10-yr. government
Sources: Statistics Sweden and NIER.                         4
                                                       bonds                                    5.2     4.9     4.5     4,7     4.8
                                                                       4
                                                       TCW index                              138.6   131.0   124.3   124.8   125.3
                                                       1 As a percentage of GDP.
                                                       2 Regular employment as a percentage of the population aged 20–64.
                                                       3 As a percentage of the labour force.
                                                       4 At year-end.

                                                       Sources: Statistics Sweden, Labour Market Board, the Riksbank and NIER.


                                                       Resource utilization is currently low. In certain sectors, the per-
                                                       centage of firms reporting shortages is as low as in the crisis
                                                       years of the early 1990’s. However, the output gap is gradually
                                                       decreasing with stronger growth in demand and is expected to
                                                       have virtually closed by the end of 2005.
                                                            Sickness absence is beginning to go down, one reason being
                                                       that physicians are increasingly prescribing part-time sick leave.
                                                       The number of approved applications for activity and sickness
                                                       benefits, however, remains high. On the whole, therefore,
                                                       ill-health is continuing to rise, limiting labour supply and poten-
                                                       tial output. It is estimated that during the period 2002-2005 po-
potential GDP will rise by an annual average of only 1.9 percent        Diagram 5 Labour Cost Index (LCI), Business
despite a relatively substantial increase in the working-age popu-      Sector
                                                                        Annual percentage change
lation.                                                                 5                                                                                      5
    In 2004 new collective-bargaining agreements will be reached
on much of the labour market. Compared to the last major                4                                                                                      4

round of negotiations in 2001, the labour market is weaker, the
krona stronger, and the inflationary outlook more subdued.              3                                                                                      3

These factors suggest that the levels reached in the 2004 settle-
                                                                        2                                                                                      2
ments will be lower than in the 2001 agreements. Moreover,
wage drift, particularly in manufacturing, has been unexpectedly        1                                                                                      1
modest so far this year. All factors considered, smaller increases
in hourly earnings – 3.5–3.7 percent per year – are expected.           0
                                                                                             99                01                   03                 05
                                                                                                                                                               0

However, labour costs are increasing more rapidly than hourly                                  Settlements
                                                                                               Wage drift
earnings, primarily this year, one reason being higher costs of                                Other wage costs
negotiated employer contributions (see Diagram 5). For this             Sources: Statistics Sweden and NIER.
reason, the increases in labour costs will still be somewhat higher
in Sweden than in the euro zone during the forecast period.
     Inflation rose rapidly last winter, owing primarily to higher
                                                                        Diagram 6 Fiscal and Monetary Policy
prices of electricity and oil. Since then, both electricity and oil                     2.5                                                                          2.5
prices have receded somewhat but are still high. During the                             2.0                                                                          2.0



                                                                        tightening
course of next year, however, increasing supply is expected to
                                                                                        1.5                                                                          1.5
push down oil prices, with the price of electricity also dropping
                                                                                        1.0                         2004                                             1.0
back. Domestic demand-related inflationary pressure will remain                                                                                         2005
                                                                                        0.5                                                                          0.5
                                                                        Fiscal policy

low; at the same time, a slow rate of increase in prices of foreign
                                                                                        0.0                                                                          0.0
exports and a strong krona will tend to restrain imported infla-                                    2003
                                                                                        -0.5                                                     2001                -0.5
tion. Given these conditions, the inflation rate is forecast to be
less than 2 percent in 2004–2005. In view of the weak economy                           -1.0                                                                         -1.0
                                                                        expansive




and the subdued inflationary outlook, it will be appropriate to                         -1.5                                                                         -1.5

lower the repo rate by a further 0.25 percentage point to 2.50                          -2.0
                                                                                                                                              2002
                                                                                                                                                                     -2.0

percent during the autumn. Nevertheless, the Swedish repo rate                          -2.5                                                                      -2.5
                                                                                            -1.0             -0.5             0.0              0.5             1.0
will still be higher than the ECB’s official interest rate when                                             lower          Repo rate          higher

Sweden joins the ERM2, a difference justified for reasons that          Note: By fiscal policy is meant the policy-dependent
                                                                        change in general-government net lending.
include a somewhat higher level of resource utilization in Swe-         Source: NIER.
den than in the euro zone. Both the ECB and the Riksbank are
expected to begin raising their official interest rates in 2004 in
view of stronger growth and rising resource utilization at that         Diagram 7 General Government Net Lending
                                                                        Percent of GDP and percent of potential GDP
time. The rate hikes, however, will be more gradual in Sweden,
                                                                                         5                                                                     5
and by the end of 2005 the repo rate will have converged fully
with the ECB’s official interest rate.                                                   2                                                                     2

     The economic downturn was countered by an expansionary                              0                                                                     0

fiscal policy in 2001–2002. This year, too, fiscal policy is slightly
expansionary, while monetary policy is stimulating the economy                          -5                                                                     -5
with a lower repo rate (see Diagram 6). In the next few years, the
output gap will close, the repo rate will be raised and fiscal policy
                                                                                   -10                                                                         -10
under current rules will become slightly restrictive. This year,
general-government net lending will be low in relation to Par-
liament’s target of a 2-percent surplus on average over a business                 -15
                                                                                               91      93     95      97       99        01      03     05
                                                                                                                                                               -15

cycle. A more restrictive fiscal policy will improve net lending,                                    Actual net lending
                                                                                                     Cyclically adjusted net lending
and cyclically adjusted net lending will reach 2.5 percent of GDP
                                                                        Sources: Statistics Sweden and NIER.
in 2005 (see Diagram 7). For purposes of stabilization policy,
this level will be appropriate in light of the high growth rate at
Diagram 8 GDP at Market Prices              that time, a closing output gap and an inflation rate near 2 per-
Annual percentage change
                                            cent. According to the NIER’s assessment, fiscal and monetary
3.0                                   3.0
                                            policies, including the anticipated central rate of SEK 9.00 to the
                                            euro, will then be well balanced from an economic point of
2.5                                   2.5   view. The high level of cyclically adjusted net lending in 2004
                                            also indicates that that the two-percent net-lending target could
2.0                                   2.0   in time be raised to 2.5 percent without requiring new expendi-
                                            ture cutbacks or tax increases.
                                                Expenditure subject to the ceiling will decrease in proportion
1.5                                   1.5
                                            to GDP because of a slow-down in rising expenditure on health
                                            insurance, less expenditure on unemployment compensation,
1.0
         03                      05
                                      1.0   and stagnating central-government consumption. Despite the
       Yes to the euro                      measures already taken, however, expenditure is expected to
       No to the euro
                                            exceed the ceiling by SEK 5 billion this year. The conclusion is
Source: NIER.
                                            that further steps will be necessary this year to avoid overrun-
                                            ning the ceiling.
                                                  With the lacklustre employment trend, local-government tax
                                            revenue is increasing less rapidly than before; this tendency,
                                            together with continuing increases in expenditure, has put pres-
                                            sure on local-government finances. It is expected that local-
                                            government tax rates will be raised by a further 0.2 percentage
                                            point next year.
                                                If Sweden remains outside the monetary union following a
                                            ”no” vote in the referendum this autumn, economic recovery
                                            will take more time (see Diagram 8). There will then be no addi-
                                            tional help from declining interest rates. Growth in household
                                            consumption and investment will be somewhat slower. It is
                                            estimated that in this case GDP growth will be limited to 2.3
                                            percent in both 2004 and 2005.
Contents
Economic Forecast ...........................................................................11

    International Economy...............................................................13

    Financial Economy......................................................................23

    Demand and Output in the Swedish Economy .....................29

       Household Consumption........................................................34
       General Government Consumption .....................................35
       Gross Fixed Capital Formation .............................................36
       Stockbuilding.............................................................................39
       Exports.......................................................................................40
       Imports.......................................................................................42
       Output........................................................................................43
       Productivity and Profitability .................................................45

    Labour Market, Resource Utilization and Prices....................53

       Labour Market ..........................................................................54
       Resource Utilization.................................................................57
       Wages and Labour Costs.........................................................60
       Inflation .....................................................................................65

    Public Finances ............................................................................69

       Fiscal Policy...............................................................................70
       Fiscal and Budget Policy Targets ...........................................75
       Revenue and Expenditure of the General Government
       Sector..........................................................................................80
       Net Lending of General Government Subsectors..............83

Comparison of Forecasts .................................................................89



Boxes

Trends and Risks in Household Indebtedness .............................31

Cyclical Effects of a “Yes” and a “No” to the Euro ...................48

EMU Rules of Fiscal Policy.............................................................72
Economic Forecast
2003–2005
                                                                                                                    13




International Economy


World Economy Slowly Picking Up

After a weakening tendency at the end of last year and early this
year, there are growing signs that the international economy is
on the road to recovery. The declining trend in manufacturing
this spring has come to a halt, and there is much to suggest that
activity is increasing in the second half of this year. In the United
States, domestic demand surged in the second quarter, and busi-
ness sentiment throughout the world has begun to brighten. The
tendency on financial markets, with rising stock prices and fal-
ling credit-risk premiums, also indicates that recovery is on the
way.
    Supported by a strongly expansionary economic policy,
global resource utilization is expected to begin rising at the turn
                                                                        Diagram 9 GDP – US and Euro Zone
of the year (see Diagram 9). By historical standards, though,           Percentage change, seasonally adjusted quarterly
                                                                        values
recovery is proceeding slowly. Moreover, there is relatively sub-
                                                                        1.5                                          1.5
stantial uncertainty about the timing and strength of the recov-
ery in the euro zone.
    To a considerable degree, firms have consolidated their fi-         1.0                                          1.0

nances over the past year; this factor, together with low financ-
ing costs, should promote investment as demand rises. Invest-           0.5                                          0.5
ment, however, will not pick up substantially until after year-end
(see Diagram 10).
                                                                        0.0                                          0.0
    Households are benefiting from decreasing inflation, and in
some countries from tax cuts. But a weak labour market in large
areas of the world economy over the next half-year, together            -0.5
                                                                                00              02       04
                                                                                                                     -0.5

with modest accumulated consumer demand, will mean a rela-                          US
                                                                                    Euro Zone
tively sluggish upturn in the growth of consumption.
                                                                        Sources Bureau of Economic Analysis, Eurostat and
    One effect of the expansionary fiscal policy in e.g. the US is      NIER.
that general-government finances for the OECD countries as a
whole are deteriorating. Together with the brighter economic
outlook and diminished concern about deflation, this tendency           Diagram 10 Fixed Capital Formation – US and
                                                                        Euro Zone
has contributed recently to an increase in long-term interest           Percentage change, seasonally adjusted quarterly
rates, thus undermining the economic effect of the expansionary         values

fiscal policy. Moreover, the repercussions of the ICT collapse          3                                                3

are still putting a damper on activity in certain industries.           2                                                2
    The prospects for the economies outside the OECD are rela-
tively bright. In Asia, the sars epidemic appears to be under           1                                                1

control, and the economic effects should be modest from now
                                                                        0                                                0
on. In China, growth is expected to remain high but to be more
subdued in the rest of Asia. In Latin America, growth is continu-       -1                                               -1

ing to rise, not least because the economic situation has been
                                                                        -2                                               -2
stabilized in Argentina. In Central and Eastern Europe, and
Russia, continued healthy growth is expected.                           -3                                               -3
                                                                               00               02        04
    All factors considered, global growth is forecast to rise                   US
somewhat from 2.9 percent last year to 3.1 percent this year. For               Euro Zone

2004 and 2005, global growth rates of 3.8 and 3.9 percent,              Sources: Bureau of Economic Analysis, Eurostat
                                                                        and NIER.
14 International Economy




Diagram 11 GDP and Inflation – OECD                                         respectively, are anticipated. This can be compared with an aver-
Annual percentage change
                                                                            age growth rate of approximately 3.5 percent during the period
6                                                                       6
                                                                            1985–2002. For the OECD countries, it is estimated that growth
5                                                                       5   will be 1.9 percent this year, rising thereafter to 2.7 percent in
                                                                            2004 and 3.1 percent in 2005 (see Diagram 11).
4                                                                       4
                                                                                Resource utilization in the OECD countries will begin rising
3                                                                       3   around the turn of the year, but so slowly that it will still be rela-
                                                                            tively modest even in 2005. The inflation rate in the OECD
2                                                                       2
                                                                            countries dropped to 2.4 percent in May. With resource utiliza-
1                                                                       1
                                                                            tion low and the economic recovery relatively sluggish, inflation
                                                                            is expected to decrease further during the autumn to about 1.5
0
        85    87    89    91   93   95   97   99    01   03    05
                                                                        0   percent and to stay at roughly that level for the rest of the fore-
             CPI*                                                           cast period.
             GDP
                                                                                Monetary policy will remain expansionary in most countries
*See footnote in Table 2.
Sources: OECD and NIER.                                                     throughout the forecast period, although the central banks in
                                                                            both the US and the euro zone are will gradually begin to raise
                                                                            official interest rates beginning next spring.

                                                                            Table 2 GDP and CPI in Other Countries
                                                                            Annual percentage change
                                                                                               GDP                           CPI
                                                                                               2002 2003 2004 2005           2002 2003 2004 2005
                                                                            United States        2.4    2.3    3.4    3.8      1.6    2.2    1.9    2.0
                                                                            Japan                0.2    2.0    1.3    1.4     –0.9   –0.2   –0.2   –0.1
                                                                            Euro zone            0.8    0.7    2.1    2.7      2.3    1.9    1.5    1.7
                                                                                Germany          0.2    0.2    1.9    2.2      1.3    0.9    0.9    1.0
                                                                                France           1.2    0.7    2.1    2.6      2.0    1.9    1.5    1.6
                                                                            United Kingdom       1.9    1.9    2.5    2.5      1.3    1.4    1.6    1.8
                                                                                    1
                                                                            OECD                 1.8    1.9    2.7    3.1      1.5    1.8    1.5    1.6
                                                                            World                2.9    3.1    3.8    3.9
                                                                            1 The GDP figures are for all OECD countries, whereas the CPI figures are for
                                                                            the OECD except for Australia, the Czech Republic, Hungary, Iceland, Korea,
                                                                            Mexico, New Zealand, Poland, Slovakia and Turkey. The CPI figures for the
                                                                            EU countries are for the harmonized CPI and HICP.
                                                                            Sources: OECD and NIER.


Diagram 12 Price of Oil
Brent USD/barrel, monthly values
35                                                                  35
                                                                            Plundering and Sabotage Driving Up the Price of Oil
30                                                                  30
                                                                            The brief war in Iraq helped to bring the price of oil back down
25                                                                  25      to around USD 23 per barrel at the end of April. Since then, oil
                                                                            prices have soared despite lower seasonal demand during the
20                                                                  20      summer and a weak international economy. In mid-August, the
                                                                            price of oil was USD 29 per barrel (see Diagram 12). At the
15                                                                  15
                                                                            same time, the pricing on the oil-options market for delivery at
10                                                                  10
                                                                            year-end indicates that prices may well remain at that level for
                                                                            the rest of the year.
    5                                                               5           There are several reasons why prices have gone up over the
         95          97        99        01        03         05
                                                                            summer; one is the surprisingly strong demand in the US, which
Note: North Sea Oil.
Sources: EcoWin, International Petroleum Exchange                           has resulted in relatively low inventories. The single most impor-
and NIER.
                                                                            tant reason, though, is the uncertainty about the supply of oil
                                                                                             International Economy 15




from Iraq in the near future. To judge from the security prob-          Diagram 13 GDP and Demand – US
                                                                        Percentage change, seasonally adjusted quarterly
lems in the country, with repeated plundering and sabotage di-          values
rected at existing oil fields and pipelines, it will take a long time     3                                                        3
to increase supply significantly. After the latest OPEC meeting
                                                                          2                                                        2
at the end of July, it is also clear that the so-called OPEC 10
(OPEC excluding Iraq) will refrain for the time being from any            1                                                        1
changes in output, even though the price of oil now exceeds the
                                                                          0                                                        0
upper limit of the target interval of USD 22-28 per barrel.
    During the autumn, the price of oil is expected to remain            -1                                                        -1

around its current level, and the price of North Sea oil is forecast
                                                                         -2                                                        -2
to be USD 28 per barrel at the end of 2003. Toward the end of
next year, an increased supply from Iraq and countries outside           -3
                                                                                  01                  03                 05
                                                                                                                                   -3

OPEC is expected to push the price of oil down to USD 26 per                       GDP
                                                                                   Fixed capital formation
barrel. In a longer-term perspective, a continuing increase in                     Household consumption
supply will make it difficult for the OPEC to keep prices near          Sources Bureau of Economic Analysis and NIER.
the middle of the target interval of USD 22-28. Consequently,
the price of oil is forecast to drop back to USD 24 per barrel by
the end of the forecast period.
                                                                        Diagram 14 Purchasing Manager Index, Ser-
                                                                        vice Sector and Manufacturing – US
                                                                        Index, monthly values
                                                                         70                                                        70
Slow Recovery in the United States
                                                                         65                                                        65
Growth in the US increased in the second quarter of this year
                                                                         60                                                        60
(see Diagram 13). Partly because of a surge in general-
government expenditure, domestic demand was stronger than                55                                                        55

expected, whereas the contribution of inventories remained               50                                                        50
negative.
                                                                         45                                                        45
     According to a number of indicators, growth will continue
upward. The Purchasing Manager Index has risen and is now                40                                                        40

high, particularly for the services sector (see Diagram 14). In          35                                                        35
                                                                                   99                     01                  03
addition, retail sales maintained their relatively rapid increase in               Service Sector
July. Employment, on the other hand, was still decreasing during                   Manufacturing

the summer (see Diagram 15).                                            Source: Institute for Supply Management.

     Inventory depletion is probably over by now, and firms will
accumulate some inventory as demand rises. The effect will be a
positive contribution to GDP growth through the end of 2004.            Diagram 15 Change in Employment – US
                                                                        Thousands, seasonally adjusted monthly values
     Despite decreasing employment, tax cuts will provide a mar-
                                                                          600                                                  600
gin for households to increase their consumption rather substan-
tially in the next few quarters. Fiscal policy will remain expan-
sionary next year as well. The already sizable deficits in the fed-       400                                                  400

eral budget will then be even larger and will persist for a long
time.                                                                     200                                                  200

     Monetary policy is also highly expansionary. The official in-
terest rate (federal funds rate) was lowered to 1 percent in June,            0                                                0
and the short-term real rate of interest is now negative (see Dia-
gram 16). Long-term market rates of interest dropped to historic         -200                                                  -200
lows early this summer, leading to a decrease in home-mortgage
rates as well. In combination with rising house prices, this de-         -400                                                  -400
velopment has led many households to increase their home                          90    92     94    96        98   00   02
                                                                        Sources: U.S. Department of Labor and Bureau of
mortgages and to step up their consumption. The lacklustre              Labor Statistics.
stock-market trend, however, has tended to reduce household
16 International Economy




Diagram 16 Output Gap and Real Rate of In-                             net wealth (see Diagram 17) in recent years, a factor that has
terest – US                                                            tended to restrain consumption.
Percent of potential GDP and percent, respectively,
quarterly values                                                           The strong economic-policy measures are one reason why
  6                                                               6    economic growth is expected to increase in the period ahead,
                                                                       but recovery will be relatively slow. Household consumption will
  4                                                               4
                                                                       be rising during the second half-year as an effect of the massive
                                                                       tax cuts. Unlike most previous economic slumps, however, there
  2                                                               2
                                                                       is no substantial pent-up consumption demand. On the other
                                                                       hand, when the fiscal-policy stimulus subsides, a gradually im-
  0                                                               0
                                                                       proving labour market will help to maintain a healthy trend in
 -2                                                               -2
                                                                       household consumption. Nevertheless, since consumption is not
                                                                       expected to increase at the same pace as household disposable
 -4                                                               -4   income, the net-lending ratio will rise somewhat from its cur-
       90       92        94    96          98    00        02
            Output gap
                                                                       rently rather low level.
            3-month real rate of interest                                  Business investment has decreased markedly in recent years,
Source: NIER.                                                          one reason being previous overinvestment. Investment is being
                                                                       fuelled by a continuing strong trend in productivity and by rising
                                                                       profits of firms (see Diagram 18), but given the low level of
Diagram 17 Household Net Wealth Ratio – US
Net wealth in proportion to disposable income, quar-                   resource utilization, it will not pick up until next year, when
terly values
                                                                       demand has grown stronger. In view of low resource utilization
 6.5                                                             6.5
                                                                       and weak inflationary pressure, the Federal Reserve (the US
                                                                       central bank) can wait before tightening monetary policy. Not
 6.0                                                             6.0   until next spring are household consumption and business in-
                                                                       vestment expected to have picked up sufficiently to require rais-
 5.5                                                             5.5   ing the federal funds rate. The increase will then be made in
                                                                       small steps that bring the federal funds rate up to 3.75 percent at
 5.0                                                             5.0   the end of 2005.

 4.5                                                             4.5   Table 3 Selected Indicators – United States
                                                                       Annual percentage change and percentage points, respectively
 4.0                                                             4.0                                          2001    2002    2003    2004    2005
       85     87     89    91   93    95     97   99   01
Sources: Federal Reserve System and Bureau of                          Household consumption                    2.5     3.1     2.8     3.3     3.2
Economic Analysis.                                                     General-government con-
                                                                       sumption                                 3.7     4.4     4.3     1.8     1.0
                                                                       Fixed-capital formation                 –2.7    –1.9     2.0     4.4     7.4
                                                                                          1
Diagram 18 Business Profits – US                                       Stockbuilding                           –1.4     0.7    –0.1     0.2     0.1
Percent, quarterly values                                                             1
                                                                       Net exports                             –0.2    –0.8    –0.7    –0.3    –0.2
 13                                                              13
                                                                       GDP                                      0.3     2.4     2.3     3.4     3.8

 12                                                              12
                                                                       CPI                                      2.8     1.6     2.2     1.9     2.0
                                                                       Unemployment                             4.8     5.8     6.1     5.9     5.6
 11                                                              11                             2, 3
                                                                       Official interest rate                  1.75    1.25    1.00    2.00    3.75
                                                                                                       2, 4
 10                                                              10    Long-term interest rate                  5.0     4.0     4.5     5.2     5.6
                                                                                  2
                                                                       YEN/USD                                126.9   122.3   120.0   120.0   120.0
  9                                                              9                    2
                                                                       USD/EURO                                0.89    1.02    1.12    1.12    1.12

  8                                                              8
                                                                       1 Contribution to GDP growth.
                                                                       2 At the end of each year.
                                                                       3 Federal funds target rate.
  7                                                              7
                                                                       4 Rate on 10-year government bonds.

  6                                                              6     Sources: Bureau of Economic Analysis, the Riksbank and NIER.
       90       92        94     96         98    00    02
Source: Bureau of Economic Analysis.
                                                                                           International Economy 17




One factor of importance for the long-term development of the         Diagram 19 Industrial Output – Euro Zone
                                                                      Annual percentage change and percentage change,
economy is the negative general-government net lending. The           respectively, monthly values
massive budget deficits are still growing and will persist for a        2.0                                                          8
long time. Therefore, even though household net lending will                                                                         6
increase somewhat in the period ahead, the need for substantial
                                                                        1.0                                                          4
inflows of foreign capital will remain. Although the sharp depre-
                                                                                                                                     2
ciation of the dollar in the past year is providing a stimulus to
exports, the sizable deficit on current account is expected to          0.0                                                          0

continue during the forecast period.                                                                                                 -2

                                                                       -1.0                                                          -4

                                                                                                                                     -6
Cautious Optimism in the Euro Zone                                     -2.0                                                          -8
                                                                                    00            01            02              03
                                                                                   Change from preceding month
Despite the end of the war in Iraq and rising stock prices, the                    Annual percentage change (right)
economy in the euro zone has remained weak during the spring          Source: Eurostat.
and summer. In manufacturing, not least, activity has been sub-
dued, with a drop in manufacturing output (see Diagram 19) and
deterioration in the order situation. The tendency in exports was
                                                                      Diagram 20 GDP and Demand – Euro Zone
also anemic, and according to preliminary statistics GDP stag-        Percentage change, seasonally adjusted quarterly
nated in the second quarter (see Diagram 20).                         values

    Recently, signs of a somewhat stronger economy have begun           1.0                                                      1.0

to appear. The Purchasing Manager Index in both the manufac-            0.5                                                      0.5
turing and service sectors rose in July (see Diagram 21). For
                                                                        0.0                                                      0.0
manufacturing, however, the index was still below 50, which is
considered the lower limit of rising output. Business confidence       -0.5                                                      -0.5
has begun to increase from its low levels last spring, not least in
                                                                       -1.0                                                      -1.0
Germany (see Diagram 22), while consumer confidence appears
to have stabilized. Probably underlying the rising optimism in         -1.5                                                      -1.5

business are the increasingly positive signals from the US econ-
                                                                       -2.0                                                      -2.0
omy and the structural reforms announced in Germany and                        01                      03                  05
                                                                                   GDP
elsewhere. However, the probability of setbacks in the reform                      Fixed capital formation
                                                                                   Household consumption
process, with possible negative effects on confidence, is still
considerable.                                                         Sources: Eurostat and NIER.

    In view of the expansionary monetary policy and an increas-
ingly stronger world economy, growth is expected to speed up
gradually during the autumn. After appreciating in the past year,     Diagram 21 Purchasing Manager Index – Euro
the euro has once again weakened somewhat over the summer,            Zone
                                                                      Index, monthly values
to the benefit of the exporting industries. Nevertheless, exports      65                                                            65
are not anticipated to assume their traditional role as the driving
force of economic recovery. This time, domestic demand will            60                                                            60
provide the principal thrust behind economic growth. House-
holds are benefiting from low interest rates and decreasing infla-     55                                                            55

tion, which will boost growth in consumption in the next year.
Relatively healthy balance sheets of firms, together with low          50                                                            50

financing costs, mean that investment will pick up toward year-
end. Stockbuilding will continue and is expected to provide a          45                                                            45

relatively large positive contribution to growth in 2003.
                                                                       40                                                            40
    All factors considered, GDP growth is expected to rise                    98                  00                  02

gradually to its potential rate of increase toward year-end. Be-               Manufacturing
                                                                               Service Sector
cause of the lacklustre tendency during the spring, GDP will          Source: NTC Research Ltd.
increase by only 0.7 percent this year. In 2004 and 2005,
18 International Economy




Diagram 22 Business Climate Index (IFO) –                    however, GDP growth is forecast to be 2.1 and 2.7 percent,
Germany                                                      respectively. This trend means that resource utilization will
Index 1991=100, monthly values
 110                                                   110
                                                             slowly increase beginning early next year, but that there will still
                                                             be unutilized resources at the end of the forecast period.
 105                                                   105       With higher prices of energy and food, the inflation rate in
 100                                                   100
                                                             the euro zone rose to 2.0 percent in June (see Diagram 23). But
                                                             the rise is considered temporary, and according to preliminary
      95                                               95    statistics, the inflation rate subsided to 1.9 percent in July. The
                                                             low level of resource utilization and a subdued tendency in unit
      90                                               90
                                                             labour costs are expected to help reduce the inflation rate fur-
      85                                               85    ther, toward 1.5 percent by year-end. Since resource utilization
                                                             will be increasing only marginally and the output gap will be
      80                                               80
           96            98          00     02               negative throughout the forecast period, the inflation rate is
                General index
                Expectations                                 anticipated to increase only slightly in 2004 and 2005.
Source: Institut für Wirtschaftsforschung (IFO).
                                                                 In view of the favourable inflation outlook, it is estimated
                                                             that the European Central Bank (ECB) will to lower its official
                                                             interest rate by a further 0.25 percentage point to 1.75 percent
                                                             during the autumn. By the spring of 2004 the outlook is for such
Diagram 23 Inflation – Euro Zone
Annual percentage change, monthly values                     strong growth that the ECB will gradually begin to raise its offi-
3.5                                                   3.5    cial interest rate.
3.0                                                   3.0
                                                             Tabell 4 Selected Indicators – Euro Zone
2.5                                                   2.5
                                                             Annual percentage change and percentage points, respectively
2.0                                                   2.0                                           2001   2002   2003   2004   2005
                                                             Household consumption ex-
1.5                                                   1.5    penditure                               1.8    0.5    1.4    2.2    2.8
                                                             General-government con-
1.0                                                   1.0
                                                             sumption expenditure                    2.0    2.7    1.4    1.4    1.6
                                                             Gross fixed-capital formation          –0.3   –2.6   –0.7    2.8    3.4
0.5                                                   0.5                      1
           99                   01               03          Stockbuilding                          –0.4   –0.1    0.4    0.1    0.0
           Consumer prices (HICP)                            Net exports
                                                                           1
                                                                                                     0.5    0.6   –0.6   –0.1    0.0
           HICP excluding food and energy
                                                             GDP                                     1.5    0.8    0.7    2.1    2.7
Source: Eurostat.
                                                             CPI                                     2.4    2.3    1.9    1.5    1.7
                                                             Unemployment                            8.0    8.3    8.9    8.8    8.7
                                                                                      2, 3
                                                             Official interest rate                 3.25   2.75   1.75   2.50   3.50
                                                                                             2, 4
                                                             Long-term interest rate                 4.8    4.3    4.1    4.4    4.7
                                                                           2
                                                             USD/EURO                               0.89   1.02   1.12   1.12   1.12
                                                             1 Contribution to GDP growth.
                                                             2 At the end of each year.
                                                             3 Refi rate.

                                                             Rate on 10-year government bonds.
                                                             Sources: Eurostat, the Riksbank and NIER.




                                                             Brightening Outlook in Japan

                                                             According to preliminary statistics, the Japanese economy grew
                                                             by 0.6 percent in the second quarter of this year. There were
                                                             increases in household consumption, investment in machinery
                                                             and equipment, and the contribution of stockbuilding. Rising
                                                             business profits led to higher bonus earnings during the
                                                                                                   International Economy 19




summer, a factor that helped to increase household consump-              Diagram 24 Confidence Indicators – Japan
                                                                         Balances, quarterly values
tion. Investment in machinery and equipment was also furthered
                                                                         20                                                                         48
by the rising profit trend, as well as by higher capacity utilization.
However, investment in construction continued to decrease.
Exports rose, while imports fell, thus also contributing to GDP           0                                                                         44

growth.
    GDP is expected to continue growing in the third quarter.            -20                                                                        40

Leading indicators point to an improvement in the economy,
and business confidence was up as the third quarter approached           -40                                                                        36
(see Diagram 24). The purchasing index has also risen during the
summer. The brighter picture is reinforced by an improved in-            -60                                                                        32
                                                                               93    94       95   96   97   98    99   00        01    02    03
ternational economy and the fact that the sars epidemic in Asia
                                                                                    All firms
now appears to be over.                                                             Large firms, manufacturing
                                                                                    Households (right)
    Household consumption is expected to continue rising
                                                                         Source: Cabinet Office.
somewhat during the third quarter, one reason being higher
bonus earnings. There has also been some improvement in con-
sumer confidence about the future. Moreover, a modest rise in
employment lowered the unemployment rate to 5.3 percent in
                                                                         Diagram 25 Operation Profits and New Or-
June. Building investment is expected to be higher since housing         ders, Machinery and Equipment – Japan
starts have gone up. The relatively healthy tendency in business         Billions of yen, quarterly and monthly values, re-
                                                                         spectively
and the recent improvement on stock markets, together with               14000                                                                    1200
increasingly high capacity utilization and a rising inflow of new
                                                                         13000                                                                    1100
orders, are expected to mean higher investment in machinery
                                                                         12000                                                                    1000
and equipment in the period ahead (see Diagram 25).
    During 2004 and 2005, a gradually strengthening interna-             11000                                                                    900

tional economy will continue to stimulate the economy of Japan.          10000                                                                    800

Growth in household consumption, however, is expected to be               9000                                                                    700
slow owing to a subdued tendency in employment and earnings.              8000                                                                    600
Moreover, savings is not anticipated to fall as rapidly as in the
                                                                          7000                                                                    500
last two years, when the savings ratio dropped from 9.8 percent
                                                                          6000                                                                    400
in 2000 to 5.8 percent in 2002. The need for firms to renew their                   95             97        99              01

stock of machinery and equipment and to invest in new tech-                              Operating Income, total industry
                                                                                         New Orders, Machinery and Equipment (right)
nology is contributing to rising investment in machinery and             Sources: Ministry of Finance and Economic and
equipment. After temporarily increasing in the second quarter            Social Research Institute.
this year, building investment is expected to decrease in 2004
because of the current excess capacity in real estate. A very            Diagram 26 GDP and CPI – Japan
                                                                         Annual percentage change
modest recovery is anticipated, but not until 2005.
                                                                           6                                                                             6
    All factors considered, GDP is forecast to rise by 2.0 percent
this year, 1.3 percent in 2004, and 1.4 percent in 2005 (see Dia-
gram 26). Consumer prices will continue to decrease, but at a              4                                                                             4

lesser rate than before. In view of this tendency, together with
the low level of resource utilization, the Bank of Japan is not            2                                                                             2
expected to raise its official interest rate of 0.1 percent during
the forecast period.
                                                                           0                                                                             0



                                                                          -2                                                                             -2
Higher Growth in the United Kingdom                                            90        92        94   96        98    00         02        04
                                                                                    GDP
                                                                                    CPI
The British economy stagnated in the first quarter of this year.
                                                                         Sources: Cabinet Office, Management and Coordi-
There was a drop in domestic demand, with a strongly negative            nation Agency, Japan and NIER.
contribution from inventories and declining investment in both
20 International Economy




Diagram 27 Underlying Inflation (RPIX) – UK                  machinery and buildings. In addition, the increase in household
Annual percentage change, monthly values
                                                             consumption showed a lacklustre trend, probably because of a
     3.5                                               3.5
                                                             weaker tendency in wages. Household consumption has been
     3.0                                               3.0   financed partly by increasing mortgages on real estate; this has
     2.5                                               2.5   been made possible by the surge in real-estate prices in recent
                                                             years. Exports, however, rose in the first quarter, one reason
     2.0                                               2.0
                                                             being weaker sterling, and are estimated to have done so in the
     1.5                                               1.5   second quarter as well. Exports are anticipated to increase more
     1.0                                               1.0   rapidly in the future as the international recovery picks up. Con-
                                                             sequently, the profits and capacity utilization of firms are ex-
     0.5                                               0.5
                                                             pected to rise, stimulating investment in machinery and equip-
     0.0
                95           97          99       01
                                                       0.0   ment.
                     Underlying inflation, RPIX                   Household consumption is also estimated to have increased
                     Harmonised CPI, EU-basis
                                                             in the second quarter. Rising stock prices and continued sub-
Source: Office of National Statistics.
                                                             stantial increases in house prices, which in July were 18 percent
                                                             higher than at the same time a year earlier, have contributed to
                                                             the upturn. Furthermore, inflation has receded somewhat; the
                                                             HICP inflation rate was 1.3 percent in July, compared to 1.6
Diagram 28 GDP and Demand – UK
Annual percentage change and contribution to GDP,            percent in March (see Diagram 27).
respectively
                                                                 The Bank of England lowered its base rate to 3.5 percent
6                                                      6
                                                             early in July this year. The more expansionary monetary policy,
4                                                      4
                                                             together with a continued expansionary fiscal policy, is stimulat-
                                                             ing domestic demand. Growth in nominal earnings is expected
2                                                      2     to be subdued in the period ahead because of increases in social-
                                                             insurance contributions. It is nevertheless anticipated that
0                                                      0     household consumption will develop relatively well throughout
                                                             the forecast period, one reason being higher employment, par-
-2                                                     -2
                                                             ticularly in the exporting industries. The unemployment rate has
-4                                                     -4
                                                             been around 5 percent since the end of 2000 and is expected to
           98               00           02       04
                                                             decrease somewhat during the forecast period. GDP is calcu-
                GDP, percentage change
                Domestic demand                              lated to rise by 1.9 percent this year and by 2.5 percent in both
                Net exports
                                                             2004 and 2005 (see Diagram 28). The HICP inflation rate is
Sources: Office of National Statistics and NIER.
                                                             forecast to increase from 1.4 percent this year to 1.8 percent in
                                                             2005, for reasons that include rising resource utilization and
                                                             weaker sterling.


                                                             The Nordic Countries

                                                             Finland’s GDP increased by 2.2 percent last year, largely because
                                                             of strongly rising net exports. The tendency in exports, however,
                                                             was weaker than in the first half of the 1990’s. In the first quar-
                                                             ter of this year, the negative contribution of net exports was the
                                                             main reason why GDP dropped by more than 1 percent com-
                                                             pared to the previous quarter. The sluggish recovery of interna-
                                                             tional investment and a strong euro are holding back growth in
                                                             exports this year. The competitive situation for the Finnish basic
                                                             and manufacturing industries has deteriorated somewhat, but
                                                             remains favourable. As the international economy strengthens,
                                                             this factor will contribute to faster growth in exports next year
                                                             and in 2005. The surplus in general-government net lending will
                                                                                                     International Economy 21




exceed 3 percent of GDP during the forecast period. The sur-           Diagram 29 GDP and Inflation – Finland
                                                                       Annual percentage change
plus in central-government net lending, though much smaller,
                                                                           8                                                             8
will make it possible to increase general-government consump-
tion through appropriations to health and nursing care as well as          6                                                             6

schools, while reducing for example the taxes on alcohol and               4                                                             4

tobacco. The unemployment rate, which was 9.1 percent last                 2                                                             2

year, is forecast to increase this year but to drop back next year         0                                                             0
and in 2005.                                                               -2                                                            -2
    Resource utilization in the Finnish economy remains low.
                                                                           -4                                                            -4
This factor, together with reduced taxes on alcohol and tobacco,
                                                                           -6                                                            -6
will contribute to a substantial decrease in the inflation rate dur-
ing the forecast period. The two-year wage settlement currently            -8
                                                                                 90        92    94     96    98    00    02    04
                                                                                                                                         -8

in effect will thus mean steadily increasing real household in-                       HICP
                                                                                      GDP
come. Household consumption expenditure, which went up last
                                                                       Sources: Central Statistical Office and NIER.
year by 1.5 percent, is therefore expected to rise more rapidly
this year and in 2004, and by more than 2 percent in 2005 as
well. GDP is forecast to increase by 1.0 percent this year, rising
to 2.5 and 2.8 percent, respectively, in 2004 and 2005 (see Dia-
                                                                       Diagram 30 GDP and Inflation – Denmark
gram 29).                                                              Annual percentage change
    In Denmark unemployment is at its highest level since 1998.        6                                                             6

The high unemployment is reflected in the recent decline in
                                                                       5                                                             5
consumer confidence. Household consumption dropped in the
first quarter of this year and is forecast to increase only margin-    4                                                             4
ally this year compared to 2002. Income-tax relief in 2004, con-
                                                                       3                                                             3
tinued low interest rates, and a brighter international economic
outlook are expected to bring much stronger growth in house-           2                                                             2
hold consumption in 2004–2005. It is estimated that exports will
provide a substantial contribution to Danish growth in 2003.           1                                                             1

Danish exports showed a healthy tendency in the first quarter of       0                                                             0
                                                                            90        92        94     96    98    00    02    04
this year despite a stronger Danish krone and economic weak-
                                                                                  HICP
ness in Germany, which imports one fifth of Danish exports.                       GDP

This outcome is due primarily to the mix of Danish exports,            Sources: Statistics Denmark and NIER.
which consist predominantly of pharmaceuticals and foodstuffs,
items not sensitive to cyclical fluctuations. All factors consid-
ered, the forecast is that GDP will increase by 1.4 percent this
year and by 2.4 percent per year in 2004–2005. The rate of             Diagram 31 GDP and Inflation – Norway
                                                                       Annual percentage change
HICP inflation is expected to be 2.2 percent this year and 2.1
                                                                       7                                                             7
and 2.0 percent in 2004 and 2005, respectively (see Diagram 30).
    In Norway, both household consumption and investment de-           6                                                             6

creased in the first quarter of this year. Household consumption       5                                                             5
was probably dampened by substantial price increases, primarily
                                                                       4                                                             4
in electricity, and by rising unemployment. But with more stock-
building and higher exports, particularly of oil, there was never-     3                                                             3

theless some growth in GDP. It is estimated that in the second         2                                                             2
quarter household consumption rose again, one reason being
                                                                       1                                                             1
that consumer prices dropped by more than two percent be-
tween February and July of this year.                                  0
                                                                            90        92        94     96    98    00    02    04
                                                                                                                                     0

    A declining rate of inflation has led to repeated cuts in the                 CPI
                                                                                  GDP
official interest rate, from 7 percent in December of last year to
                                                                       Sources: Statistics Norway and NIER.
the current level of 3 percent. The reduction is one reason why
the krone has depreciated by some 9 percent so far this year.
22 International Economy




                           This tendency, together with a strengthening international econ-
                           omy, is expected to mean higher growth in exports in the next
                           two years, with rising employment as a result. The development
                           of the export sector will thus help to stabilize the labour market,
                           where the unemployment rate rose from 3.8 percent in May
                           2002 to 4.6 percent in May of this year. The low interest rates
                           are stimulating both household consumption and investment.
                           Households are also benefiting from a somewhat more expan-
                           sionary fiscal policy with rising transfer payments to pensioners
                           and lower day-care fees. Nevertheless, investment is anticipated
                           to be modest, since capacity utilization at firms is relatively low.
                           All factors considered, GDP growth in Norway is forecast to be
                           only 0.6 percent this year but to rise to 1.9 percent in 2004–
                           2005. Declining prices of energy are expected to reduce the in-
                           flation rate to 2 percent in 2004–2005 (see Diagram 31).
                                                                                                                                23




Financial Economy                                                     Diagram 32 Development of the Stock Market
                                                                      – Sweden and US
                                                                      Index, monthly values
                                                                      500                                                           5000



Stock Market Recovery                                                 400                                                           4000



At the outset of this year, stock markets fell throughout the         300                                                           3000

world, one reason being the uncertainty surrounding the escalat-
ing conflict in Iraq. The outbreak of war there marked the be-        200                                                           2000

ginning of substantial recovery on world stock markets. In Swe-
                                                                      100                                                           1000
den and Japan, the recover has continued during the summer.
Since the outset of this year, the SAX index has risen by ap-
                                                                        0                                                           0
proximately 20 percent, while the US Nasdaq index has gone up                1997             1999           2001            2003

by some roughly 30 percent, and the more broadly based Stan-                       SAX
                                                                                   Standard and Poor's 500 (right)
dard and Poor’s 500 index by about 14 percent (see Diagram                         Nasdaq Composite (right)

32). The rise in the euro zone has been around 7 percent, and in      Source: EcoWin.
Japan, stock markets are up by some 20 percent.
    The uncertainty surrounding the Iraq conflict is also reflected
in the pricing of options, and volatility rose as the risk of armed
                                                                      Diagram 33 Volatility Index for Options, Stan-
conflict increased (see Diagram 33). Since the end of the war in      dard and Poor’s 100 index
                                                                      Index, daily values
Iraq, volatility has subsided, and it has remained low during the
                                                                        55                                                               55
summer.
    After the stock-market decline over the last three years, the       50                                                               50

SAX and Standard and Poor’s 500 indices are back at their 1997          45                                                               45
levels. Nevertheless, the P/E ratio, or the relationship between
                                                                        40                                                               40
stock prices and reported earnings, for the Standard and Poor’s
500 index has remained high by historical standards. One expla-         35                                                               35

nation for the high valuation of these shares is that investors are     30                                                               30
counting on corporate earnings to increase as time passes. In
                                                                        25                                                               25
addition, interest rates are depressed, which means that the dis-
counting rate for future profits is low. The so-called Fed Model        20                                                               20

relates the return on stocks to the return on bonds. The differ-        15                                                               15
ence between the inverted P/E ratio and the real rate of return                   97               99              01               03
                                                                      Note: Index for implicit standard deviation, annual
on bonds can be viewed as a measure of the additional return on       rate, calculated from options maturing in one month.
higher-risk investment in stocks. This differential widened in the    Source: Chicago board of options exchange.

later months of 2002 and early in 2003 (see Diagram 34). The
reasons were the sharp drop on stock markets and the decline in       Diagram 34 Fed Model
                                                                      Percentage points, monthly values
US long-term interest rates. However, the differential is still
                                                                        8                                                                  8
fairly modest by historical standards, one interpretation being
that the market has high implicit expectations about future
growth in profits.                                                      6                                                                  6



                                                                        4                                                                  4

Rising Interest Rates on International Bond Markets
                                                                        2                                                                  2
    US interest rates on ten-year bonds have gone up sharply af-
ter bottoming in June. The rise in interest rates is one of the
fastest ever recorded on US bond markets. The general concern           0
                                                                             90        92     94        96    98        00     02
                                                                                                                                           0

of financial markets about the massive budget deficit and how to                  Inverted P-E, Standard and Poor´s 500
                                                                                  Real interest rate, US
finance it is one explanation for the increase in interest rates.
                                                                      Note: The real interest rate is calculated as the dif-
Another is that there are signs of a brightening outlook for the      ference between the nominal ten-year interest rate
US economy. Bond rates in the euro zone have also risen, but          and the expected inflation rate according to the sur-
                                                                      vey.
                                                                      Sources: Philadelphia Fed, EcoWin and NIER.
24 Financial Economy




Diagram 35 Nominal Exchange Rates                          not to the same extent as in the US. The pervasive worry of
5-days centred moving average, daily values
                                                           financial markets last spring about deflation now appears to have
1.50                                               150
                                                           receded. One indication is the greater interest rate differential
1.40                                               140
1.30                                               130
                                                           between nominal bonds and indexed-linked bonds, the so-called
1.20                                               120     break-even inflation. The break-even inflation rate can be
1.10                                               110     viewed as a rough measure of the market’s long-term inflation-
1.00                                               100     ary expectations. Both the European Central Bank (ECB) and
0.90                                               90      the Federal Reserve have emphasized that they take the risk of
0.80                                               80
                                                           deflation seriously and that they will respond if necessary.
0.70                                               70
                                                               The stronger economic outlook in the US has also contrib-
0.60                                               60
0.50                                               50
                                                           uted to some appreciation of the US dollar over the summer.
        99        00          01    02    03
                                                           However, the dollar is still weaker than it was last spring and is
        Dollar/Euro
        Pound/Euro                                         currently trading at around USD 1.12–1.13 to the euro (see Dia-
        Yen/Euro (right)
                                                           gram 35). Also in trade-weighted terms, the dollar is weaker than
Sources: EcoWin and NIER.
                                                           last spring, by about 3 percent. The Japanese yen has generally
                                                           been stable against the dollar during the summer. Thus, it has
                                                           kept pace with the rise of the dollar against the euro, unlike ster-
                                                           ling, which has more closely followed the euro.
Diagram 36 Nominal Exchange Rates
5-days centred moving average, daily values                    After strengthening somewhat during the spring, the krona
 155                                                11.0   has once again weakened against the euro. One explanation is
 150                                                10.5
                                                           the continued weakness of public support for a “yes” vote in the
                                                           coming referendum on the euro. Since June, the krona has
 145                                                10.0
                                                           weakened by about 5 percent against the dollar. As an overall
 140                                                9.5    effect, the krona has also depreciated in effective terms. Meas-
 135                                                9.0    ured by the TCW index, the krona has weakened from around
 130                                                8.5
                                                           126 in June to more than 128 in August (see Diagram 36).
 125                                                8.0

 120                                                7.5
         99        00          01    02       03           Further Cuts in the Refi Rate by the ECB
         TCW-index
         SEK/euro (right)
         SEK/dollar (right)                                The forecast presented here is based on the assumption that
Sources: EcoWin and NIER.                                  Sweden will join the ERM2 collaboration on exchange rates at
                                                           the end of 2003 and will become a member of the European
                                                           Monetary Union in January 2006. Thus, the monetary policy of
                                                           the ECB will have a strong influence on Swedish interest-rate
                                                           policy throughout the forecast period. The ECB’s price-stability
                                                           target is a rate of inflation in the euro zone just below 2 percent
                                                           in the medium term. This target is thus lower than the current 2-
                                                           percent inflation target of the Riksbank.
                                                               In view of indications that the economy will soon pick up in
                                                           Europe, market operators are divided in their assessments re-
                                                           garding further cuts in the ECB’s official interest rate, the refi
                                                           rate. The pricing of forward interest rates suggest that the refi
                                                           rate will be kept at a low level for some time. It is estimated that
                                                           resource utilization will remain low in the euro zone throughout
                                                           the forecast period, one reason why the HICP inflation rate is
                                                           forecast to be less than 2 percent at the end of 2005. All factors
                                                           considered, the ECB is expected to lower the refi rate by an-
                                                           other 0.25 percentage point to 1.75 percent during the autumn,
                                                           contributing to some further weakening of the euro against the
                                                           dollar. With rising resource utilization, the ECB will begin to
                                                                                                   Financial Economy 25




raise the refi rate during the spring of 2004. The refi rate is fore-      Diagram 37 Official Interest Rates
                                                                           Percent, daily values
cast to be 2.5 percent at the end of 2004 and 3.5 percent at the
                                                                           7                                               7
end of 2005 (see Diagram 37).
    The US is somewhat ahead of Europe in the business cycle.              6                                               6

The favourable outlook for the US economy means that no                    5                                               5
further rate cuts by the Fed are to be expected. The subdued               4                                               4
outlook for inflation will help to keep the official interest rate
                                                                           3                                               3
(federal funds rate) at a low level for some time yet. Resource
utilization will begin to rise slightly in the latter part of this year.   2                                               2

During 2004–2005, growth will accelerate, leading the Fed to               1                                               1

begin raising the federal funds rate gradually during 2004, so that        0                                               0
                                                                                  00              02           04
it reaches 3.75 percent at the end of 2005 (see Diagram 37).
                                                                                   Sweden
                                                                                   Euro Zone
                                                                                   US

                                                                           Sources: The Riksbank, national sources and NIER.
Low Domestic Inflationary Expectations

Interest rates on Swedish bonds have followed European rates
during the summer, thus rising less than those in the US. The
                                                                           Diagram 38 Interest Rate Differentials Against
interest-rate differential between ten-year government bonds in            the Euro Zone, 10-Year Bonds
Sweden and in Germany has long been about 0.5-0.6 percentage               Percentage points, weekly values

point (see Diagram 38). Long-term inflationary expectations, as            0.8                                           0.8

measured by so-called break-even inflation, dropped back
                                                                           0.6                                           0.6
sharply at the outset of the year. Over the summer, however,
they have risen again to the same level as in early May, though            0.4                                           0.4
they are still substantially below the Riksbank’s inflation target of
2 percent. Measured in this way, inflationary expectations in-             0.2                                           0.2
clude time-variable risk and liquidity premiums, which compli-
cate the analysis (see Diagram 39). Household inflationary ex-             0.0                                           0.0

pectations have dropped back since the spring, according to the
                                                                           -0.2                                          -0.2
HIP Consumer Survey. Confidence in the Riksbank’s inflation                            00                 02
                                                                                       Sweden-Germany
target thus remains strong despite the high rate of inflation in                       Denmark-Germany
the early months of this year.                                                         UK-Germany

    After the latest cuts in the repo rate, the pricing of forward         Source: The Riksbank and NIER.

rates suggests that market operators are no longer expecting any
further reductions. Calculations of the implicit future official
interest rate based on the yield curve confirm this impression             Diagram 39 Break-even Inflation – Sweden
                                                                           Percent, daily values
(see Diagram 40).
                                                                           2.4                                           2.4
    With Sweden joining the ERM2 collaboration on exchange
rates and entering the monetary union in January 2006, the                 2.2                                           2.2
Riksbank will gradually lose its ability to control the course of
                                                                           2.0                                           2.0
inflation via the repo rate. The principal functions of the Riks-
bank until Sweden enters the monetary union will be to maintain            1.8                                           1.8
the exchange rate within the agreed interval around the central
rate and to facilitate the transition to the euro. Much of the re-         1.6                                           1.6

sponsibility for stabilization policy will be shifted to fiscal policy     1.4                                           1.4
right from the time Sweden joins the ERM2.
    According to the latest Business Tendency Survey, the do-              1.2                                           1.2

mestic outlook for manufacturing was still weak, with lacklustre           1.0                                           1.0
expectations about the future in most sectors. Together with the                            01                      03
                                                                           Sources: EcoWin and NIER.
sluggish recovery of the international economy, particularly in
the euro zone, this factor means that the Swedish output gap
26 Financial Economy




Diagram 40 Expected Repo Rate in Sweden                                    will remain negative up to the end of 2005. The UND1X infla-
According to Implicit Forward Interest Rates                               tion rate will be less than 2 percent in 2004 and 2005. Conse-
Percent, daily values
5.5                                                                  5.5
                                                                           quently, there will be room for the Riksbank to lower the repo
                                                                           rate by another 0.25 percentage point to 2.5 percent. Thus, the
5.0                                                                  5.0
                                                                           official interest rate in Sweden will be 0.75 percent higher than
4.5                                                                  4.5
                                                                           the ECB’s official rate when Sweden enters the ERM2; the rea-
4.0                                                                  4.0
                                                                           sons advanced for the interest-rate differential include the as-
3.5                                                                  3.5   sessment that resource utilization is somewhat higher in Sweden
3.0                                                                  3.0   than in the euro zone. In both Sweden and the euro zone, offi-
2.5                                                                  2.5
                                                                           cial interest rates will then be held constant through year-end.
                                                                           Thereafter, the ECB and the Riksbank will begin to raise their
2.0                                                                  2.0
      0        2        4         6
                                 Year
                                             8        10        12         official interest rates during 2004 as the economic outlook im-
           August 18, 2003                                                 proves and resource utilization rises. However, as part of the
           June 24, 2003
           May 20, 2003                                                    process of adjustment toward a common official interest rate,
Note: Calculated from the yield curve at different
                                                                           the rate hikes will be more modest in Sweden than in the euro
points in time.                                                            zone, and by the end of 2005 the repo and refi rates will have
Sources: The Riksbank and NIER.
                                                                           fully converged (see Diagram 37).
                                                                               Long-term interest rates in the euro zone will rise in 2004–
Diagram 41 Repo Rate – Sweden
Percent, daily values                                                      2005. But the upturn will be relatively limited since the price-
4.5                                                                  4.5   stabilization policy of the euro zone is expected to remain credi-
                                                                           ble and the economy in the euro zone will strengthen rather
4.0                                                                  4.0
                                                                           slowly. Swedish bond rates will adjust gradually to bond rates in
3.5                                                                  3.5
                                                                           the euro zone. This process will advance in step with the con-
                                                                           vergence of the repo and refi rates and with the approach of
3.0                                                                  3.0   Sweden’s accession to the monetary union. It is estimated that
                                                                           the interest-rate differential between Swedish and German ten-
2.5                                                                  2.5
                                                                           year government bonds will be 0.1 percentage point at the end
2.0                                                                  2.0   of 2005.
          00       01       02          03       04        05
           Repo rate
                                                                               Corporate and home-mortgage bonds carry higher rates of
           NIER assessment                                                 interest than corresponding government bonds because of a
           Expectations of market agents, August 18, 2003
           Expectations of market agents, June 24, 2003                    greater credit risk and less liquidity. In a small currency area like
Note: Expectations according to the yield curve.                           Sweden, so-called liquidity premiums are higher than in the euro
Sources: The Riksbank and NIER.
                                                                           zone. The ongoing harmonization of financial regulations within
                                                                           the EU and the resulting integration of financial markets tend to
                                                                           increase competition and to reduce various types of interest-rate
Diagram 42 Inflation and 3-months Interest                                 premiums. Swedish membership in the monetary union would
Rate – Euro Zone and Sweden
Percent, monthly values
                                                                           accelerate and reinforce financial integration between Sweden
6                                                                     6    and the euro zone; one consequence would be to reduce Swed-
                                                                           ish liquidity premiums. The differential between Swedish credit-
5                                                                     5
                                                                           market rates and Swedish bond rates is expected to decrease by
4                                                                     4    0.15 percentage point as an effect of Sweden’s joining the EMU.
3                                                                     3

2                                                                     2
                                                                           SEK 9.00 for a Euro
1                                                                     1
                                                                           The future development of the Swedish krona will be dominated
0                                                                     0
          99                       01                           03         by accession to the ERM2 around the end of this year and by
          3-months interest rate: Sweden
          3-months interest rate: euro zone                                accession to the monetary union in January 2006. According to
          HICP: Sweden
          HICP: euro zone
                                                                           the NIER’s assessment, SEK 9.00 to the euro is an economically
Sources: The Riksbank, Eurostat and Statistics
Sweden.
                                                                              Financial Economy 27




well-balanced central and conversion rate.1 With a credible cen-
tral rate, ERM2 membership will dramatically reduce the uncer-
tainty about the tendency of the krona. Together with a higher
official interest rate in Sweden than in the euro zone, the dimin-
ished uncertainty will mean that the krona strengthens to a level
slightly below the central rate when Sweden joins the ERM2,
gradually weakening thereafter to around SEK 9.00 per euro as
interest rates converge. This development will be reflected in the
TCW index, which will appreciate to a level just above 124 at the
end of 2003 and then depreciate by about one percent during
the ensuing two years.

Table 5 Interest Rates and Exchange Rates at the End of
Each Year
                                  2001     2002       2003    2004    2005
Official interest rates
    Repo rate (Riksbank)           3.75        3.75    2.50    2.75    3.50
    Refi rate (ECB)                3.25        2.75    1.75    2.50    3.50
    Federal funds target rate      1.75        1.25    1.00    2.00    3.75
                           1
Long-term interest rates
    Sweden                          5.2         4.9     4.5     4.7     4.8
    Euro zone                       4.8         4.3     4.1     4.4     4.7
    United States                   5.0         4.0     4.5     5.2     5.6
Exchange rates
    SEK/USD                       10.56        8.95    7.97    8.00    8.04
    SEK/EURO                       9.44        9.09    8.93    8.97    9.00
    TCW index                     138.6   131.0       124.3   124.8   125.3
1 Interest rate on 10–year government bonds.

Sources: the Riksbank and NIER.




1See the box captioned ”What Conversion Rate Will Be Appropriate When
Sweden Joins the Monetary Union?” in The Swedish Economy – June 2003.
                                                                                                                                        29




Demand and Output in the Swedish                                              Diagram 43 GDP at Market Prices
                                                                              Billions of SEK, constant prices and percent, sea-
Economy                                                                       sonally adjusted quarterly values
                                                                                690                                                             1.8

The growth of the Swedish economy has been weak since the                       660                                                             1.5

third quarter of last year (see Diagram 43). During the spring,                 630                                                             1.2
however, growth increased somewhat even though the strike by
                                                                                600                                                             0.9
the Swedish Municipal Workers’ Union negatively affected the
                                                                                570                                                             0.6
second quarter. The economic recovery is proceeding slowly in
other countries, but demand for exports will begin picking up                   540                                                             0.3

around year-end. However, the contribution of foreign trade to                  510                                                             -0.0
growth in demand will be modest since imports are increasing
                                                                                480                                                             -0.3
even faster. Rather, recovery will be driven by household con-                             97           99         01        03        05
                                                                                                Outcome
sumption and later also by investment, which is being stimulated                                Forecast
                                                                                                Percentage change (right)
by factors that include low interest rates. GDP growth will
therefore gradually accelerate in 2003–2005.                                  Sources: Statistics Sweden and NIER.

    Both household consumption and net exports contributed to
stronger growth in demand in the second quarter (see Diagram
44). Local-government consumption is surging in the third quar-               Diagram 44 Contribution to Growth in Demand
                                                                              Percentage points, seasonally adjusted quarterly
ter now that the strike is over, but will increase slowly thereafter.         values
Household consumption, on the other hand, is continuing to                    1.5                                                           1.5
rise strongly as interest rates are low and households are becom-
                                                                              1.0                                                           1.0
ing increasingly optimistic about the economic tendency, a de-
velopment reflected in the Consumer Survey (see Diagram 45)                   0.5                                                           0.5
and elsewhere. Investments are now judged to have reached
                                                                              0.0                                                           0.0
bottom and are thus expected to contribute increasingly to
growth in demand beginning in the fourth quarter of this year                 -0.5                                                          -0.5

(see Diagram 44). Given the slow pace of economic recovery in
                                                                              -1.0                                                          -1.0
other countries, together with a stronger exchange rate for the
Swedish krona, the upturn in exports will be relatively modest.               -1.5
                                                                                           01                     03              05
                                                                                                                                            -1.5

                                                                                            Net exports
                                                                                            Total consumption expenditure
Table 6 Supply and Demand                                                                   Gross fixed capital formation

Billions of SEK, current prices, and percentage change, constant              Sources: Statistics Sweden and NIER.
prices
                                      2002    2002       2003   2004   2005
GDP at market prices                 2 340      1.9       1.3    2.5    2.7   Diagram 45 Consumer Confidence Indicator
Household consumption expendi-                                                (CCI)
ture                                 1 139      1.3       2.0    3.3    2.8   Balances, monthly values

General-government consumption                                                40                                                            40
expenditure                            656      2.1       0.7    0.8    0.5
Gross fixed capital formation          400     –2.5      –1.4    3.1    7.0
                                                                              20                                                            20
                  1,2
Stockbuilding                             3    –0.1       0.2    0.0    0.0
Exports of goods and services        1 012      0.4       3.8    6.5    7.1
Imports of goods and services          871     –2.7       4.0    7.3    8.2     0                                                           0

Total domestic demand                2 198      0.7       1.2    2.6    2.9
              1
Net exports                            142      1.2       0.1    0.1    0.0   -20                                                           -20
                        3
Current account                          97     4.2       3.8    4.3    4.6
1 Change as a percentage of GDP for the previous year.                        -40                                                           -40
2 Including investment in objects of value.
3 As a percentage of GDP, current prices.

Sources: Statistics Sweden and NIER.                                          -60                                                           -60
                                                                                      93           95        97         99   01        03
                                                                              Source: NIER.
30 Demand and Output in the Swedish Economy




Diagram 46 GDP at Market Prices                    Both household consumption and investment were dampened
Annual percentage change
                                                   by the uncertainty surrounding the conflict in Iraq. Now that the
5                                             5
                                                   uncertainty has subsided and interest rates have decreased,
4                                             4    household consumption is rising more rapidly. The forecast is
3                                             3
                                                   based on the assumption of a “yes” to the euro in the referen-
                                                   dum. The repo rate will then be adjusted gradually downward to
2                                             2
                                                   the level of the ECB’s official interest rate. A “yes” vote in the
1                                             1    referendum will also have an expansionary effect on domestic
0                                             0
                                                   demand through lower credit-market interest rates; see the box
                                                   captioned “Cyclical Effects of a ‘Yes’ and a ‘No’ to the Euro”.
-1                                            -1
                                                   With the resulting low interest rates, together with reduced un-
-2                                            -2   certainty and higher capacity utilization, both residential invest-
-3                                            -3
                                                   ment by households and manufacturing investment in machin-
     81 83 85 87 89 91 93 95 97 99 01 03 05
                                                   ery and equipment will pick up next year. In 2005, the increase
Sources: Statistics Sweden and NIER.
                                                   in total investment will be even greater as investment in build-
                                                   ings and constructions begin to rise.
                                                       GDP growth is forecast to be 1.3 percent this year, rising to
                                                   2.5 and 2.7 percent, respectively, in 2004 and 2005 (see Diagram
                                                   46 and Table 6). The greater number of working days in 2004
                                                   compared to 2003 is expected to add 0.3 percentage point to
                                                   GDP growth. Adjusted for calendar effects, GDP growth will be
                                                   2.2 percent in 2004. Thus, the economic upturn will be relatively
                                                   gradual.
                                                       The current account will strengthen from 3.8 percent of
                                                   GDP in 2003 to 4.6 percent in 2005. The reasons are that Swe-
                                                   den’s terms of trade (the ratio between prices of exports and
                                                   prices of imports) will improve by a total of 2 percent, and that
                                                   interest payments abroad will go down as the country’s foreign
                                                   debt decreases.
                                                                               Demand and Output in the Swedish Economy 31




Trends and Risks in Household In-
debtedness
In the next few years, household consumption is expected to be
the strongest driving force behind economic recovery. The up-
turn in consumption is based on the premise that households
will continue to reduce their net lending and increase their in-
debtedness. This tendency entails risks. For example, will house-
holds be overburdened by interest expenditure when interest
rates return to normal? And what about prices of homes? Will
they drop back if interest rates rise by a couple of percentage
points? How great is the risk that this development will put a
stop to the upturn in consumption?


Household Interest Expenditure at Low Level

There has been a relatively strong increase in household debt in                    Diagram 47 Household Debt and Interest Ex-
recent years. According to financial accounts, aggregate house-                     penditure
                                                                                    Percent of disposable income, quarterly values
hold indebtedness has increased by an annual average of 9 per-                        140                                                             14
cent since 1999. The annual rate of increase slowed slightly to 8
percent in the first quarter of this year. Since household dispos-                    130                                                             12

able income has been increasing more slowly, debt in relation to
                                                                                      120                                                             10
disposable income has risen markedly. The debt ratio, however,
is still much lower than at the end of the 1980’s (see Diagram                        110                                                             8

47). Owing to low interest rates, household interest expenditure
                                                                                      100                                                             6
after taxes is modest in relation to income (see Diagram 47). In
2002, interest expenditure was equivalent to 4.4 percent of dis-                          90                                                          4
posable income, and declining interest rates have lowered this
                                                                                          80                                                          2
percentage further during the first half of 2003 despite increased                             80 82 84 86 88 90 92 94 96 98 00 02

debt. From the end of 2002 to the end of 2005, interest rates are                                     Debt
                                                                                                      Interest expenditure after taxes (right)
expected to rise by 0.0 to 0.5 percentage points depending on
                                                                                    Sources: Statistics Sweden and NIER
time to maturity (see Diagram 48).2
     If debt increases at the same rate as income, an average in-
crease of 1 percent in interest rates will mean that after-tax inter-
                                                                                    Diagram 48 Interest on Treasury Bills and
est expenditure in relation to disposable income will rise by 0.8                   Bonds of Various Maturities
percentage point. Household interest expenditure after tax                          Monthly values

would then be 5.2 percent of disposable income, still a relatively                    9                                                                   9

modest level. If, on the other hand, indebtedness continues to                        8                                                                   8
go up by 8 percent per year while disposable income rises at an                       7                                                                   7
annual rate of 3.3 percent, the debt ratio will be 132 percent at
                                                                                      6                                                                   6
the end of 2005. But even with this historically high debt ratio
and a rise of 1 percentage point in interest rates, interest expen-                   5                                                                   5

diture will be only about 6 percent of disposable income, a level                     4                                                                   4
that is not remarkably high.                                                          3                                                                   3

                                                                                      2                                                                   2
                                                                                               96          98          00          02            04
                                                                                                    3 month
                                                                                                    5 year
2 This interest-rate forecast is based on the assumption of a ”yes” to the euro.                    10 year
Even if the referendum results in a “no” to the euro, the increase in interest
                                                                                    Sources: The Riksbank and NIER.
rates is expected to be modest: between 0.4 and 0.9 percentage point
depending on time to maturity.
32 Demand and Output in the Swedish Economy




Diagram 49 Household Debt                                           Modest Mortgage Ratio Even if Real Estate Prices
Percent of property value, quarterly values                         Level Out
 75                                                            75

                                                                    Single- and two-family houses, as well as other categories of
 70                                                            70
                                                                    homes, serve to a large degree as security for household debt,
                                                                    which has often arisen in connection with the purchase of these
 65                                                            65
                                                                    homes or other home investment. The total indebtedness of
 60                                                            60
                                                                    households in relation to the market value of their homes (sin-
                                                                    gle- and two-family houses, holiday homes and owner-occupied
 55                                                            55   flats) dropped sharply during the second half of the 1990’s with
                                                                    rising real-estate prices and is now approximately 55 percent (see
 50                                                            50   Diagram 49). If real-estate prices level off after rising strongly,
                                                                    the mortgage ratio will gradually increase as properties change
 45                                                            45
        70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02          owners. The mortgage ratio can also increase if the current
Sources. Statistics Sweden and NIER.                                owner takes out a new mortgage to finance various types of
                                                                    investment or consumption. If real-estate prices stop rising (and
Diagram 50 Prices of Homes in Real Terms                            the stock of houses also remains unchanged so that the market
Index 1981=100, quarterly values                                    value is constant), while at the same time debt increases by 8
 130                                                          130
                                                                    percent per year, the mortgage ratio will rise by slightly more
                                                                    than 4 percent age points annually. However, the mortgage ratio
 120                                                          120
                                                                    would still be relatively modest even if this trend persisted for
 110                                                          110
                                                                    three years.
                                                                        Aside from sharply increasing interest rates, the factor that
 100                                                          100   can lead to a substantial reduction in borrowing and thus to
                                                                    decreased consumption is a dramatic drop in real-estate prices
   90                                                         90    that leaves the mortgage ratio at an overly high level. In real
                                                                    terms, prices of single- and two-family homes have been soaring
   80                                                         80
                                                                    since 1996 and are now above their previous peak in 1990,
                                                                    though lower than at the end of the 1970’s (see Diagram 50).
   70                                                         70
         70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02         Compared to the end of the 1980’s, the current situation is more
Note: Index of real-estate prices, yaer-round homes,
single- and two-family houses / implicit price index
                                                                    stable since both interest payments and indebtedness are lower
for household consumption.                                          in relation to disposable income. Nor does it appear very likely
Source: Statistics Sweden.
                                                                    that the dramatic rise in real after-tax rates of interest that oc-
                                                                    curred around 1990 will recur in the foreseeable future. At that
Diagram 51 Interest Rate on Five-year Home                          time, real interest rates shot up by some 10 percentage points
Mortgage, Spintab                                                   when inflation plummeted and the tax benefit for interest ex-
Monthly values
  20                                                          20
                                                                    penditure was reduced from a normal level of 50 percent to 30
                                                                    percent, while nominal interest rates increased (see Diagram 51).
  15                                                          15


  10                                                          10
                                                                    Low Inflation Requires Faster Debt Repayment
   5                                                          5
                                                                    An element of risk may be present in that despite currently low
   0                                                          0
                                                                    nominal interest rates, real rates of interest are not particularly
   -5                                                         -5    low (see Diagram 51). The low rate of CPI inflation means that
                                                                    the real value of debt is decreasing less rapidly than when the
 -10
         80 82 84 86 88 90 92 94 96 98 00 02
                                                              -10
                                                                    inflation rate is high. Households must then maintain a faster
             Nominal interest rate before taxes                     debt-repayment rate than in periods of high inflation in order
             Real interest rate after taxes (ex post)
                                                                    for their debt to develop at the same rate in real terms. Many
Note: Real interest rate (ex post) = nominal interest
rate after taxes minus CPI inflation in the coming                  households may have ignored this fact and will therefore in-
year.
Sources: Spintab, Statistics Sweden and NIER.
                                                                    crease their rate of debt repayment in the future. With low infla-
                                                                                Demand and Output in the Swedish Economy 33




tion, it also takes longer to restore the indebtedness ratio after a                 Diagram 52 Construction Costs in Real Terms
                                                                                     Index 1981=100, quarterly values
sharp drop in real-estate prices.
                                                                                       125                                                  125
    But compared to the situation at the end of the 1980’s,
household net lending is considerably higher despite rising in-                        120                                                  120

debtedness. In 1987-1990 household net lending was negative                            115                                                  115
and equivalent on average to minus 4.5 percent of disposable
                                                                                       110                                                  110
income. Last year, the same measure of net lending3 was 0.2
percent of disposable income. This means that on average                               105                                                  105

households are not consuming on credit as they did in the late                         100                                                  100
1980’s.
                                                                                        95                                                  95

                                                                                        90                                                  90
                                                                                             80 82 84 86 88 90 92 94 96 98 00 02
High Building Costs Pushing Up Real Estate Prices                                               Group-built single- and two-family houses
                                                                                                Blocks of flats

                                                                                     Note: Factor price index (constructions costs) / im-
The long-term tendency in real-estate prices is heavily influenced                   plicit price index for household consumption.
by the trend in building costs. During the crisis years of the early                 Source: Statistics Sweden.

1990’s, building costs decreased, but in recent years they have
been rising more rapidly than consumer prices (see Diagram 52).
The long-term tendency in building costs is difficult to forecast.
If these costs develop roughly in line with consumer prices while
prices of land (because of a land shortage) are increasing some-
what faster, real-estate prices should rise in real terms in the long
run. Real building costs are now some 20 percent higher than in
1981 (see Diagram 52) while prices of real estate in real terms
are 15 percent higher (see Diagram 50). In this light, real-estate
prices do not appear unreasonably high, but the present analysis
cannot determine whether real-estate prices are currently above
the level sustainable in the long run.


Little Risk for the Development of Consumption

The conclusion is that household indebtedness, though substan-
tially increasing in recent years, is not expected to halt the rise in
consumption; the reasons are low interest rates and high prices
of real estate. Even with the forecast increases in interest rates
and with debt continuing to rise by 8 percent per year in the
next few years, indebtedness does not appear unsustainably high.
The principal risk is probably that real-estate prices would
plummet. Such a development would pose major problems for
households with high indebtedness and would halt the increase
in debt and in household consumption. A rise in real interest
rates like the one in the early 1990’s, however, appears unlikely.




3 The data are for net lending except for net lending in negotiated pensions,
since there are no data for net lending in negotiated pensions before 1993.
34 Demand and Output in the Swedish Economy




Diagram 53 Household Disposable Income
Annual percentage change, constant prices
                                                                               Household Consumption
5                                                                       5

4                                                                       4

3                                                                       3      Steady Increase in Household Income 2003–2005
2                                                                       2      Real household income rose last year by 4.7 percent even though
1                                                                       1      the number of hours worked fell by 1.2 percent. The strong
                                                                               increase in income is due to the fact that income taxes were cut
0                                                                       0
                                                                               by some SEK 20 billion because of changes in tax rules and that
-1                                                                      -1     households paid roughly SEK 19 billion less in capital-gains
-2                                                                      -2     taxes because of the weak stock market.
                                                                                   This year the labour market is continuing to weaken, and the
-3                                                                      -3
         81 83 85 87 89 91 93 95 97 99 01 03 05                                number of hours worked will decrease by 1.0 percent. Local-
Sources: Statistics Sweden and NIER.                                           government taxes will be raised by an average of 0.65 percentage
                                                                               point, equivalent to some SEK 8.5 billion. A countervailing
                                                                               effect will arise from the transition to fully taxed pensions,
                                                                               which has been designed to leave pensioners with higher in-
Diagram 54 Consumer Survey
Balances, monthly values
                                                                               comes after taxes.
     60                                                                  60        In 2004 and 2005, the number of hours worked will increase
                                                                               as an effect of economic recovery. It is estimated that local-
     40                                                                  40
                                                                               government taxes will be raised by an average of 0.20 percent
     20                                                                  20    point in 2004 and remain unchanged in 2005. Throughout the
         0                                                               0     period 2003–2005, real household income will be increasing at a
                                                                               steady rate averaging 1.8 percent per year, somewhat higher than
     -20                                                                 -20
                                                                               the average rate of increase since 1980 (see Diagram 53).
     -40                                                                 -40

     -60                                                                 -60   Table 7 Household Income
     -80                                                                 -80   Billions of SEK, current prices, and contribution to growth in dispos-
              93        95       97        99        01        03
                                                                               able income, constant prices, percentage points
                   Micro index
                   Macro index                                                                                        2002    2002   2003   2004   2005
Source: NIER.                                                                  Disposable income                      1 172    4.7    1.9    1.8    1.7
                                                                               Contribution from:
                                                                               Wages                                   997     1.6    0.3    2.8    2.3
                                                                               Other factor incomes                    194    –1.4    0.1    0.3    0.6
Diagram 55 Retail Sales                                                        Transfers from the
Annual percentage change                                                       general-government sector               430     1.0    2.1    0.6    0.3
15                                                                  15         Transfers from the household sector      49    –0.1   –0.1   –0.1    0.0
                                                                               Taxes and contributions                 497     3.6   –0.5   –1.8   –1.5
10                                                                  10         Sources: Statistics Sweden and NIER.

     5                                                              5

                                                                               Low Interest Rates Fuelling Household Consump-
     0                                                              0
                                                                               tion
 -5                                                                 -5
                                                                               During the fourth quarter of last year, households became more
                                                                               pessimistic, according to the Consumer Survey (see Diagram
-10                                                                 -10
             95          97           99        01        03                   54). Retail sales stagnated and sales of new automobiles flattened
                  Durables
                  Non-durables                                                 out (see Diagrams 55 and 56). During the spring, pessimism
Note: 3-month moving average.
                                                                               increased with the approach of war in Iraq, but after the war
Source: Statistics Sweden.                                                     optimism returned, stimulating retail trade and new-car sales.
                                                                               Another factor probably underlying this development is the
                                                                                 Demand and Output in the Swedish Economy 35




expansionary monetary policy, with a one-percent reduction in                           Diagram 56 New Registrations of Passenger
the repo rate between March and July.                                                   Cars, Households
                                                                                        Thousands, seasonally adjusted monthly values
    Household consumption rose more strongly than expected in                           16                                                 16
the second quarter according to the quick version of the Na-
tional Accounts (see Diagram 57). Low interest rates, the mix of                        14                                                 14

consumption, and the forward-looking indicators suggest that
consumption will rapidly continue to surge. Both the Consumer                           12                                                 12

Confidence Indicator (CCI) and the Macro Index of the Con-
                                                                                        10                                                 10
sumer Survey have been rising since April, while the Micro In-
dex has been going up since March (see Diagrams 45 and 54). In
                                                                                         8                                                 8
June, trade in durable goods increased at an annual rate (calen-
dar-adjusted) of 11.5 percent. New registrations of automobiles                          6                                                 6
rose in June and July at an average annual rate of more than 13
percent (see Diagram 56). Prices of real estate levelled out in                          4
                                                                                              95           97         99        01   03
                                                                                                                                           4

November of last year but have been rising again for the last                           Source: Statistics Sweden.
four months while turnover on the real-estate market has been
fairly high (see Diagram 58).
    The forecast is based on the assumption that the referendum
                                                                                        Diagram 57 Houshold Consumption
will result in a ”yes” to the euro, leading to lower interest rates                     Billions of SEK, constant prices and percent, sea-
                                                                                        sonally adjusted quarterly values
that stimulate consumption; see the box captioned “Cyclical
                                                                                        380                                               3.0
Effects of a ‘Yes’ and a ‘No’ to the Euro”.
    All factors considered, household consumption is expected                           360                                               2.4

to grow rapidly during the forecast period. After a strong out-                         340                                               1.8
come in the second quarter, this means an increase of 2.0 per-                          320                                               1.2
cent in consumption this year, 3.3 percent next year and 2.8
                                                                                        300                                               0.6
percent in 2005. Household net lending will thus be decreasing
during the forecast period (see Diagram 59).                                            280                                               0.0

                                                                                        260                                               -0.6

Table 8 Household Consumption Expenditure                                               240                                               -1.2
                                                                                              97           99         01        03   05
Billions of SEK, current prices, and percentage change, constant                                   Outcome
prices                                                                                             Forecast
                                                                                                   Percentage change (right)
                                        2002    2002     2003    2004    2005
                                                                                        Sources: Statistics Sweden and NIER.
Consumption Expenditure                 1 139      1.3     2.0     3.3      2.8
    of which: Durable goods               225      5.7     3.8     6.6      5.0
              Automobiles                  37    –5.6      7.5     5.5      3.4
              Non-durable goods           184      2.1     3.5     2.2      1.7         Diagram 58 Real Estate Market for Single and
              Consumption abroad           48    –6.9      0.2    12.2    12.5          Two Family Houses
                                                                                        Ratio and thousands, monthly values
              Services excl. housing      297      0.3     1.6     3.5     3.4
              1
                                                                                        2.6                                               5.6
Net lending                               102      8.2     7.7     6.2      5.3
Net lending excl. negotiated pen-                                                       2.4
      1                                                                                                                                   4.9
sions                                      33      2.8     2.7     1.3      0.2
                                                                                        2.2
1Net lending in billions of SEK, current prices, and net lending as a percent-
                                                                                                                                          4.2
age of disposable income.                                                               2.0
Sources: Statistics Sweden and NIER.
                                                                                        1.8
                                                                                                                                          3.5

                                                                                        1.6
                                                                                                                                          2.8
General Government Consumption                                                          1.4

                                                                                        1.2                                               2.1
                                                                                               92 93 94 95 96 97 98 99 00 01 02 03
Owing to the strike by the Municipal Workers’ Union, general-                                      Purchase-price coefficient
government consumption fell in the second quarter of this year                                     Turnover, trend (right)

but is increasing rather substantially in the third quarter (see                        Source: Statistics Sweden.
36 Demand and Output in the Swedish Economy




Diagram 59 Household Net Lending Ratio                                  Diagram 60). Thereafter, general-government consumption will
Percent of disposable income, quarterly values
                                                                        grow relatively slowly up to 2005.
  15                                                             15
                                                                            Central-government consumption will be held back this year
                                                                        and next year by a general cutback in appropriations to central-
  10                                                             10
                                                                        government authorities and by special cutbacks in infrastructure
      5                                                          5
                                                                        and defence. Consumption will nevertheless increase somewhat
                                                                        this year since the number of employees is rising. Additions to
      0                                                          0      staff have been made primarily at universities and colleges, the
                                                                        Swedish Migration Board and the social-insurance offices. Next
  -5                                                             -5     year the number of employees is expected to level out, while
                                                                        cutbacks will also limit growth in consumption in other ways.
 -10
          80 82 84 86 88 90 92 94 96 98 00 02 04
                                                                 -10    Central-government consumption will thus decrease somewhat
                Net-lending ratio, excl. negotiated pensions            next year and stabilize in 2005.
                Net-lending ratio

Sources: Statistics Sweden and NIER.
                                                                        Table 9 General Government Consumption
                                                                        Billions of SEK, current prices, and annual percentage change, con-
                                                                        stant prices
Diagram 60 General Government Consump-                                                                         2002   2002   2003   2004   2005
tion                                                                    General-government consump-
Billions of SEK, constant prices and percent, sea-
sonally adjusted quarterly values
                                                                        tion expenditure                        656    2.1    0.7    0.8    0.5
 171                                                             2.4
                                                                        Percent of GDP                                28.0   28.3   28.1   27.8
                                                                         Central-government consumption         188    1.7    0.7   –0.4    0.1
 168                                                             1.6
                                                                         Percent of GDP                                8.0    8.0    7.8    7.7
 165                                                             0.8     Local-government consumption           468    2.3    0.7    1.3    0.6
                                                                         Percent of GDP                               20.0   20.3   20.3   20.1
 162                                                             0.0
                                                                        Sources: Statistics Sweden and NIER.
 159                                                             -0.8

 156                                                             -1.6
                                                                        Growth in local-government consumption is falling rapidly this
 153                                                             -2.4
                                                                        year, partly because of strained local-government finances, but
 150
           97           99          01         03         05
                                                                 -3.2   also because of the strike by the Municipal Workers’ Union. The
                Outcome                                                 expansion of local-government operations in recent years has
                Forecast
                Percentage change (right)                               now slackened, and by most indications the rate of growth will
Sources: Statistics Sweden and NIER.                                    be weaker in the next few years. The extension of the temporary
                                                                        employment subsidy will mean that local governments can hire
                                                                        some new staff in 2004 as well, thus maintaining growth in con-
Diagram 61 Investment                                                   sumption to a certain extent. However, the termination of the
Billions of SEK, constant prices and percent, sea-
sonally adjusted quarterly values                                       employment subsidy will tend to curb growth in consumption in
120                                                            3.6      2005.
114                                                            2.7

108                                                            1.8

102                                                            0.9
                                                                        Gross Fixed Capital Formation
 96                                                            -0.0     The decline in gross fixed-capital formation in recent years is
 90                                                            -0.9     continuing this year as well, but somewhat more slowly. A cau-
 84                                                            -1.8
                                                                        tious upturn in investment will begin toward the end of the cur-
                                                                        rent year (see Diagram 61). The outlook of a more stable econ-
 78                                                            -2.7
          97          99          01         03         05              omy, rising capacity utilization, higher profits and low interest
               Outcome
               Forecast
                                                                        rates all indicate that investment will pick up (see Diagram 62).
               Percentage change (right)                                Next year total investment will go up by 3.1 percent, accelerating
Sources: Statistics Sweden and NIER.                                    to 7.0 percent in 2005 as capacity utilization rises and the stimu-
                                                                        lus of lower interest rates takes increasing effect. The upswing in
                                                                      Demand and Output in the Swedish Economy 37




investment will be strongest in machinery and equipment (see                 Diagram 62 Return on Capital and Capacity
Diagram 63). Growth in general-government investment has                     Utilization, Business Sector
                                                                             Percent and ratio, respectively
slowed substantially and is forecast to drop from 9.5 percent last             27                                                            0.68
year to 2.0 percent this year and –2.1 percent next year. Owing
to cutbacks by the Government, investments previously planned                  24                                                            0.64
for these years will be postponed until 2005.
                                                                               21                                                            0.60


Table 10 Gross Fixed Capital Formation
                                                                               18                                                            0.56
Billions of SEK, current prices, and percentage change, constant
prices
                                                                               15                                                            0.52
                                       2002   2002   2003   2004   2005
Manufacturing                            74   –7.8   –3.5    4.8    8.8        12                                                            0.48
                                                                                       80 82 84 86 88 90 92 94 96 98 00 02 04
Other goods industries                   40   –0.1   –1.6    5.3    8.0
                                                                                          Return on capital
Service industries excl. housing        166   –8.1   –2.3    3.3    6.8                   Capacity utilization (right)
Housing                                  49   10.4    0.1    5.1    9.0      Note: Excl. finance and real estate. Capacity utiliza-
Total, business sector                  330   –4.7   –2.1    4.2    7.8      tion is defined here as the ratio of value added to
                                                                             the stock of capital.
Public authorities                       70    9.5    2.0   –2.1    3.3      Source: NIER.
Total                                   400   –2.5   –1.4    3.1    7.0
Sources: Statistics Sweden and NIER.                                         Diagram 63 Investment, Machinery and Con-
                                                                             struction Sector
                                                                             Annual percentage change
Compared to the euro zone, the differences in the investment                      15                                                          15

tendency are substantial, particularly toward the end of the fore-
cast period, when investment in Sweden will be increasing much                    10                                                          10

faster than in the euro zone. The difference is largely an effect of
                                                                                   5                                                          5
the additional stimulus to capital formation provided by the
downward convergence of interest rates to the levels in the euro
                                                                                   0                                                          0
zone. To some extent, this effect on investment will be delayed;
see also the box captioned “Cyclical Effects of a ‘Yes’ and a ‘No’                -5                                                          -5
to the Euro”.
                                                                               -10                                                            -10
                                                                                         97          99         01            03        05
                                                                                              Machinery
Declining Investment in Manufacturing This Year                                               Construction

                                                                             Sources: Statistics Sweden and NIER.
The tendency in manufacturing is currently weak, and manufac-
turing output is expected to increase by a meagre 1.4 percent this
year. Investment in manufacturing has continued to decline                   Diagram 64 Capacity Utilization, Manufactur-
                                                                             ing
during the first half-year and will fall by 3.5 percent for 2003 as a        Percent, seasonally adjusted quarterly values
whole. Capacity utilization is going up in manufacturing (see                92                                                              92

Diagram 64), and with manufacturing output rising in the next
two years, it is expected to increase further. Firms have raised             90                                                              90

profits by cutting cost; and together with lower interest rates,
                                                                             88                                                              88
these reductions have been laying the foundation for an upturn
in investment when capacity utilization rises. Investment in                 86                                                              86
manufacturing is thus forecast to increase by 4.8 and 8.8 percent,
respectively, in 2004 and 2005 (see Diagram 65).                             84                                                              84
    In other goods industries – construction, energy and agricul-
ture – only in the energy sector will investment be increasing this          82                                                              82

year. In 2004 and 2005, the business outlook in construction will
strengthen, and investment in that sector will then rise rather              80
                                                                                    91         93      95     97         99        01   03
                                                                                                                                             80

sharply (see Table 10).                                                      Source: Statistics Sweden.
38 Demand and Output in the Swedish Economy




Diagram 65 Gross Fixed Capital Formation                              Investment Upturn in Service Industries
Annual percentage change
30                                                          30        Investment in service industries excluding housing decreased in
                                                                      the first half-year but is now estimated to have taken an upturn.
20                                                          20
                                                                      For the year as a whole, however, investment will decrease by
10                                                          10
                                                                      2.3 percent (see Table 10). The preliminary National Accounts
                                                                      show a decline in investment in machinery and equipment for
 0                                                          0         the second quarter, primarily as a consequence of a temporarily
                                                                      strong first quarter4. The decline will cease in the second half-
-10                                                         -10       year owing to such factors as the continued expansion of the 3G
                                                                      system and higher investment in the financial sector. Despite
-20                                                         -20
          94       96       98      00      02        04              this upswing, investment in machinery and equipment will be 3.8
               Goods industries
               Service industries
                                                                      percent lower this year than last year. Investment in buildings
               Public authorities                                     and constructions have now begun rising again and is expected
Sources: Statistics Sweden and NIER.                                  to be unchanged for this year. In the next two years, the rate of
                                                                      growth in output will rise while profitability improves; therefore,
                                                                      investment in service industries excluding housing is expected to
                                                                      increase by 3.3 and 6.8 percent, respectively, in 2004 and 2005
Diagram 66 Residential Construction                                   (see Diagram 65).
Annual percentage change
  40                                                            40


  20                                                            20    Low Interest Rates Stimulating Residential Con-
                                                                      struction
      0                                                         0

                                                                      The trend of increasing investment in housing came to a halt in
 -20                                                            -20
                                                                      the second quarter of 2002, and operators on the construction
                                                                      market feared that a sharp downturn would follow (see Diagram
 -40                                                            -40
                                                                      66 and Table 11). In the opinion of the NIER, however, the
 -60                                                            -60
                                                                      decline in housing investment in the winter months of
           94        96       98      00         02    04
                 Blocks of flats
                                                                      2002/2003 would be temporary. This prediction has now been
                 Single- and two-family houses                        borne out in the quick version of the National Accounts for the
                 Total
                                                                      second quarter. Several factors indicate that residential construc-
Sources: Statistics Sweden and NIER.
                                                                      tion will increase during the forecast period. The investment
                                                                      subsidy for production of smaller homes, though not yet ap-
                                                                      proved by the EU, is expected to have a positive effect on con-
                                                                      struction in 2004–2005. Residential construction is also being
                                                                      stimulated by low interest rates and the growing shortage of
                                                                      housing. Continued strong demand for single-and two-family
                                                                      houses is putting upward pressure on prices, and construction of
                                                                      these dwellings is anticipated to increase more than previously
                                                                      forecast. The tendency in the Stockholm area, however, is
                                                                      weaker, one reason being the high cost of production.




                                                                      4 In the first quarter, registration of ships under Swedish flag brought in over
                                                                      SEK 1 billion more than in the second quarter, according to preliminary
                                                                      National Accounts. Registration of a ship under Swedish flag increases imports
                                                                      of goods as much as investment and thus in the end has no effect on GDP; on
                                                                      the other hand, it will lead to substantial temporary effects on the investment
                                                                      tendency from one quarter to the next.
                                                                       Demand and Output in the Swedish Economy 39




Table 11 Housing Starts                                                       Diagram 67 Inventories, Assessment of Cur-
                             2001       2002     2003     2004     2005       rent Situation, Manufacturing
                                                                              Balances, monthly values
Blocks of flats            12 451      11 460   13 590   13 500   15 150       35                                                            35
Single- and two-family
houses                      7 023       6 921    8 132    8 700    9 200       30                                                            30

Total                      19 474      18 381   21 722   22 200   24 350
                                                                               25                                                            25
Sources: Statistics Sweden and NIER.
                                                                               20                                                            20

                                                                               15                                                            15

Postponement of Central Government Investment                                  10                                                            10

                                                                                    5                                                        5
As a consequence of the infrastructure programme begun in
2002, the National Road and National Rail Administrations have                      0
                                                                                         97                99                 01
                                                                                                                                             0

contributed to a strong increase in general-government invest-                                Input-goods inventories
                                                                                              Finished-goods inventories
ment since 2001. Central-government investment continued to
                                                                              Note: Higher balances mean that more firms are
rise during the first half of this year, but because of the cutbacks          dissatisfied about excessive inventories.
announced by the Government in its spring budget proposal,                    Source: NIER.

investment is now decreasing, a tendency that is expected to last
until the end of 2004. It is estimated that central-government                Diagram 68 Inventories, Assessment of Cur-
                                                                              rent Situation, in Trade
investment will pick up again in 2005, when work will begin on                Balances, quarterly values
such projects as the City Tunnel in Malmö.                                      70                                                           70

                                                                                60                                                           60

                                                                                50                                                           50

Stockbuilding                                                                   40                                                           40

                                                                                30                                                           30

                                                                                20                                                           20

                                                                                10                                                           10
Inventories on the Large Side
                                                                                    0                                                        0

In the Business Tendency Survey, the proportion of firms re-                   -10
                                                                                             97             99                01
                                                                                                                                             -10

sponding that their inventories were too large increased in the                               Trade in motor vehicles
                                                                                              Wholesale trade
second quarter (see Diagrams 67 and 68). In both manufacturing                                Retail trade in durable goods

and trade, inventories have become excessive after the end of                 Note: Higher balances mean that more firms are
                                                                              dissatisfied about excessive inventories.
last year. To a substantial extent, firms are expected to restore             Source: NIER.
inventories to desired levels by the second half of this year when
growth in demand picks up (see Diagram 69). The greatest ad-                  Diagram 69 Changes in Inventory
justments will probably be made in manufacturing, particularly                Billions of SEK, constant prices, seasonally adjusted
                                                                              quarterly values
of finished goods.
                                                                              10                                                        10
    The contribution of stockbuilding to growth in demand will
be limited to 0.2 percentage point of GDP. Next year, invento-                 5                                                        5
ries in trade are expected to decrease somewhat further, one
reason being higher growth in consumption. It is also estimated                0                                                        0
that inventories in manufacturing will remain virtually un-
changed. In total, inventories are forecast to increase at a steady            -5                                                       -5

rate, resulting in virtually no contribution from stockbuilding to
growth in demand in 2004 and 2005.                                            -10                                                       -10


                                                                              -15                                                       -15
                                                                                        98            00           02              04
                                                                                             Total
                                                                                             Manufacturing and trade

                                                                              Sources: Statistics Sweden and NIER.
40 Demand and Output in the Swedish Economy




Diagram 70 Exports of Goods
Billions of SEK, constant prices and percent, sea-
                                                         Exports
sonally adjusted quarterly values
280                                                 8

260                                                 6
                                                         Stronger Growth in Exports Next Year
240                                                 4

220                                                 2    After two years of virtually no change in exports, conditions
200                                                 0
                                                         now appear to favour a stronger tendency. World demand is
                                                         expected to rise substantially in the next few years (see the In-
180                                                 -2
                                                         ternational Economy section), a factor that will contribute to a
160                                                 -4   stronger increase in Swedish exports (see Diagrams 70 and 71).
140                                                 -6   Prices of exports in Swedish currency will be decreasing this year
      97            99          01        03   05
            Outcome                                      as well because of a stronger krona. They are expected to remain
            Forecast
            Percentage change (right)
                                                         largely unchanged next year and then to rise somewhat in 2005.
Sources: Statistics Sweden and NIER.
                                                         Table 12 Exports of Goods and Services
                                                         Annual percentage change
Diagram 71 Exports of Services                                                  Change in volume            Change in price
Billions of SEK, constant prices and percent, sea-
                                                                                2002 2003 2004 2005 2002 2003 2004 2005
sonally adjusted quarterly values
72                                                  12   Exports of goods         2.3   4.4     6.0   6.7   –2.5   –1.8    0.1   1.5
                                                          Manufactured
66                                                  9     goods                   2.2   4.9     6.9   7.5   –2.2   –1.8   –0.1   1.4
60                                                  6     Primary Products        4.3   1.5     1.1   1.7   –4.4   –1.6    1.2   2.0
                                                         Exports of services     –5.9   1.9     8.2   8.3    0.5   –2.0    0.5   1.9
54                                                  3
                                                         Total exports            0.4   3.8     6.5   7.1   –1.9   –1.8    0.2   1.6
48                                                  0
                                                         Sources: Statistics Sweden and NIER.
42                                                  -3

36                                                  -6

30                                                  -9
      97           99          01        03    05
           Outcome                                       Growing Demand for Manufactured Goods
           Forecast
           Percentage change (right)
                                                         Exports of manufactured goods, which rose at an unexpectedly
Sources: Statistics Sweden and NIER.
                                                         high rate in the first quarter of this year, eased off in the second
                                                         quarter. According to statistics on the mix of exports, the great-
                                                         est increase in the first five months of this year was in exports of
Diagram 72 Exports of Telecommunication                  motor vehicles and pharmaceuticals. Exports of telecommunica-
Products, Motor Vehicles and Medicine
Billions of SEK, current prices, seasonally adjusted     tion products were somewhat higher than at the end of 2002 but
monthly values
                                                         are still much lower than a year ago (see Diagram 72).
12                                                  12
                                                             The Business Tendency Survey reports that firms are expect-
10                                                  10   ing a weak tendency in exports in the third quarter. Data from
                                                         Statistics Sweden on new orders for exports also indicate that
 8                                                  8
                                                         growth will remain limited for some time yet. Given these cir-
 6                                                  6    cumstances, it is estimated that there will also be little increase in
                                                         exports of manufactured goods in the third quarter. Thus, the
 4                                                  4
                                                         more rapid growth of demand in other countries is not expected
 2                                                  2    to strengthen Swedish exports until the fourth quarter of this
 0                                                  0
                                                         year.
      97                 99              01
                                                             In both 2004 and 2005, market growth is estimated at more
           Tele products (sitc 764)
           Motor vehicles (sitc 781_4)                   than 7 percent (see Diagram 73). Swedish exports are expected
           Medicine (sitc 54)
                                                         to be in line with market growth and in 2005 even to exceed it
Source: Statistics Sweden.
                                                         somewhat because of their product mix. With an increasingly
                                                                                Demand and Output in the Swedish Economy 41




vigorous international economy, there will be a generally strong                       Diagram 73 World Market Growth for Manu-
rise in demand for investment goods as early as next year, and                         factured Goods
                                                                                       Annual percentage change
somewhat later, investment in telecommunications will pick up                               14                                                                          14
substantially.
    Prices of exports will continue to decrease through the first                           12                                                                          12

quarter of next year because of a stronger krona and will then                              10                                                                          10
increase gradually and modestly for the rest of the forecast pe-
riod. Prices of more specialized Swedish steel products, how-                                8                                                                          8

ever, will already begin rising this year.                                                   6                                                                          6


                                                                                             4                                                                          4

Exports of Primary Products Increasing More Slowly                                           2                                                                          2
This Year
                                                                                             0                                                                          0
                                                                                                      97             99             01             03             05
This year exports of primary products are increasing much more
                                                                                       Sources: Statistics Sweden and NIER.
slowly than last year. Exports of sawnwood are decreasing be-
cause of a stronger krona as well as slackening demand and an
increasing supply on the world market. Exports of nonferrous
                                                                                       Diagram 74 Exports of Primary Products
metals are also decreasing. The reason why growth will be no                           Percentage change and index 2002=100, seasonally
weaker than 1.5 percent this year is that exports of petroleum                         adjusted quarterly values

products and iron ore will be higher. With an improved econ-                           8                                                                           120

omy in other countries and inventory accumulation by purchas-                          6                                                                           114
ers of primary products, these exports will increase in total by
                                                                                       4                                                                           108
1.1 percent next year (see Diagram 74).
    Prices of primary products fell in the first half-year as a con-                   2                                                                           102

sequence of a weaker dollar and lower international prices of                          0                                                                           96
petroleum products. The price of oil, however, has risen over
                                                                                       -2                                                                          90
the summer, and for 2003 as a whole, export prices of petroleum
products in Swedish currency are expected to increase some-                            -4                                                                          84

what. Prices of other primary products, however, are forecast to                       -6                                                                          78
                                                                                                 97        98   99        00   01        02   03        04   05
decrease this year. In 2004 and 2005, the price of wood pulp will                                     Percentage change, volume
surge as demand for paper and paperboard rises in a strengthen-                                       Price (right)

ing economy, whereas prices of petroleum products will be fal-                         Sources: Statistics Sweden and NIER.

ling.


Growth in Exports of Services

Although the decrease last year in exports of services was due
primarily to the weakness in telecommunications, exports of
services in other areas also fell. According to preliminary Na-
tional Accounts5 exports of services turned upward at the outset
of this year and are expected to increase fairly rapidly as demand
improves (see Diagram 71).
    Demand for technical consultancy services is increasing, as
sales of services related to investments in the telecommunica-
tions sector will do. Freight and transportation services will also

5Beginning with the first quarter of 2003, statistics on foreign trade in services
are based on surveys. Since this change of method may lead to differences
between levels in time series, the tendency at the close of 2002 and the outset
of 2003 should be interpreted with caution.
42 Demand and Output in the Swedish Economy




Diagram 75 Imports of Goods                           be stimulated by an increasingly strong world economy. To
Billions of SEK, constant prices and percent, sea-
sonally adjusted quarterly values
                                                      some extent, the more vigorous growth in consumption in other
260                                              8    countries will include increasing foreign tourism in Sweden.
                                                         This year, exports of services are forecast to rise by almost 2
240                                              6
                                                      percent, whereas the increase will be more than 8 percent in
220                                              4
                                                      each of the next two years.
200                                              2

180                                              0

160                                              -2   Imports
140                                              -4

120                                              -6
      97           99         01       03   05
           Outcome
           Forecast                                   Upturn in Imports of Goods
           Percentage change (right)

Sources: Statistics Sweden and NIER.                  After decreasing in 2001 and 2002, imports of goods increased
                                                      strongly in the first quarter of this year (see Diagram 75). One
                                                      principal reason is the surge in imports of electricity. But im-
                                                      ports also increased in other categories of goods, particularly
                                                      motor vehicles. Preliminary statistics indicate that imports of
                                                      goods fell back somewhat in the second quarter, but imports are
                                                      now beginning to pick up and will accelerate as the economy
                                                      improves.
                                                          Imports of manufactured goods are forecast to increase by
                                                      3.9 percent in 2003 and by 8.7 and 9.6 percent, respectively, in
                                                      2004 and 2005 (see Table 13). The largest contributions to
                                                      growth in imports in 2003-2005 will come from rising household
                                                      consumption and the increasing demand of the exporting indus-
                                                      tries for input goods, but also from higher investment in ma-
                                                      chinery and equipment, particularly in 2005. With the krona
                                                      appreciating, prices of imported manufactures will be decreasing
                                                      through 2004.

                                                      Table 13 Imports of Goods and Services
                                                      Annual percentage change
                                                                             Change in volume             Change in price
                                                                             2002 2003 2004 2005 2002 2003 2004 2005
                                                      Imports of goods        –1.4   4.7      6.5   7.8   –0.3   –2.2   –1.7   0.6
                                                       Manufactured
                                                       goods                  –3.1   3.9      8.7   9.6   –0.1   –2.2   –0.8   1.0
                                                        Primary Products       3.9   5.2     –0.4   1.3   –1.7   –3.0   –5.2 –1.4
                                                      Imports of services     –6.1   2.1      9.6   9.3    2.4   –1.4   –0.7   2.0
                                                      Total imports           –2.7   4.0      7.3   8.2    0.4   –2.0   –1.5   1.0
                                                      Sources: Statistics Sweden and NIER.


                                                      Imports of primary products are continuing to increase this year
                                                      (see Table 13). The increase is due primarily to substantially
                                                      higher imports of crude oil and electric power because of the
                                                      cold winter of 2002-2003. Imports of electricity, however, are
                                                      now receding. Imports of foodstuffs and petroleum products are
                                                      continuing to increase this year, though at a more subdued rate.
                                                                    Demand and Output in the Swedish Economy 43




Next year, imports of primary products are expected to decrease,           Diagram 76 Imports of Primary Products
                                                                           Percentage change, constant prices and index
with imports of electricity down by half and imports of crude              2002=100, seasonally adjusted quarterly values
and petroleum products dropping as well.                                   16                                                               108
    This year, the world-market price of oil is rising. Prices of
                                                                           12                                                               102
imports, however, will be falling for the full year as the krona
strengthens. Prices will continue to decrease in 2004 and 2005              8                                                               96

because of declining oil prices and some additional appreciation            4                                                               90
of the krona in 2004 (see Diagram 76).
                                                                            0                                                               84

                                                                            -4                                                              78

Demand for Foreign Services to Increase                                     -8                                                              72

                                                                           -12                                                              66
The decrease in imports of services has now levelled out, and an                      97     98   99   00    01        02   03   04   05
                                                                                           Percentage change, volume
upturn is on the way (see Diagram 77). Particularly household                              Price (right)
consumption abroad is expected to increase markedly, one rea-              Sources: Statistics Sweden and NIER.
son being a stronger exchange rate. As the economy gains sig-
nificant momentum during 2004, demand for foreign business
services will also increase. Similarly, imports of transportation
                                                                           Diagram 77 Imports of Services
services are expected to rise in the coming years.                         Billions of SEK, constant prices and percent, sea-
    All factors considered, imports of services are forecast to            sonally adjusted quarterly values

grow by 2.1 percent this year and then to surge by more than 9             78                                                                10

percent annually in 2004 and 2005.                                         72                                                                8

                                                                           66                                                                6

                                                                           60                                                                4
Output                                                                     54                                                                2

                                                                           48                                                                0

                                                                           42                                                                -2
Output Picking Up
                                                                           36                                                                -4
                                                                                  97              99         01             03         05
The recovery in GDP growth that got under way at the end of                            Outcome
2001 lost momentum in the third quarter of last year (see Dia-                         Forecast
                                                                                       Percentage change (right)
gram 78). The primary reason was a weakening tendency in
                                                                           Sources: Statistics Sweden and NIER.
manufacturing due to temporarily slackening demand for ex-
ports. The softness in exports, however, did not fully impact
output since firms built up their inventories and as imports were
dampened. Output increased somewhat more rapidly in the                    Diagram 78 Output
                                                                           Percentage change, constant prices, seasonally
fourth quarter. For last year as whole, GDP growth was 1.9                 adjusted quarterly values
percent (see Table 14). The growth in the output of the business                1.0                                                          1.0

sector was somewhat stronger, whereas the output of public                      0.8                                                          0.8

authorities increased by only 0.9 percent.                                      0.6                                                          0.6
    This year growth has remained weak, particularly in manufac-                0.4                                                          0.4
turing (see Diagram 79), and in the second quarter the labour                   0.2                                                          0.2
conflict had a negative effect in the local-government sector.                  0.0                                                          0.0
During the first half of this year, the NIER’s surveys have re-
                                                                            -0.2                                                             -0.2
ported gradually slackening growth in demand and output in
                                                                            -0.4                                                             -0.4
manufacturing, probably related at least initially to the Iraq crisis.
                                                                            -0.6                                                             -0.6
The tendency in the second quarter was disappointing for large                              01                    03                  05

portions of the manufacturing sector. In August, however, the                                GDP (basic prices)
                                                                                             Public authorities
Business Tendency Survey reported less dissatisfaction with                                  Business sector

orders on hand and inventories of finished goods, as well as               Sources: Statistics Sweden and NIER.
production plans indicating some increase in manufacturing
44 Demand and Output in the Swedish Economy




Diagram 79 Output of Business Sector                             output in the next few months. The overall effect was a certain
Percentage change, constant prices, seasonally
adjusted quarterly values
                                                                 increase in the confidence indicator for manufacturing com-
  4                                                         4    pared to the preceding month, although the indicator is still
                                                                 relatively low by historical standards (see Diagram 80).
  2                                                         2

                                                                 Table 14 Output
  0                                                         0    Billions of SEK, current prices, and percentage change, constant
                                                                 prices
                                                                                                        2002    2002    2003    2004      2005
  -2                                                        -2
                                                                 Manufacturing                            433     2.9     1.4      4.5     4.8
                                                                 Construction                              87     2.3     1.1      1.6     2.8
  -4                                                        -4
            01                  03              05               Other goods industries                    93    –1.0    –0.7      1.4     1.1
            Manufacturing                                        Finance and real estate                  292    –0.3     1.5      1.8     1.9
            Construction
            Services                                             Other service industries                 729     2.9     1.4      3.0     3.4
                                                                                        1
                                                                 Total, business sector                 1 583     2.0     1.3      3.1     3.4
Sources: Statistics Sweden and NIER.
                                                                 Public authorities                       436     0.9     0.6      0.8     0.2
                                                                                    2
                                                                 GDP (basic prices)                     2 049     1.8     1.1      2.5     2.7
                                                                 Product taxes/subsidies                  291     2.6     2.1      2.1     2.8
                                                                                        2
Diagram 80 Conficence Indicator, Manufactur-                     GDP (market prices)                    2 340     1.9     1.3      2.5     2.7
ing
Balances, seasonally adjusted monthly values
                                                                 1 Financial services not allocated by industry have been subtracted.
                                                                 2 Including output of nonprofit organizations in the household sector.
30                                                   30
                                                                 Note: Output refers to value added.
                                                                 Sources: Statistics Sweden and NIER.
20                                                   20


10                                                   10          In the Business Tendency Survey, construction firms remain
                                                                 pessimistic. The business outlook in construction, however,
  0                                                  0
                                                                 appears somewhat more favourable in the National Accounts,
                                                                 where a significant increase in the volume of construction was
-10                                                  -10
                                                                 noted for the second quarter. The principal reason is the infra-
-20                                                  -20
                                                                 structure investment of the National Rail and Road Administra-
                                                                 tions, which is not included in the Business Tendency Survey. In
-30                                                  -30         view of the tight budgetary situation of the central government,
       96             98             00   02
Note: Estimated orders on hand – estimated finished
                                                                 a certain downward revision of investment in infrastructure will
goods inventory + expected output. Mean 1996-                    affect the volume of construction in the second half of this year
2002=0.
Source: NIER.                                                    as well as next year.
                                                                     The service firms that did fairly well in the first quarter, ac-
                                                                 cording to the Business Tendency Survey, showed an unexpect-
Diagram 81 Contrubution to GDP Growth
Percentage points, seasonally adjusted quarterly                 edly weak tendency in the second quarter. This category consists
values                                                           primarily of firms engaged in trade. A large share of service
0.8                                                  0.8
                                                                 firms, however, are cautiously optimistic about the tendency in
0.6                                                  0.6
                                                                 the third quarter, though there is less optimism at firms provid-
0.4                                                  0.4
                                                                 ing services to the construction sector, including wholesalers in
0.2                                                  0.2         building materials, architects and building consultants.
0.0                                                  0.0             The stronger growth in demand is expected to result in a
-0.2                                                 -0.2        more positive trend in output in the second half-year compared
-0.4                                                 -0.4        with the first. Recovery in the local-government sector now that
-0.6                                                 -0.6        the strike is over will contribute to the increase in output in the
-0.8
        01                    03           05
                                                     -0.8        third quarter (see Diagram 81). For the year as a whole, the
            Public authorities                                   growth in the output of the business sector is estimated at only
            Service industries
            Manufacturing                                        1.3 percent. The output of public authorities is increasing more
            Other goods industries
                                                                 slowly because of the strike in local government and a gradual
Sources: Statistics Sweden and NIER.                             transition from local-government production to procurement of
                                                                Demand and Output in the Swedish Economy 45




services from the business sector. Demand from abroad will             Diagram 82 Contribution to GDP Growth, Te-
gradually strengthen during the forecast period. The entire busi-      lecommunication Products Industry
                                                                       Percentage points
ness sector, but particularly manufacturing, business services and     5                                                5
wholesale trade, will benefit from this development. The ten-
dency in the business sector is thus expected to be more favour-       4                                                4

able in 2004 and 2005, when output is forecast to increase by 3.1      3                                                3
and 3.4 percent, respectively. For the reasons noted above,
growth in the output of the general-government sector will be          2                                                2

lower; for this reason, GDP is forecast to rise by 2.5 percent in
                                                                       1                                                1
2004 and somewhat more in 2005.
    This year, manufacturing will contribute little to GDP             0                                                0

growth (see Diagram 81). Growth will be sustained primarily by
                                                                       -1                                               -1
the service industries. Also in 2004 and 2005, the service indus-                94          96       98    00    02
                                                                                      Communication
tries will provide the greatest contribution to increased output,                     Other
but by then manufacturing will also be contributing significantly.     Note: The contributions add up to GDP at basic
The contribution of the telecommunication-products industry to         prices.
                                                                       Sources: Statistics Sweden and NIER.
GDP growth was substantial in the 1990’s, but weakened and
turned slightly negative in 2001–2002 (see Diagram 82). GDP
                                                                       Diagram 83 Output and Hours Worked, Busi-
growth, however, was not driven solely or even primarily by the        ness Sector
increased output of this sector, but was the result of a broad-        Annual percentage change

based upswing in business-sector output. The contribution of                8                                                8

the telecommunication-products industry is expected to be                   6                                                6
modest this year as well, but to increase gradually during 2004–
                                                                            4                                                4
2005.
                                                                            2                                                2


                                                                            0                                                0
Productivity and Profitability
                                                                            -2                                               -2


                                                                            -4                                               -4
                                                                                  97           99      01    03    05
                                                                                       Output
Productivity Growth Strong Despite a Modest In-                                        Hours worked
                                                                                       Productivity
crease in Output
                                                                       Sources: Statistics Sweden and NIER.

Productivity in the business sector rose by 4.1 percent last year
after a very weak tendency in 2001. This development is explain-
able by the fact that firms initially continued to increase the
number of their employees despite a substantial drop in output
growth in 2001. The adjustment of hours worked to the prevail-
ing volume of output was not made until 2002, a factor that
strongly increased productivity growth during the course of that
year and will also reinforce it for 2003 as a whole (see Table 15
and Diagram 83).
46 Demand and Output in the Swedish Economy




Diagram 84 Profit Share and Return on Capi-                  Table 15 Productivity
tal, Business Sector                                         Annual percentage change, constant prices
Percent
 50                                                     50                                           2001     2002      2003       2004    2005
                                                             Manufacturing                             0.9      7.6         4.2      3.9    3.9
                                                             Construction                              1.8      2.5         0.9      1.2    2.3
 40                                                     40
                                                             Other goods industries                    4.9      1.4         1.1      0.9    0.8
                                                             Finance and real estate                  –0.4     –0.2         2.5      1.2    1.3
 30                                                     30   Other service industries                  1.1      4.3         2.4      2.4    2.5
                                                                                     1
                                                             Total, business sector                    0.4      4.1         2.7      2.5    2.6
                                                             Public authorities                        0.8      0.1         0.6     –0.2    0.2
 20                                                     20
                                                                                    2
                                                             GDP (market prices)                       0.5      3.1         2.3      1.8    2.2
                                                             1 Financial services not allocated by industry have been subtracted.
 10                                                     10   2 Including output of nonprofit organizations in the household sector.
      80 82 84 86 88 90 92 94 96 98 00 02 04
            Profit share (total)                             Sources: Statistics Sweden and NIER.
            Profit share (excl fre)
            Return on capital (excl. fre)

Note: fre = finance and real estate.
Sources: Statistics Sweden and NIER.
                                                             Productivity growth in the business sector is anticipated to be
                                                             about the same in 2004 and 2005, despite a stronger increase in
                                                             output. The reason is that previously underemployed staff will
Diagram 85 Product Prices and Cost of Pro-                   be put to greater use as early as 2003. Thereafter, higher output
duction, Business Sector
Percentage change                                            must be achieved primarily by increasing the number of hours
4.0                                                   4.0    worked.


3.0                                                   3.0
                                                             Profitability Stabilizing in the Business Sector
2.0                                                   2.0    Profitability in the business sector fell in 2001 and 2002 as the
                                                             economy slumped. In the business sector excluding finance and
1.0                                                   1.0    real estate, however, profitability is not particularly low by his-
                                                             torical standards (see Diagram 84).
                                                                  Last year, costs of firms were contained by high productivity
0.0                                                   0.0
      97           99           01          03   05          growth and a weak tendency in prices of imported input goods
           Product price
           Total variable cost per unit                      (see Table 16 and Diagram 85). Nevertheless, owing to substan-
Sources: Statistics Sweden and NIER.
                                                             tial weakening in product prices, primarily in the basic industries
                                                             (forest products and metals), the profit share dropped further in
                                                             the business sector.

                                                             Table 16 Costs of Output, Prices and Profits in the Busi-
                                                             ness Sector
                                                             Per unit of output. Annual percentage change
                                                                                                      2002       2003             2004     2005
                                                             Cost of inputs consumed                    1.1           0.9          0.5      1.6
                                                             Cost of labour                             2.6           1.4          1.4      0.7
                                                                 Hourly cost of labour                  6.9           4.3          3.9      3.8
                                                                 Productivity                           4.2           2.7          2.8      2.9
                                                             Total variable cost                        1.6           1.2          0.8      1.3
                                                             Product price                              0.9           1.4          1.1      1.7
                                                             Profit margin (percentage points)         –0.7           0.3          0.3      0.2
                                                             Profit share (percentage points)          –1.2           0.3          0.4      0.6
                                                             Note: Productivity is calculated here on the basis of gross output, in contrast to
                                                             the productivity table above, where it is calculated on the basis of value added.
                                                             Gross output and the cost of labour are divided by the number of hours
                                                             worked for employees.
                                                             Source: NIER.
                                                                 Demand and Output in the Swedish Economy 47




This year it is expected that the krona will continue appreciating,     Diagram 86 Profit Shares, Manufacturing
                                                                        Percent
and that severe competition, particularly in telecommunication
                                                                        70                                            70
products, will make it difficult for manufacturing firms to raise
prices of manufactured exports in Swedish currency. It is also          60                                            60

anticipated that the world-market price trend in products of the
                                                                        50                                            50
basic industries will remain weak, thus further reducing the
profit share in manufacturing (see Diagram 86). For the service         40                                            40

industries, the profit share is forecast to rise somewhat as a re-      30                                            30
sult of a fairly strong productivity trend and falling prices of
imports. For the business sector as a whole, the profit share will      20                                            20

increase somewhat this year.                                            10                                            10
                                                                             80 82 84 86 88 90 92 94 96 98 00 02 04
    In 2004–2005, stronger international demand in combination
                                                                                Total manufacturing
with comparatively good growth in productivity is expected to                   Manufacturing, primary products
                                                                                Manufacturing, investment goods
lay a foundation for some recovery of profit levels in manufac-
                                                                        Sources: Statistics Sweden and NIER.
turing. Prices of basic-industry products are also considered
likely to rise, with prices of exported manufactures gradually
following suit. For service industries, too, the profit share is
forecast to increase. Thus, the profit share in the business sector
as a whole will be rising in both 2004 and 2005.
48 Demand and Output in the Swedish Economy




                                             Cyclical Effects of a “Yes” and a “No”
                                             to the Euro
                                             In the NIER’s main forecast for the economy in 2003-2005, it is
                                             assumed that the Swedish people will say ”yes” to the euro in
                                             the referendum to be held on September 14. This assumption,
                                             however, is not intended as a forecast of the outcome of the
                                             referendum, or as a statement of a position on the issue.
                                                 In this box, we present the basic outlines of the NIER’s as-
                                             sessment of the economic tendency if the referendum results in
                                             a ”no” and Sweden remains outside the European exchange-rate
                                             mechanism (ERM2) for the time being. The differences com-
                                             pared to the main forecast are due primarily to lower interest
                                             rates following a ”yes” vote in the referendum, leading to more
                                             rapid economic recovery. But the development of the economy
                                             will also be influenced by the effects on capital formation and
                                             foreign trade, for example, and by increased competition, par-
Diagram 87 Repo Rate in Sweden               ticularly in the longer run. Such effects, which are also significant
Percent, monthly values
                                             for potential output and growth, are analyzed here only to the
4.0                                    4.0
                                             extent that they clearly affect the tendency of the economy in
                                             the next few years.
3.5                                    3.5       The findings are similar to those presented in The Swedish
                                             Economy – June 2003. The discrepancies that nevertheless exist
3.0                                    3.0   are due to minor revisions of the forecasts for the exchange rate
                                             of the krona and for the repo rate, and to an expanded analysis
                                             of household consumption.
2.5                                    2.5



2.0                                    2.0
         03                       05         A ”Yes” Means Lower Interest Rates
       Yes to the euro
       No to the euro
                                             Currently, the Riksbank’s repo rate is 0.75 percentage point
Sources: The Riksbank and NIER.              higher than the ECB’s official interest rate. If Sweden says “no”
                                             to the euro, the Riksbank will continue to conduct an independ-
                                             ent monetary policy. Given the outlook for subdued inflation,
                                             the repo rate will be lowered by another 0.5 percentage point to
Diagram 88 Interest Rates on Three-month
Treasury Bills – Sweden
                                             2.25 percent later this year. The Swedish economy will gradually
Percent, monthly values                      improve, and in the summer of 2004, the Riksbank will begin
4.5                                    4.5   quickly raising the repo rate, which will reach 4.00 percent at the
                                             end of 2005. However, even at that level, monetary policy will
4.0                                    4.0
                                             still be slightly expansionary. If Sweden joins the ERM2, the
                                             repo rate instead will converge gradually toward the ECB’s offi-
3.5                                    3.5
                                             cial interest rate, which is forecast to be 3.50 percent at the end
                                             of 2005 (see Diagram 87). Initially the repo rate will not be re-
3.0                                    3.0
                                             duced as much as in the case of a ”no” vote since longer-term
2.5                                    2.5
                                             credit-market interest rates will be rapidly approaching the lower
                                             levels prevailing in the euro zone, with a powerful expansionary
2.0                                    2.0   effect on the development of demand (see the analysis below).
         03                       05
       Yes to the euro
                                             In 2005, however, the repo rate will be lower with “yes” to the
       No to the euro                        euro than with a ”no” because of the convergence toward the
Sources: The Riksbank and NIER.              ECB’s official interest rate, a tendency that will also be reflected
                                             in short-term market interest rates (see Diagram 88).
                                                                  Demand and Output in the Swedish Economy 49




     Interest rates for the krona will also be higher than those for
the euro for reasons other than monetary policy. In a long-term
perspective, if both the Riksbank and the ECB follow a neutral
monetary policy, it is estimated that borrowing rates for both
households and firms will be 0.65 percentage point higher for
the krona than the corresponding rates for the euro. If Sweden
joins the monetary union, the differential will disappear, and
these interest rates will begin to converge directly following the
referendum.
    In the long term, the differential between interest rates for
Swedish currency and for the euro is linked to three factors.
First, the ECB’s inflation target is somewhat lower than the
Riksbank’s. The ECB’s targeted inflation rate is just under two
percent, whereas the Riksbank’s target is exactly two percent.
This difference is interpreted to mean that interest rates in
Swedish currency will be 0.25 percentage point higher than euro
rates.
    Second, with the flexible exchange rate of the krona, there is
                                                                         Diagram 89 Interest Rate on Five-year Gov-
an exchange-rate premium that raises the required rate of return         ernment Bonds – Sweden
on interest-bearing assets in Swedish currency. This exchange-           Percent, monthly values

rate premium is also estimated at 0.25 percentage point and              5.5                                     5.5

disappears entirely when the krona is converted to the euro. The
                                                                         5.0                                     5.0
total of 0.5 percentage point is roughly equivalent to the current
differential between bond rates in Sweden and those in the euro
                                                                         4.5                                     4.5
zone.
    The third factor is related to the effect of Swedish member-         4.0                                     4.0
ship in the monetary union, which will accelerate and reinforce
financial integration between Sweden and the euro zone. One              3.5                                     3.5
consequence will be that the so-called liquidity premiums on
Swedish credit-market interest rates will decrease by an esti-           3.0                                     3.0
                                                                                  03                       05
mated 0.15 percentage point with an oncoming transition to the                  Yes to the euro
                                                                                No to the euro
euro. The so-called swap rates, of major significance for interest
rates on home-mortgage and corporate bonds, are identical in             Sources: The Riksbank and NIER.

the different countries of the euro zone. In Sweden, the differ-
ence between a five-year swap rate and the corresponding inter-
est rate on government bonds is about 0.35 percentage point. In
Finland, for example, this difference is much less, approximately
0.20 percentage point.
    The three factors cited above, together with a more expan-
sionary monetary policy in 2005, mean that long-term interest
rates will be lower with a ”yes” to the euro than with a ”no”. It
is estimated that the interest rate on five-year government bonds
will be about 0.4 percentage point lower in 2004–2005 (see Dia-
gram 89). For households and firms, interest rates will drop by
an additional 0.15 percentage point.
50 Demand and Output in the Swedish Economy




Diagram 90 Swedish Krona per Euro             A ”Yes” Means a Temporary Stronger Krona
Monthly values
9.25                                   9.25   In the main forecast, it is assumed that the krona will be linked
9.20                                   9.20   to the ERM2 at the end of 2003. The NIER’s assessment is that
                                              a central and conversion rate of SEK 9.00 to the euro is well
9.15                                   9.15
                                              balanced from the standpoint of the national economy.6
9.10                                   9.10        The exchange-rate risk will decrease dramatically when Swe-
9.05                                   9.05   den joins the ERM2, and it is estimated that the repo rate will
                                              exceed the ECB’s official interest rate until the end of 2005.
9.00                                   9.00
                                              Consequently, the krona will strengthen to a level just below
8.95                                   8.95   SEK 9.00 per euro when Sweden joins the ERM2 and then
8.90                                   8.90   weaken slightly to SEK 9.00 per euro when the country enters
          03                      05
        Yes to the euro
                                              the monetary union (see Diagram 90). Also in the event of a
        No to the euro                        “no” to the euro, the krona will appreciate in the long term since
Sources: The Riksbank and NIER.               the equilibrium exchange rate will strengthen in the future.7
                                              However, with a ”no” the krona is expected to weaken some-
                                              what directly after the referendum owing to increased uncer-
                                              tainty; then gradually to strengthen to SEK 9.00 per euro by the
                                              end of 2005 (see Diagram 90). Joining the ERM2 thus means
                                              that the krona will be temporarily stronger against the euro, also
                                              in terms of the TCW index, until the end of 2005 (see Table 18).

                                              Table 17 Supply and Demand With a ”No” to the Euro
                                              Annual percentage change, constant prices
                                                                                                       Difference between
                                                                              ”No” to the euro         ”yes” and ”no” to the
                                                                                                       euro
                                                                              2003    2004   2005      2003 2004 2005
                                              GDP                               1.3    2.3       2.3     0.0    0.2     0.4
                                              Household consumption expen-
                                              diture                            2.0    2.6       2.4     0.1    0.7     0.4
                                              General-government consump-
                                              tion expenditure                  0.7    0.8       0.5     0.0    0.0     0.0
                                              Gross fixed-capital formation    –1.4    2.3       4.4     0.0    0.8     2.6
                                              Stockbuilding                     0.2    0.0       0.0     0.0    0.0     0.0
                                              Exports of goods and services     3.8    7.1       7.2     0.0   –0.6    –0.2
                                              Imports of goods and services     4.0    7.1       7.8     0.0    0.2     0.4
                                              Source: NIER.



                                              A ”Yes” Means Stronger Recovery

                                              If Sweden votes ”yes” to the euro, lower market interest rates
                                              and a somewhat stronger exchange rate will affect the develop-
                                              ment of aggregate demand and thus the strength of the eco-
                                              nomic recovery. Table 17 presents the NIER’s assessment of the
                                              demand tendency until 2005 in the event of a “no” to the euro
                                              and the additional effects according to the main forecast if the
                                              outcome is a “yes”.

                                              6 See the box captioned ”What Conversion Rate Will Be Appropriate When
                                              Sweden Joins the Monetary Union?” in The Swedish Economy – June 2003.
                                              7 Ibid.
                                                                Demand and Output in the Swedish Economy 51




    The immediate effect of lower market interest rates will be        Diagram 91 Household Consumption
                                                                       Percentage change, seasonally adjusted quarterly
faster growth in household consumption (see Diagram 91). It is         values
estimated that growth in consumption will already increase             0.90                                         0.90
somewhat this year and that next year it will be 0.7 percentage        0.80                                         0.80
point higher with a ”yes” to the euro than with a “no”. Invest-
                                                                       0.70                                         0.70
ment will also increase more rapidly as a result of lower interest
                                                                       0.60                                         0.60
rates (see Diagram 92). The effect, however, will occur some-
what later than for consumption, and growth in investment is           0.50                                         0.50

expected to be 0.8 and 2.6 percentage points higher in 2004 and        0.40                                         0.40

2005, respectively.                                                    0.30                                         0.30
    In 2005, growth in consumption will be favourably affected         0.20                                         0.20
both by lower interest rates and by household expectations of
                                                                       0.10                                         0.10
rising incomes in coming years. Capital formation will already                   03                        05
                                                                               Yes to the euro
have begun to increase as a result of the lower interest rates. In             No to the euro
the longer run, this development will mean higher capital inten-       Sources: Statistics Sweden and NIER.
sity in production and thus somewhat higher GDP. Households
are expected to draw on some of this long-term increase in out-
put as early as 2005, when growth in consumption will be 0.4
                                                                       Diagram 92 Gross Fixed Capital Formation
percentage point faster.                                               Percentage change, seasonally adjusted quarterly
                                                                       values
    Aggregate growth in demand will be curbed somewhat by the
                                                                       2.0                                          2.0
limiting effect of a transitionally stronger exchange rate on ex-
ports, which are expected to increase by 0.6 and 0.2 percentage        1.5                                          1.5

points less in 2004 and 2005, respectively. Imports will be stimu-     1.0                                          1.0
lated both by the higher level of demand in the economy and by
                                                                       0.5                                          0.5
the stronger exchange rate, which will lead to some increase in
the growth of imports in both years. As a combined effect of           0.0                                          0.0

lower interest rates and a stronger exchange rate, GDP growth          -0.5                                         -0.5
will be 0.2 and 0.4 percentage points higher in 2004 and 2005,
                                                                       -1.0                                         -1.0
respectively (see Diagram 93).
    The underlying inflation rate, UND1X, is expected to be            -1.5
                                                                                 03                           05
                                                                                                                    -1.5

somewhat higher with a ”yes” to the euro since higher demand                   Yes to the euro
                                                                               No to the euro
will raise the level of resource utilization in the economy (see
                                                                       Sources: Statistics Sweden and NIER.
Table 18). The rise in inflation, however, will be dampened by a
weaker tendency in prices of imports as a result of the stronger
exchange rate. The CPI inflation rate, which includes the cost of
interest on owner-occupied homes, will be somewhat lower with          Diagram 93 GDP at Market Prices
                                                                       Percentage change, seasonally adjusted quarterly
a “yes” to the euro because of lower interest rates.                   values
    Lower market interest rates will also reduce the interest ex-      0.70                                         0.70
penditure of the general-government sector after a ”yes” vote in
the referendum. Tax revenue will be higher, and expenditure on         0.60                                         0.60

transfer payments will be lower, because of more hours worked.
Higher household consumption will also increase tax receipts           0.50                                         0.50

from VAT. All factors considered, it is estimated that with a
                                                                       0.40                                         0.40
“yes” to the euro, the net lending of the general-government
sector will be somewhat higher (see Table 18).
                                                                       0.30                                         0.30


                                                                       0.20                                         0.20
                                                                                 03                        05
                                                                               Yes to the euro
                                                                               No to the euro

                                                                       Sources: Statistics Sweden and NIER.
52 Demand and Output in the Swedish Economy




                                         Table 18 Key Numbers With a ”No” to the Euro
                                         Percentage points
                                                                                                            Difference between
                                                                                   “No” to the euro         “yes” and “no” to the
                                                                                                            euro

                                                                                   2003 2004      2005      2003    2004   2005
                                                                        1
                                         3-month interest rate                        2.9   2.5       3.6     0.0    0.2   –0.3
                                         Interest rate on 5-year
                                               1
                                         bonds                                        3.9   4.3       4.8     0.0   –0.3   –0.5
                                                                        1, 2
                                         SEK per euro (level)                       9.18 9.09     9.03       –0.5   –1.5   –0.5
                                                                 1, 2
                                         TCW index (level)                         128.4 126.5 125.7         –0.5   –1.5   –0.5

                                                         1
                                         CPI inflation                                2.0   0.7       2.3     0.0    0.0   –0.3
                                                             1
                                         UND1X inflation                              2.3   0.9       1.6     0.0    0.0    0.1
                                                                               1
                                         Unemployment rate (level)                    4.7   4.7       4.6     0.0   –0.1   –0.3
                                         General-government net
                                                 3
                                         lending                                      0.4   0.9       1.5     0.0    0.3    0.3
                                         1 Annual average.
                                         2 Difference in percent.
                                         3 As a percentage of GDP.

                                         Source: NIER.


                                         As an overall effect of a ”yes” vote in the referendum, lower
                                         interest rates will lead to stronger growth in demand in the next
                                         few years. Output will increase faster in 2003-2005, and unem-
                                         ployment will decrease more rapidly. Thus, the calculations show
                                         that a “yes” to the euro will speed up economic recovery
                                         through lower interest rates and expectations of higher output in
                                         the future. This finding, however, says nothing about the overall
                                         long-term effects of a transition to the euro on output and wel-
                                         fare.
                                                                       53




Labour Market, Resource Utilization
and Prices
The demand for labour will pick up gradually at the outset of
next year and with a certain time lag in relation to demand and
output. The increase in employment will be held back, however,
by rising average hours worked and will be limited to 0.1 percent
next year and 0.4 percent in 2005.
     The weak employment trend, together with cutbacks in la-
bour-market programmes, means that the unemployment rate
will rise from 4.0 percent last year to 4.7 percent this year, drop-
ping thereafter to 4.2 percent at the end of 2005.
     Resource utilization is currently low. In some sectors, the
proportion of firms reporting shortages is as small as in the early
1990’s. However, the output gap will gradually narrow in 2004-
2005 as a result of stronger growth in demand.
     In 2004 new collective-bargaining agreements will be reached
on a large portion of the labour market. Negotiations will be
conducted in a weak labour market. Inflation was temporarily
high last winter but has now dropped back and is expected to
remain low in the next few years. The recently negotiated wage
increases for the Municipal Workers’ Union are relatively low for
2004. On the assumption that Sweden will join the European
Monetary Union, the more modest wage increases in the euro
zone will set the norm to a greater extent. In these circum-
stances, it is anticipated that the wage settlements in 2004 will be
lower than those reached in the last major round of negotiations
in 2001. Increases in hourly earnings are expected to be modest
throughout the forecast period. Labour costs, however, will be
rising somewhat faster than hourly earnings, particularly this
year, one reason being higher costs of negotiated employer con-
tributions. It is estimated that the increases in labour costs will
be somewhat higher in Sweden than in the euro zone.
     The inflation rate receded gradually during the spring but is
still being sustained by high prices of energy. Domestic demand-
related inflationary pressure is expected to be low throughout
the forecast period. At the same time, imported inflation will be
limited by the modest increases in prices of foreign exports and
by a strong krona. All factors considered, the UND1X inflation
rate is forecast to be less than 2 percent in both 2004 and 2005.
54 Labour Market, Resource Utilization and Prices




Diagram 94 Population in Different Age
Percent of population aged
                                                                      Labour Market
 21                                                              72


 20                                                              70


 19                                                              68
                                                                      Labour Supply Increasing Slightly

 18                                                              66   It is estimated that population growth will contribute 0.8 percent
                                                                      per year to the labour supply during the forecast period. The
 17                                                              64
                                                                      labour supply, however, will be increasing much more slowly
 16                                                              62   since persons of working age account for a declining share of
                                                                      the population (see Diagram 94) and the number of persons on
 15                                                              60
      80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10                 activity and disability benefits is continuing to increase. In addi-
           16-24
           55-64                                                      tion, the labour supply is dependent to some extent on the state
           25-54 (right)
                                                                      of the economy, and this year it is being held back by rising un-
Source: Statistics Sweden.                                            employment.

                                                                      Table 19 Net Contribution to Labour Supply
Diagram 95 Number of Ill Persons in and Out-                          Level in thousands of persons and annual percentage change or
side the Labour Force                                                 contribution in percentage points
Thousands, seasonally adjusted quarterly values
                                                                                                               2002    2002     2003    2004     2005
600                                                         600
                                                                      Labour force                             4 421      0.1     0.7      0.1     0.0
500                                                         500       of which net contribution from:
                                                                      Population aged 16–64                    5 666      0.8     0.8      0.8     0.9
400                                                         400                             1
                                                                      Training programmes                        –93    –0.1      0.4      0.1     0.0
300                                                         300
                                                                      Regular education                        –424     –0.2     –0.3    –0.4     –0.4
                                                                      Sick persons2                            –377     –0.7     –0.4    –0.3     –0.2
200                                                         200       Persons receiving negotiated pen-
                                                                      sions                                      –80      0.2     0.1      0.0     0.0
100                                                         100       Other
                                                                              3
                                                                                                               –272       0.1     0.2    –0.2     –0.2

  0                                                         0
                                                                      1 Training-programme participants outside the labour force, according to
      87   89   91    93   95   97    99   01     03   05             Labour Force Surveys.
           Ill persons outside the labour force                       2 The category of sick persons outside the labour force consists of individuals
           Absent from work because of illness
           Ill persons total                                          receiving activity and disability benefits as well as persons receiving sickness
                                                                      benefits and without employment.
Sources: Statistics Sweden and NIER.
                                                                      3 The group designated ”Other” consists of homemakers, persons on leave,

                                                                      persons residing abroad etc.
                                                                      Sources: Statistics Sweden, Labour Market Board and NIER.
Diagram 96 Labour Market Programmes
Thousands of participants, seasonally adjusted qu-
arterly values                                                        The strong growth of the population aged 16–24, together with
250                                                         250       the expansion of universities and colleges, means that the num-
                                                                      ber of students in regular education is increasing. The Adult
200                                                         200
                                                                      Education Initiative has been partly replaced by a selective cen-
150                                                         150
                                                                      tral-government subsidy equivalent to 53 500 places in education
                                                                      in 2003–2005. The growing number of persons in regular educa-
100                                                         100       tion is restricting the increase in the labour supply by 0.3–0.4
                                                                      percentage points per year.
 50                                                         50            The number of sick persons outside the labour force, i.e. per-
                                                                      sons receiving activity and disability benefits as well as persons
  0                                                         0
      96         98        00        02           04                  receiving sickness benefits and without employment, has been
           Labour-market programmes
           Employment programmes
                                                                      gradually rising in recent years is currently almost 400 000. The
           Training programmes                                        increase is expected to persist, though at a declining rate. As
Sources: Labour Market Board and NIER.                                shown in Table 19, this trend accounts for a substantial negative
                                                                      contribution to the development of the labour supply. The
                                                                 Labour Market, Resource Utilization and Prices 55




number of sick persons in the labour force, i.e. persons absent           Diagram 97 Population, aged 16-64
                                                                          Millions, quarterly values
from work because of illness, has decreased in recent months,
                                                                            6.0                                                              6.0
according to Labour Force Surveys (LFS). The decrease is con-
firmed by statistics from the National Social Insurance Board
                                                                            5.5                                                              5.5
showing that benefit payments by social-insurance offices in
terms of sick-benefit days are also decreasing. In 2004 and 2005,           5.0                                                              5.0
sickness absence is expected to continue decreasingly slightly.
All factors considered, the total ill-health statistics are expected        4.5                                                              4.5
to continue rising, but at a somewhat decreasing rate in coming
years (see Diagram 95).                                                     4.0                                                              4.0
                                                                                      98            00          02           04
    In the past year, the number of persons in labour-market                               Labour Force
programmes has dropped by 25 000. The decrease is expected to                              On negotiated pensions and other
                                                                                           Sick-listed
continue if there are no changes in current appropriations and                             In regular education
                                                                                           In labour-market tranining programmes
rules (see Diagram 96). As shown in Table 19, the reduced par-
                                                                          Sources: Statistics Sweden and NIER.
ticipation in labour-market training programmes will provide a
net contribution of 0.4 percentage points to the labour force in
2003.
    All factors considered, it is estimated that the labour supply
                                                                          Diagram 98 Shortage of Labour, Business
will increase by 0.7 percent this year and remain unchanged               Sector
thereafter (see Diagram 97).                                              Balances, quarterly values
                                                                          40                                                             40




Limited Demand for Labour                                                 30                                                             30


The number of hours worked in the business sector is continu-
ing to decrease this year, particularly in manufacturing, and de-         20                                                             20
mand for labour is low. According to the latest Business Ten-
dency Survey, there is no shortage of labour at firms (see Dia-
gram 98), and the number of new vacancies reported to em-                 10                                                             10

ployment offices is decreasing. The output tendency will be
weak in the second half of this year as well. In the business sec-
                                                                           0                                                             0
tor, the number of hours worked is expected to decrease by                       91         93      95     97        99    01      03

1.4 percent this year, while the decrease for the economy as a            Note: Proportion of firms, weighted by industry, re-
                                                                          porting shortages in Business tendency Survey.
whole will be limited to 1.0 percent.                                     Source: NIER.
    Average hours worked, measured as the number of hours
worked per employed individual, has decreased in recent years.            Diagram 99 Components of Average Hours
To some extent, this tendency is due to reduction in the normal           Worked
                                                                          Contribution to average hours worked, percentage
number of hours worked and to the day of the week on which                points
public holidays have fallen, as well as the decrease in overtime           1.5                                                          1.5

because of the weak economy. The main reason, however, is the
                                                                           1.0                                                          1.0
rise in sickness absence (see Diagram 99). Adjusted for the tim-
ing of public holidays, average number of hours worked is ex-              0.5                                                          0.5

pected to increase when the demand for labour rises, and there-
                                                                           0.0                                                          0.0
after to remain unchanged.
    In the business sector, the lacklustre increase in output is          -0.5                                                          -0.5

leading to reduction of the labour force this year. Employment
                                                                          -1.0                                                          -1.0
is forecast to drop by 10 000 persons, or 0.4 percent. For the                         99                        01
                                                                                       Overtime
economy as a whole, employment will remain constant because                            Negotiated work hours
of expansion in the general-government sector.                                         Sick leave
                                                                                       Public holidays
                                                                                       Vacation hoidays, etc.

                                                                          Source: Statistics Sweden.
56 Labour Market, Resource Utilization and Prices




                                                           Table 20 Key Numbers for the Labour Market
                                                           Level in thousands of persons and annual percentage change
                                                                                                   2002    2002    2003    2004 2005
                                                                 1
                                                           GDP                                     2 340     1.9     1.3      2.4    2.7
                                                           Productivity                                      3.1     2.3      1.8    2.2
                                                                                    2
                                                           Number of hours worked                  6 885    –1.2    –1.0      0.7    0.5
                                                           Number of persons at work               3 517    –0.6    –0.1      0.2    0.5
                                                           Number of persons absent                 727      3.6     0.5     -0.5   -0.5
                                                           Average hours worked                             –1.3    –0.9      0.6    0.1
                                                           Number of persons employed              4 244     0.1     0.0      0.1    0.4
                                                                          3
                                                           Unemployment                              176     4.0     4.7      4.6    4.3
                                                           Unemployment according to the ILO
                                                                      3, 4
                                                           definition                                233     5.2     5.5      5.4    5.1
                                                           Expanded unemployment                    305      6.7     6.9      6.8    6.5
                                                           Number of persons in labour-market
                                                                       4
                                                           programmes                                117     2.6     2.2      2.0    2.0
                                                                                        5
                                                           Regular-employment ratio                         78.1    78.0    77.7    77.5
                                                           1 Billions of SEK. 2 Millions of hours.
                                                           3 Level and percentage of the labour force.
                                                           4 The ILO’s definition also includes those persons who are able and willing to
Diagram 100 Regular Employment Ratio
Percent of population aged 20-64                           work but are also studying full-time.
                                                           5 Proportion employed of the population aged 20–64, excl. persons in labour-
80                                                    80
                                                           market employment programmes.
79                                                    79   Sources: Statistics Sweden, Labour Market Board and NIER.
78                                                    78

77                                                    77   The demand for labour will not increase until early in 2004. The
                                                           number of hours worked is forecast to rise by 0.7 percent in
76                                                    76
                                                           2004 and 0.5 percent in 2005. To a significant extent, however,
75                                                    75
                                                           the increase in 2004 will be due to a greater number of working
74                                                    74   days than in the current year. In 2003 and 2004, the so-called
73                                                    73
                                                           employment subsidy will contribute to increased employment in
         93 94 95 96 97 98 99 00 01 02 03 04 05            the local-government sector.
           Regularly employed, aged 20-64
           Employment target

Sources: Statistics Sweden and NIER.
                                                           The Employment Target Will Not Be Met

                                                           Government and Parliament have set the target of regular em-
Diagram 101 Empoyment Ratio for Various                    ployment for 80 percent of the population between the ages of
Ages                                                       20 and 64 by 2004.8
Percent
                                                               Last year, about 4.09 million persons in this age group were
100                                               100
                                                           employed, for an employment ratio of 78.1 percent. In 2004 the
                                                           employment ratio is expected to decrease to 77.5 percent, short
 80                                               80
                                                           of the target by about 125 000 persons (see Diagram 100).
                                                               The weak economy is the primary reason for the decreasing
 60                                               60
                                                           employment ratio. In a somewhat longer-term perspective, the
                                                           employment ratio is influenced by changes in the age distribu-
 40                                               40
                                                           tion of the population. The population is increasing in the
                                                           youngest and oldest age groups, where the employment ratio is
 20                                               20
                                                           relatively low (see Diagram 101 and Diagram 94). It is estimated
                                                           that demographic changes will reduce the employment ratio by
     0                                            0
         20 24 28 32 36 40 44 48 52 56 60 64               0.1 percentage point annually for the next few years. Thus, the
                         Age
Source: Statistics Sweden.                                 8 Persons participating in labour-market employment programmes are not
                                                           regarded as regularly employed.
                                                                Labour Market, Resource Utilization and Prices 57




demographic trend will make it more and more difficult to                Diagram 102 Number Employed, Labour force
achieve an employment ratio of 80 percent.                               and Unemployment Rate
                                                                         Millions and percent, seasonally adjusted quarterly
                                                                         values
                                                                         4.80                                                     10

Unemployment to Continue Rising for the Rest of                          4.60                                                     8
the Year
                                                                         4.40                                                     6
According to the Labour Force Surveys (LFS) of Statistics Swe-
den, the unemployment rate in the second quarter was 4.7 per-            4.20                                                     4
cent, adjusted for normal seasonal variations. The unemploy-
ment rate is forecast to continue rising until the end of 2003,          4.00                                                     2

when it will reach 4.9 percent. The increase will be due partly to
declining employment and partly to the expected decrease in the          3.80
                                                                                90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05
                                                                                                                                  0

number of participants in labour-market programmes. Employ-                         Employed
                                                                                    Labour force
ment will not begin to recover until next year; unemployment                        Unemployment rate (right)

will then recede in 2004–2005. The unemployment rate is fore-            Sources: Statistics Sweden and NIER.
cast to be 4.2 percent at the end of 2005 (see Diagram 102 and
Table 20).
                                                                         Diagram 103 Traininig Programmes and Full
    The so-called expanded unemployment rate is defined as un-           Time Students Latently Seeking Employment
employment plus persons potentially seeking of employment.               Thousands, seasonally adjusted quarterly values
One of its uses is in estimating the degree of resource utilization       180                                                     180

in the Swedish economy. Those potentially seeking employment              160                                                     160
are persons who are able and willing to work but who are study-
                                                                          140                                                     140
ing full-time or who have not looked for work in the past month
and thus do not meet the LFS definition of unemployed. Ap-                120                                                     120

proximately 45 percent of this group are full-time students,              100                                                     100
many of whom are participating in labour-market training pro-
                                                                           80                                                     80
grammes. In 2003 and at the outset of 2004, when the number
of places in training programmes will be reduced, the number of            60                                                     60

full-time students who are latent seekers of employment is ex-             40                                                     40
                                                                                  96        98       00         02     04
pected to decrease to a corresponding degree (see Diagram 103).                        Training programmes
    The other group potentially looking for work, persons who                          Full-time students

are able and willing to work but did not look for work during            Sources: Statistics Sweden, Labour Market Board
                                                                         and NIER.
the week when the survey was taken, usually diminishes when
the labour market improves. Many of these persons then begin
to look for employment and thus become officially employed or
unemployed. All factors considered, the number of persons
potentially seeking employment is expected to decrease during
the forecast period. The expanded-unemployment rate will thus
drop from 6.9 percent this year to 6.5 percent in 2005.



Resource Utilization


Low Level of Resource Utilization

The first half of this year was marked by rising unemployment,
fewer new unfilled vacancies and a high number of announced
layoffs. In large portions of the economy, resource utilization is
58 Labour Market, Resource Utilization and Prices




Diagram 104 Principal Obstacle to Increasing              low. According to the latest Business Tendency Survey, the
Output, Manufacturing and Construction                    principal limitation on the output of firms is weak demand, not
Balances, seasonally adjusted quarterly values
100                                                100
                                                          the availability of labour or other factors of production (see
                                                          Diagrams 104 and 105). Moreover, a decreasing number of firms
                                                          are reporting a shortage of labour; the proportion is now as low
 50                                                50
                                                          as in the early 1990’s (see Diagram 98).
                                                              With resource utilization and demand at their current levels,
   0                                               0      firms are expected to trim their work forces further. To a large
                                                          extent, it is considered possible to meet the expected gradual rise
 -50                                               -50    in demand with the current labour force. Thus, the employment
                                                          tendency will remain relatively weak in 2003 and early in 2004.
                                                          In the business sector, employment will not increase until the
-100                                               -100
       91       93      95     97      99     01          second half of 2004.
            Manufacturing
            Construction

Note: Balances = restrictions on supply – restric-
tions on demand.
Source: NIER.
                                                          Output Gap Near Zero at the End of 2005

                                                          The concise picture of resource utilization in the economy is
Diagram 105 Principal Obstacle to Increasing
Output, Commissioned Assignments and
                                                          provided by the so-called output gap. The output gap is defined
Computer Services                                         as the difference between actual and potential output, i.e. the
Balances, seasonally adjusted quarterly values
                                                          level of output compatible with a stable rate of inflation.
100                                                100
                                                              The output gap can be divided into a labour-market gap and
                                                          a productivity gap. The labour-market gap reflects the difference
 50                                                50     between the actual and potential number of hours worked and
                                                          provides a picture of resource utilization on the labour market.
   0                                               0      The productivity gap indicates the difference between actual and
                                                          trend-level total factor productivity, and is a measure of the
                                                          cyclical portion of the level of productivity.
 -50                                               -50
                                                              Both aggregate output and the demand for labour are cur-
                                                          rently low in relation to their trend levels.
-100                                               -100
       91       93      95     97      99     01
            Other business activities
            Computer and related activities               Table 21 Potential Employment and Output
Note: Balances = restrictions on supply – restric-        Level in thousands of persons and annual percentage change
tions on demand.
Source: NIER.                                                                                     2002    2002   2003    2004    2005
                                                          Labour force                            4 421    0.1     0.7     0.1     0.0
Diagram 106 Employment                                                                    1
Millions, seasonally adjusted quarterly values            Latent seekers of employment             128     0.2    –0.3     0.1    –0.1
4.50                                               4.50   Potential employment                    4 256    0.4     0.4     0.1    –0.1
                                                          Potential average hours worked                  –1.1    –0.7    –0.2    –0.1
4.40                                               4.40                                       2
                                                          Potential number of hours worked        6 987   –0.8    –0.4    –0.1    –0.1
4.30                                               4.30   Potential labour productivity                    2.6     2.2     2.1     2.2
                                                          Potential output                        2 355    1.9     1.8     2.0     2.1
4.20                                               4.20
                                                          1Contribution to expanded labour force.
4.10                                               4.10   2Millions of hours.
                                                          Note: The calculations are corrected for differences between years in the num-
4.00                                               4.00   ber of working days.
                                                          Sources: Statistics Sweden and NIER.
3.90                                               3.90

3.80                                               3.80
       80 82 84 86 88 90 92 94 96 98 00 02 04
            Actual
                                                          Potential output is determined by the supply of labour, the func-
            Potential                                     tioning of the labour market, productivity and capital formation.
Sources: Statistics Sweden and NIER.                      Potential employment is calculated as the difference between the
                                                                           Labour Market, Resource Utilization and Prices 59




expanded labour supply and the assumed equilibrium level of                         Diagram 107 Number of Hours Worked
                                                                                    Billions, seasonally adjusted quarterly values
expanded unemployment.
                                                                                    1.80                                                1.80
    It is estimated that this year and next year some 30 000 more
persons on average could be employed without straining the
                                                                                    1.75                                                1.75
labour market (see Diagram 106). However, the increase in the
potential labour supply and the potential number of hours                           1.70                                                1.70
worked will be limited throughout the forecast period by a con-
tinued rise in the number of sick persons outside the labour                        1.65                                                1.65
force. As a result, the tendency in the potential number of hours
worked will be weak (see Diagram 107). Rising ill-health will                       1.60                                                1.60

thereby reduce potential GDP growth by an annual average of
0.3 percentage points per year in 2000–2005. In the period                          1.55
                                                                                           80 82 84 86 88 90 92 94 96 98 00 02 04
                                                                                                                                        1.55

2002–2005, potential output is consequently estimated to in-                                    Actual
                                                                                                Potential
crease by average of only 1.9 percent per year.
                                                                                    Sources: Statistics Sweden and NIER.
    The expanded-unemployment rate is forecast at 6.9 percent
for this year, dropping to 6.5 percent in 2005. This yields a la-
bour-market gap of about –0.4 percent that will gradually close
during the forecast period (see Table 22). At the same time,
                                                                                    Diagram 108 Labour Market and Productivity
growth in productivity is expected to exceed its potential rate.                    Gaps
The currently negative productivity gap will thus close gradually                   Percent of potential GDP, quarterly values

and turn slightly positive in 2005. The output gap, that is, the                     4                                                    4

sum of the two gaps, will thus close around the end of 2005 (see
                                                                                     2                                                    2
Diagrams 108 and 109).
                                                                                     0                                                    0

Table 22 Output Gap
Percent of potential GDP and percent                                                -2                                                    -2

                                   2002        2003        2004        2005
                    1
                                                                                    -4                                                    -4
Actual GDP growth                    1.9         1.4         2.2         2.7
Labour-market gap                   –0.2        –0.4        –0.4        –0.2
                                                                                    -6                                                    -6
Productivity gap                    –0.1        –0.3        –0.2         0.0             90     92     94    96    98    00   02   04
Output gap                          –0.3        –0.7        –0.6        –0.1                  Labour-market gap
                                                                                              Productivity gap

                                                                                    Source: NIER.
Output gap according to the
SVAR model                          –0.8        –1.1        –0.7         0.0
Note: The calculations are corrected for differences between years in the num-
ber of working days.
                                                                                    Diagram 109 Output Gap
Source: NIER.                                                                       Percent of potential GDP, quarterly and yearly val-
                                                                                    ues, respectively
                                                                                     4                                                    4
The NIER’s overall assessment of resource utilization is consis-
tent with the picture provided by the so-called SVAR model,                          2                                                    2
which was presented in The Swedish Economy – December 2002. All
factors considered, it is estimated that resource utilization will be                0                                                    0

relatively low throughout the forecast period, thus restraining
the development of prices and wages.                                                -2                                                    -2


                                                                                    -4                                                    -4


                                                                                    -6                                                    -6
                                                                                         90     92     94    96    98    00   02   04
                                                                                              Production-function approach
                                                                                              SVAR model

                                                                                    Source: NIER.
60 Labour Market, Resource Utilization and Prices




Diagram 110 Hourly Earnings
Annual percentage change, monthly values
                                                   Wages and Labour Costs
7                                              7

6                                              6

5                                              5   Modest Wage Increases This Year
4                                              4
                                                   The average increase in hourly earnings in the Swedish economy
3                                              3   is beginning to slacken. According to preliminary calculations, in
2                                              2
                                                   which wage increases are often underestimated, the annual rate
                                                   of increase for the first five months of this year was 3.1 percent.
1                                              1
                                                   Of this increase, an estimated 2.1 percentage points were pro-
0                                              0   vided by negotiated settlements, while wage drift accounted for
    97              99          01
      Hourly earnings                              1.0 percentage point (see Diagram 110). However, the boundary
      Wage drift
                                                   between negotiated wage increases and wage drift is often un-
Note: 3-month moving average.
Sources: National Mediation Office and NIER.
                                                   clear since collective-bargaining agreements now provide for
                                                   more local wage formation and more central settlements that do
                                                   not specify wage increases in figures. The relatively low prelimi-
                                                   nary outcome indicates that the rate of wage increases is con-
                                                   tinuing to decline, particularly in manufacturing. Retroactive
                                                   additional payments of wages and salaries are expected, espe-
                                                   cially in the central-government and local-government sectors,
                                                   where the agreements reached during the spring have not yet
                                                   been included in the statistics.
                                                       The Labour Cost Index (LCI) for the business sector rose by
                                                   3.4 percent during January–May this year compared to the same
                                                   period in 2002.9 In addition to hourly earnings, this measure
                                                   includes compensation for time not worked, such as public-
                                                   holiday pay, sick pay and vacation-holiday pay. Also included is
                                                   the cost of other cash compensation as well as legislated and
                                                   negotiated employer contributions. One principal reason why
                                                   the LCI has risen more than hourly earnings is that negotiated
                                                   employer contributions have increased.


                                                   The Labour Negotiations in 2004

                                                   In the spring of 2004, the collective-bargaining agreements for
                                                   the major portion of the labour market will expire, and negotia-
                                                   tions will begin in the autumn of 2003. To some extent, the new
                                                   round of negotiations has already been led off by the Municipal
                                                   Workers’ Union with the settlements for 2003 and 2004 after the
                                                   strike this spring. The settlements provide for relatively modest
                                                   wage increases in the second year covered; which may have a
                                                   certain normative and moderating effect on the labour negotia-
                                                   tions in 2004.
                                                       A starting point for forecasting the outcome of the 2004 la-
                                                   bour negotiations is to compare the situation at that time with

                                                   9 According to Statistics Sweden, the LCI for the first half of 2002 was

                                                   calculated on the basis of erroneously high negotiated employer contributions
                                                   for salaried employees. Here an adjustment has been made for this error,
                                                   resulting in a rate of increase of 3.4 percent in the LCI.
                                                                 Labour Market, Resource Utilization and Prices 61




the one in 2001, when the last major round of negotiations was            Diagram 111 Shortage of Labour According to
held. The 2001 agreements were reached in a strong economy                Business Tendency Survey, Manufacturing
                                                                          Proportion of firms, quarterly values
where employment had been rising rapidly for three years. The             40                                                         40
current state of the economy is considerably weaker, with a
more limited labour shortage, for example (see Diagrams 111
                                                                          30                                                         30
and 112). Inflation is anticipated to remain modest throughout
the forecast period, and the expectations of the labour-market
parties concerning wages are lower now than they were late in             20                                                         20

2000 and early in 2001, i.e. just before and during the previous
labour negotiations (see Diagram 113). One factor that may tend           10                                                         10
to increase wage demands is that the income-tax cuts in 2000–
2002 will be followed by higher local-governments taxes this
                                                                           0                                                         0
year and next year.                                                                91       93       95       97     99     01
                                                                                        Technical employees
    In the forecast it is assumed that Sweden will vote ”yes” to                        Skilled labour
the euro and that the krona will be linked to the ERM2 at a rate          Source: NIER.
of SEK 9.00 per euro. This implies a considerably stronger
krona than at the outset of 2001, a factor that should have a
restraining effect on the rate of wage increases. Other relevant
                                                                          Diagram 112 Shortage of Labour According to
circumstances that may tend to moderate the rate of wage in-              Business Tendency Survey, Service Sector
creases are that the ECB’s inflation target is lower than the             Proportion of firms, quarterly values

Riksbank’s, and that the more limited wage increases in the euro          100                                                    100

zone would have a greater normative effect than in the 2001                80                                                    80
round of negotiations. On the other hand, the Riksbank will be
less able to respond to excessive wage increases with a tighter            60                                                    60

monetary policy, a change that could contribute to a higher rate
                                                                           40                                                    40
of wage increases.
    All factors considered, the settlements for 2004 and 2005 are          20                                                    20
expected to be somewhat lower than those reached in 2001. In
the business sector, the negotiated wage increases are forecast to             0
                                                                                   91 92 93 94 95 96 97 98 99 00 01 02
                                                                                                                                 0

average 2.0 percent for 2004 and 2005, compared to the annual                            Computer and related activities
                                                                                         Other business activities
average negotiated settlements of 2.4 percent for 2001 and 2002.                         Durable goods trade
                                                                                         Wholesale trade

                                                                          Source: NIER.

Wages Increasing More Slowly in the Business Sec-
tor
                                                                          Diagram 113 Expected Wage Increases in the
The labour-market situation in the business sector as a whole weak-       Next Two Years
                                                                          Annual percentage change, quarterly values
ened further in the first half of this year. Particularly in manufac-     4.5                                                    4.5
turing, the demand for labour is low, and employment has con-
tinued to decrease (see Diagram 114). According to the Business
                                                                          4.0                                                    4.0
Tendency Survey, there have been further downward revisions
in the hiring plans of firms, and the number of layoff notices so
far this year has been somewhat greater than for the same period          3.5                                                    3.5

in 2002. The business outlook in manufacturing is expected to
improve to some extent during the autumn, but employment is               3.0                                                    3.0
not expected to start rising until the middle of 2004. According
to preliminary statistics for the first five months of this year, the
                                                                          2.5                                                    2.5
rate of increase in hourly earnings was 3.0 percent in manufac-                     96            98           00          02

turing, over a percentage point less than the rate last year. The                        Employers
                                                                                         Employees
construction industry presents a mixed picture this year. Although
                                                                          Source: Prospera Research AB.
building investment has increased, employment in this industry
62 Labour Market, Resource Utilization and Prices




Diagram 114 Employment, Business Sector                   remained virtually unchanged in the first half-year. The percent-
Percentage change, seasonally adjusted half-year
values
                                                          age of firms reporting labour shortages has been low, and em-
  1.0                                              1.0    ployment is expected to decrease in the coming year. However,
                                                          the rate of wage increases in the first five months is about as
  0.5                                              0.5    high as last year, and the forecast for the full year is 3.6 percent.
                                                          The employment trend in the service industries was slightly positive
  0.0                                              0.0
                                                          in the first half of this year, and the situation is still gradually
 -0.5                                              -0.5
                                                          improving. Given these circumstances, hourly earnings in the
                                                          business sector are forecast to increase by 3.3 percent this year
 -1.0                                              -1.0   (see Table 23 and Diagram 115), over half a percentage point
                                                          less than in 2002. As noted above, the negotiated wage increases
 -1.5
               02                        04
                                                   -1.5   in the business sector are forecast at 2.0 percent for both 2004
               Manufacturing                              and 2005. As a consequence, hourly earnings in the business
               Construction
               Service industries                         sector are expected to rise by 3.4 percent in 2004 and, owing to a
Sources: Statistics Sweden and NIER.                      somewhat stronger economy, by 3.6 percent in 2005.

                                                          Table 23 Hourly Earnings and Negotiated Settlements
Diagram 115 Hourly Earnings, Business Sec-                Annual percentage change
tor
Annual percentage change, quarterly values                                     2002        2003          2004          2005
                                                                               Earn-   Earn- Settle- Earn- Settle- Earn- Settle-
 6                                                   6
                                                                               ings    ings ments ings ments ings ments
                                                          Manufacturing         4.1     3.2    2.2       3.3   2.1   3.6   2.1
 5                                                   5
                                                          Construction          3.7     3.6    2.5       3.6   2.1   3.7   2.1
                                                          Service industries    3.8     3.3    2.4       3.4   2.0   3.6   2.0
 4                                                   4
                                                          Business sector       3.9     3.3    2.3       3.4   2.0   3.6   2.0
 3                                                   3
                                                          Local government      4.5     4.2    2.4       3.8   2.6   3.8   2.5
                                                          Central govern-
                                                          ment                  4.3     3.7    2.2       3.6   2.1   3.6   2.0
 2                                                   2
                                                          Total                 4.1     3.5    2.3       3.5   2.2   3.7   2.1

 1                                                   1    Sources: National Mediation Office and NIER.
        98              00          02        04
             Manufacturing
             Construction
             Service industries

Sources: National Mediation Office and NIER.

                                                          Rate of Wage Increases in Local Government Re-
                                                          mains High
Diagram 116 Employment, General Govern-
ment Sector                                               Wages in local government will continue rising rapidly in 2003. Em-
Percentage change, seasonally adjusted half-yaer
values
                                                          ployment in local government was up in the first half of this year
  1.5                                              1.5
                                                          (see Diagram 116). In 2004 and 2005, however, the shortage of
                                                          labour in local government will be mitigated, and employment
                                                          will be increasing more slowly, in part because of this year’s high
  1.0                                              1.0
                                                          wage increases. Hourly earnings are expected to rise by 4.2 per-
                                                          cent this year (see Diagram 117), one reason being the relatively
  0.5                                              0.5    high wage settlements for the members of the Municipal Work-
                                                          ers’ Union. Even though the more modest settlement for next
  0.0                                              0.0    year will help to slow the rate of wage increases to 3.8 percent in
                                                          2004 and 2005, wages in local government will continue to rise
                                                          somewhat more rapidly than in the business sector.
 -0.5                                              -0.5
               02                        04                   In the central government, employment is expected to increase
               Local government
               Central government                         in 2003, to stabilize thereafter and then to start decreasing once
Sources: Statistics Sweden and NIER.
                                                                 Labour Market, Resource Utilization and Prices 63




more in 2005. The rate of wage increases is forecast to be 3.7            Diagram 117 Hourly Earnings, General Gov-
                                                                          ernment Sector
percent this year and only marginally less in 2004 and 2005.              Annual percentage change, quarterly values
                                                                              6                                                                 6


                                                                              5                                                                 5
Weaker Increases in Hourly Earnings Throughout
the Economy                                                                   4                                                                 4


The overall forecast is that hourly earnings in the economy as a              3                                                                 3

whole will increase by 3.5 percent this year (see Diagram 118).               2                                                                 2
Negotiated settlements are expected to account for 2.3 percent-
age points and wage drift for the remaining 1.2 percentage                    1                                                                 1

points. It is also estimated that the rate of increase will be un-            0                                                                 0
changed in 2004 and then rise to 3.7 percent in 2005.                               98             00              02        04
                                                                                         Local government
    During the period 1993–2002, consumer real wages, i.e. the                           Central government
wages employees receive after taxes and inflation, rose by an             Note: The decrease in the first quarter of 2003 is
annual average of 1.8 percent. Product real wages, which meas-            due largely to agreements not yet shown in the sta-
                                                                          tistics.
ure the labour costs of employers in real terms, increased by 2.5         Sources: National Mediation Office and NIER.
percent (see Diagram 119) during the same period. Until 1998,
                                                                          Diagram 118 Hourly Earnings, Negotiated Set-
consumer real wages after taxes rose more slowly than product             tlements and Wage drift
real wages owing to the depreciation of the krona and to in-              Annual percentage change
creases in general individual social-security contributions. There-       5                                                                 5

after, consumer real wages went up more rapidly, partly because
of cuts in income taxes. This year, consumer real wages will no           4                                                                 4

longer be boosted by tax cuts. However, given the slow rate of
                                                                          3                                                                 3
increase in consumer prices, consumer real wages after taxes are
forecast to rise by 2.1 percent on average in 2004-2005, whereas
                                                                          2                                                                 2
product real wages will go up by only 1.4 percent.
                                                                          1                                                                 1



Substantially Higher Labour Costs in 2003                                 0
                                                                                   99              01               03            05
                                                                                                                                            0

                                                                                    Settlements
The hourly cost of labour, as measured by the Labour Cost In-                       Wage drift

dex (LCI), is forecast to rise by 4.3 percent in 2003, compared to        Sources: National Mediation Office and NIER.
3.8 percent in 2002 (see Table 24 and Diagram 124). The expla-            Diagram 119 Consumer and Product Real
nation for the higher rate of increase this year is that the negoti-      Wage
                                                                          Annual percentage change
ated employer contributions are going up for both hourly and
                                                                              8                                                                 8
salaried employees. The one-week extension of employer-
financed sick pay will increase labour costs by about 0.3 percent-            6                                                                 6

age points beginning July 1 of this year. As an estimated overall             4                                                                 4
effect, other wage costs will account for 1.0 percentage point of
                                                                              2                                                                 2
this year’s increase in labour costs. Other wage costs are ex-
pected to rise more slowly in 2004 and 2005.                                  0                                                                 0

                                                                              -2                                                                -2

Table 24 Hourly Cost of Labour                                                -4                                                                -4

Annual percentage change
                                                                              -6                                                                -6
                                                                                   93        95      97       99        01   03        05
                             2002      2003        2004        2005
                                                                                         Consumer real wage
LCI, business sector           3.8      4.3          3.7         3.8                     Product real wage

NA, business sector            6.9      4.3          3.9         3.8      Note: Consumer real wage = hourly earnings ac-
NA, total                      6.0      4.3          3.9         3.9      cording to National Accounts, exckluding direct
                                                                          taxes and individual social-security contributions,
Sources: Statistics Sweden and NIER                                       deflated by implicit-price index. Product real wage =
                                                                          hourly earnings according to National Accounts,
                                                                          including employer contributions, deflated by GDP
                                                                          deflator.
                                                                          Sources: Statistics Sweden and NIER.
64 Labour Market, Resource Utilization and Prices




Diagram 120 Labour Cost Index (LCI), Busi-                Another measure of hourly labour costs is the ratio of total earn-
ness Sector                                               ings in the National Accounts (NA) to the number of hours
Annual percentage change
5                                                 5
                                                          worked. In addition to the items included in the LCI, labour
                                                          costs in the NA include various types of supplementary earnings
4                                                 4       such as piece-rate compensation, bonuses and commissions.
                                                          This year, labour costs in the NA are expected to increase by 4.3
3                                                 3       percent both in the business sector and in the economy as a
                                                          whole. In subsequent years, however, the rate of increase will
2                                                 2       decline (see Table 24 and Diagram 121). If the Government
                                                          target of an 80-percent employment ratio is to be met, there
1                                                 1
                                                          must be a sufficiently high and flexible labour supply, a require-
                                                          ment that imposes considerable demands on labour-market,
0                                                 0
        99               01    03            05           educational, social and health policies. Another requirement is
         Hourly wage
         Other wage costs                                 that labour costs in the next few years increase more slowly than
Sources: Statistics Sweden and NIER.
                                                          forecast. Given these conditions, the NIER’s assessment is that
                                                          for the national economy, an appropriate rate of increase in
                                                          labour costs in the next few years would be 3.5 percent.10
Diagram 121 Labour Costs (NA), Total and in
Business Sector
Annual percentage change
                                                          Labour Costs in the Euro Zone
8                                                 8

                                                          In the euro zone, hourly labour costs in the business sector in-
6                                                 6       creased by 3.7 percent last year (see Diagram 122). In the first
                                                          quarter of this year, the cost increases were significantly lower –
                                                          2.7 percent. Although this low outcome is preliminary and based
4                                                 4
                                                          in part on temporary factors, it appears that the weak economic
                                                          tendency in the euro zone has had an impact on cost increases.
2                                                 2       Employment in the euro zone is rising primarily in the services
                                                          sector. Nevertheless, unemployment has gone up and is almost
0                                                 0       0.5 percentage point higher than last year. The cost increases in
        99               01    03            05
         Total
                                                          the euro zone are expected to slacken somewhat in the next few
         Business sector                                  years because of a weak economic tendency and rising unem-
Sources: Statistics Sweden and NIER.                      ployment. For 2003–2005, it is estimated that labour costs in the
                                                          business sector will rise by an average annual of 3.4 percent, a
                                                          rate less than the labour-cost increases of 4.3, 3.9 and 3.8 per-
Diagram 122 Labour Costs, Business Sector                 cent, respectively, forecast for the Swedish business sector in
Annual percentage change, quarterly values
                                                          2003–2005.
    8                                                 8
                                                              One widely used measure of the competitiveness of different
    7                                                 7   countries is their relative labour costs per unit of output, ex-
    6                                                 6
                                                          pressed in a common currency. This measure takes into consid-
                                                          eration the tendency in labour costs and productivity as well as
    5                                                 5
                                                          the exchange rate. Relative to the euro zone, cost levels in Swe-
    4                                                 4   den decreased markedly when the krona weakened in the early
    3                                                 3
                                                          1990’s (see Diagram 123). Since the mid-1990’s, the country’s
                                                          relative costs have increased somewhat, but are still low even
    2                                                 2
                                                          when compared to the mid-1980’s. In the euro zone, the pro-
    1
         96               98   00            02
                                                      1   ductivity trend has recently begun to recover; this development,
             Euro Zone                                    together with moderately rising labour costs, will help to limit
             Sweden
                                                          the upward progression of unit labour costs in the euro zone. In
Note: The Swedish cost of labour per hour is meas-
ured according to the Eurostat definition. The Swe-
dish series resembles the Swedish LCI.
Source: Eurostat.                                         10   See Wage Formation – Economic Conditions in Sweden 2002, NIER 2002
                                                                  Labour Market, Resource Utilization and Prices 65




view of the stronger increases in Swedish labour costs and an              Diagram 123 Relative Unit Labour Cost, Busi-
appreciation of the krona, unit labour costs are expected to rise          ness Sector – Sweden in Relation to Euro
                                                                           Zone
somewhat more rapidly in Sweden than in the euro zone during               Index, 1980=100
the forecast period.                                                            130                                                     130

                                                                                120                                                     120

                                                                                110                                                     110
Inflation                                                                       100                                                     100

                                                                                 90                                                     90

                                                                                 80                                                     80
Inflation Rate Gradually Decreasing in 2003
                                                                                 70                                                     70

The monetary-policy target of the Riksbank is to limit inflation                 60                                                     60
                                                                                      80 82 84 86 88 90 92 94 96 98 00 02 04
to 2 percent with a tolerance of 1 percentage point for devia-                              Common currency
tions from this rate. CPI inflation exceeded the upper tolerance                            National currency

limit of 3 percent late in 2002 and early in 2003, but then sub-           Sources: OECD, EcoWin and NIER.

sided quickly (see Diagram 124). The high rate of inflation last
winter was due to price increases in electricity and oil. An au-
                                                                           Diagram 124 CPI Excluding Certain Goods
tumn with little rain and a cold winter sent prices soaring on the         Annual percentage change, monthly values
electric-power exchange. The price of electricity to consumers              4                                                           4

has also risen substantially, and in July it still accounted for 1
percentage point of the CPI inflation rate. The increase in the             3                                                           3

price of oil was due largely to the conflict in Iraq. Unlike the
                                                                            2                                                           2
price of electricity, the price of oil has receded from its high
levels as uncertainty about the geopolitical situation has dimin-
                                                                            1                                                           1
ished. This development has helped to reduce the prices of fuel
and heating oil, thus contributing to a lower rate of inflation.            0                                                           0
Aside from wide variations in certain energy prices, underlying
inflationary pressure is currently regarded as modest because of           -1                                                           -1
                                                                                      98                   00                  02
weak growth and the low level of resource utilization.                                CPI
    One way of calculating the underlying rate of inflation is to                     CPI excl. electricity, heating oil, fuel (8,7%)

exclude certain categories of goods that are found to deviate              Sources: Statistics Sweden and NIER.
from the general inflation trend, particularly if inflation is due to
disturbances in supply. In the current situation, it is reasonable
to exclude prices of electricity and oil, which have recently fluc-
tuated strongly. Thus measured, the underlying inflation rate was          Diagram 125 Measures of Underlying Inflation
                                                                           Annual percentage change, monthly values
only 0.8 percent in July (see Diagram 124). Measures of underly-
                                                                                4                                                            4
ing inflation can also be derived with statistical models. A cen-
tred mean can be calculated by excluding from the CPI those                     3                                                            3
categories of goods with the largest and smallest price increases.
Another statistical method is to change the weights of items                    2                                                            2

included in the CPI so that categories of goods with normally
                                                                                1                                                            1
wide price fluctuations are given lower weights than categories
with more stable prices (see Diagram 125). Also by these meas-
                                                                                0                                                            0
ures, the conclusion is that the underlying rate of inflation has
dropped well below 2 percent.                                                   -1                                                           -1
                                                                                       98                   00                   02
    To provide a fairer comparison of the inflation rates in dif-                          CPI inflation
ferent EU countries, analysts often use the so-called harmonized                           15% excluded
                                                                                           Weighted
index of consumer prices, or HICP. This index excludes certain
                                                                           Sources: Statitics Sweden and NIER.
items, such as the cost of interest on home mortgages. In 1998-
2000, the inflation rate was lower in Sweden than in the euro
66 Labour Market, Resource Utilization and Prices




Diagram 126 HICP                                                     zone. In 2002 and 2003 the inflation rate has been fluctuating
Annual percentage change, monthly values
                                                                     strongly and is now somewhat higher than the average rate in
     3.5                                                      3.5
                                                                     the euro zone (see Diagram 126).
     3.0                                                      3.0

     2.5                                                      2.5

     2.0                                                      2.0    Low Domestic Inflationary Pressure
     1.5                                                      1.5
                                                                     UNDINHX inflation, or CPI inflation excluding costs of inter-
     1.0                                                      1.0
                                                                     est, changes in indirect taxes and import-intensive goods and
     0.5                                                      0.5
                                                                     services, provides a measure of underlying domestic inflation.
     0.0                                                      0.0    The UNDINHX inflation rate subsided considerably in 2002,
     -0.5
             96            98             00        02
                                                              -0.5   from 5.0 percent in January 2002 to just below 3.0 percent to-
                  HICP, Euro Zone                                    ward year-end.
                  HICP, Sweden
                                                                         Electricity prices to consumers boosted UNDINHX infla-
Sources: Statitics Sweden and NIER.
                                                                     tion again this past winter, accounting for as much as 1.5 per-
                                                                     centage points in February. The current assessment is that prices
                                                                     of electricity will recede less rapidly in 2003 than was assumed in
                                                                     the previous forecast. Water levels in reservoirs are extremely
Diagram 127 Price of Electricity, Contribution
to CPI Inflation
                                                                     low, a condition that can lead to price increases during the au-
Percentage points                                                    tumn and winter. It is assumed, however, that from the spring of
     1.5                                                      1.5    2004 until the end of the forecast period the price of electricity
                                                                     will gradually go down, thus providing a negative contribution to
     1.0                                                      1.0    inflation (see Diagram 127).
                                                                         Rents, with a weight of about 25 percent in the UNDINHX,
     0.5                                                      0.5    are estimated to rise by 3.0 percent in 2003 and by 2.0 percent in
                                                                     both 2004 and 2005. It is assumed that rents this year will be
     0.0                                                      0.0
                                                                     boosted by increases in prices of electricity and oil.
                                                                         The output gap will not close until late in 2005; consequently,
                                                                     demand-driven inflationary pressure will remain low during the
     -0.5                                                     -0.5
                                                                     forecast period (see Diagram 109). Unit labour costs are esti-
                                                                     mated to increase by 2.0 percent in 2003 and by about
     -1.0                                                     -1.0
              01                    03               05              1.0 percent in 2004 and 2005. This tendency, too, will help to
Sources: Statistics Sweden and NIER.                                 keep domestic inflationary pressure down (see Diagram 128).
                                                                         All factors considered, domestic inflation is expected to re-
                                                                     main relatively high for the remaining months of 2003, then to
Diagram 128 Domestic Inflation and Cost                              drop to a minimum early in 2004 as the contribution of electric-
Pressure                                                             ity prices rapidly diminishes. A low level of resource utilization
Annual percentage change, monthly values
6                                                             6
                                                                     throughout the forecast period will also contribute to a modest
                                                                     rate of price increases.

4                                                             4
                                                                     Table 25 Domestic Inflation (UNDINHX)
                                                                     Annual percentage change. Annual average
2                                                             2
                                                                                                            2002   2003   2004      2005

                                                                     GDP growth                              1.9    1.3     2.5        2.7
0                                                             0
                                                                     Output gap                             –0.3   –0.7    –0.6       –0.1


-2                                                            -2     Unit labour costs                      –1.0    2.0     1.1        1.0
       95           97      99           01    03        05
            UNDINHX
                                                                     Rents                                   2.6    3.0     2.0        2.0
            Unit labour costs                                        Electricity                             6.7   21.7   –10.3       –1.6
Sources: Statistics Sweden and NIER.                                 UNDINHX                                 3.5    3.4     1.4        2.1
                                                                     Sources: Statistics Sweden and NIER.
                                                                 Labour Market, Resource Utilization and Prices 67




Subdued Rate of Imported Inflation                                        Diagram 129 Prices of Imports to Producers
                                                                          and Consumers
                                                                          Annual percentage change, monthly values
The rate of price increases for the import-intensive goods in the
                                                                           15                                                         15
CPI has varied substantially in recent months. The principal
cause has been the widely fluctuating price of oil. A stronger
                                                                           10                                                         10
exchange rate has contributed to a subdued rate of price in-
creases (see Diagram 129).                                                  5                                                         5
    Margins – i.e. the differences between prices of imported
goods to consumers and to producers – have gradually risen                  0                                                         0
somewhat this year but are still considered low.
    The continued appreciation of the krona is helping to limit            -5                                                         -5

price increases to producers for imported goods. Since the im-
pact on consumer prices is both delayed and only partial, prices          -10
                                                                                     95 96 97 98 99 00 01 02 03 04 05
                                                                                                                                      -10

to consumers will be increasing faster than to producers in 2003-                      Consumption-weighted producer prices of imports
                                                                                       Import-intensive goods in the CPI (excl. taxes)
2004. Thus, margins on imported goods will be increasing next
                                                                          Sources: Statistics Sweden and NIER.
year and to some extent in 2005 as well (see Diagram 130).
    All factors considered, the inflation rate for import-intensive
goods is forecast to be 0.4 percent in 2003, 0.1 percent in 2004
and 0.9 percent in 2005. The upward adjustment for 2003 com-              Diagram 130 Margin and Exchange Rate
                                                                          Annual percentage change, monthly values
pared to the previous forecast is due primarily to higher oil               15                                                             15
prices.
                                                                            10                                                             10

                                                                                5                                                          5
Table 26 Imported Inflation (UNDIMPX)
Annual percentage change. Annual average                                        0                                                          0

                                       2002   2003   2004      2005             -5                                                         -5

TCW index                              –1.7   –4.5    –2.4       0.4        -10                                                            -10
Prices of imports (to producers)        0.0   –2.2    –2.5       0.2
                                                                            -15                                                            -15
of which oil                           –1.5   –4.2    –9.1      –7.0
Margin                                  0.7    2.7     2.6       0.8        -20                                                            -20
                                                                                      95        97         99   01      03       05
UNDIMPX                                 0.7    0.4     0.1       0.9
                                                                                           Margin
                                                                                           Exchange rate
Sources: Statistics Sweden and NIER.
                                                                          Sources: Statistics Sweden and NIER.




Low Inflationary Pressure During the Forecast Pe-
riod

Both domestic inflation and inflation in prices of import-
intensive items have contributed to an upward revision of
underlying inflation (UND1X) compared to the forecast in June.
The goods and services in the UNDINHX carry a weight of 67
percent in the UND1X aggregate, with import-intensive goods
and services accounting for the rest. The UND1X inflation rate
is forecast to average 0.9 percent in 2004, rising thereafter to 1.7
percent in 2005.
    CPI inflation is expected to be somewhat higher than
UND1X inflation toward the end of the forecast period, primar-
ily because of higher costs of interest, which are not included in
UND1X inflation. The rising costs of interest will be a conse-
68 Labour Market, Resource Utilization and Prices




Diagram 131 CPI and UND1X                                             quence of the anticipated repo-rate hikes during the latter part of
Annual percentage change, monthly values
                                                                      the forecast period (see Diagram 131).
4                                                              4
                                                                          The inflation rate is heavily influenced by the tendency of
                                                                      energy prices during the forecast period. This year the Riksbank
3                                                              3
                                                                      has been emphasizing that its monetary-policy assessments are
2                                                              2
                                                                      not influenced by temporary price effects except when these
                                                                      might cause repercussions elsewhere in the economy. In other
1                                                              1      words, monetary policy is to be guided by a measure of inflation
                                                                      from which energy prices have been removed. CPI inflation
0                                                              0      excluding costs of interest, electricity, heating oil and fuel is
                                                                      similar to the measure used by the Riksbank. The inflation rate
-1
        98            00             02            04
                                                               -1     thus calculated will be less than 2 percent in 2003 and 2004, but
             CPI                                                      will gradually rise to 2 percent in 2005, when the economy has
             UND1X
                                                                      improved (see Diagram 132).
Sources: Statistics Sweden and NIER.
                                                                          In 2004, when the effects of the increases in energy prices
                                                                      have subsided, HICP inflation in Sweden is expected to bottom
                                                                      out at a level somewhat below the corresponding measure of
                                                                      inflation in the euro zone. There, as in Sweden, inflation is fore-
Diagram 132 Inflation Rate Excluding Cost of
Interest and Fuel                                                     cast to be 1.7 percent in 2005 (see Table 3).
Annual percentage change, monthly values
     3.5                                                       3.5
                                                                      Table 27 Consumer Prices
     3.0                                                       3.0
                                                                      Annual percentage change
     2.5                                                       2.5
                                                                                                        2002         2003   2004   2005
     2.0                                                       2.0
                                                                      Annual average
     1.5                                                       1.5
                                                                      UNDINHX                                  3.5    3.4    1.4     2.1
     1.0                                                       1.0    UNDIMPX                                  0.7    0.4    0.1     0.9
     0.5                                                       0.5    UND1X                                    2.5    2.3    0.9     1.7
                                                                      Costs of interest (contribution
     0.0                                                       0.0
                                                                      to CPI inflation)                        0.2   –0.4   –0.2     0.4
     -0.5                                                      -0.5   Indirect taxes (contribution to
              00               02                04
                                                                      CPI inflation)                           0.1    0.2    0.1     0.0
               CPI-inflation
               CPI-inflation excl. cost of interest and fuel          CPI                                      2.4    2.0    0.7     2.0
Sources: Statistics Sweden and NIER.                                  HICP                                     2.0    2.3    0.9     1.7

                                                                      In December
                                                                      UNDINHX                                  2.8    2.6    1.7     2.3
                                                                      UNDIMPX                                  1.3   –0.9    0.9     1.1
                                                                      UND1X                                    2.2    1.7    1.3     1.9
                                                                      CPI                                      2.3    1.2    1.4     2.3
                                                                      HICP                                     1.7    1.8    1.4     1.9
                                                                      Sources: Statistics Sweden and NIER.
                                                                                                                              69




Public Finances                                                                Diagram 133 Net Lending, General Govern-
                                                                               ment Sector
                                                                               Percent of GDP
                                                                                5                                              5
Fiscal policy has been expansionary in recent years, but under
current rules it will have a restrictive effect on the development
of demand in the next few years. This year general-government                   0                                              0

net lending will be low in relation to Parliament’s target of a
2-percent surplus on average over a business cycle (see Table 28
                                                                                -5                                             -5
and Diagram 133). The tighter fiscal policy will improve net
lending, and cyclically adjusted net lending will exceed 2 percent
in 2005. From the standpoint of stabilization policy, this shift is            -10                                             -10
justified in view of the high rate of growth at a time when the
output gap is closing and the inflation rate is around 2 percent.
The high level of cyclically adjusted net lending in 2005 suggests             -15
                                                                                     80 82 84 86 88 90 92 94 96 98 00 02 04
                                                                                                                               -15

that the two-percent target for net lending could in time be ad-               Sources: Statistics Sweden and NIER.
justed upward to 2.5 percent without requiring any further cut-
backs in expenditure. If the target is adjusted upward as early as
2005, there will be no margin for unfinanced increases in expen-
diture or for tax cuts in either 2004 or 2005.

Table 28 Finances of the General Government Sector
Billions of SEK and percent of GDP, current prices
                                       2001    2002    2003    2004    2005
Revenue                                1 337   1 330   1 370   1 436   1 499
Percent of GDP                          59.0    56.8    56.6    56.6    56.3
                1
 of which taxes                        1 225   1 212   1 253   1 312   1 369
 percent of GDP                         54.0    51.8    51.8    51.7    51.4
Expenditure                            1 233   1 305   1 361   1 406   1 449
Percent of GDP                          54.4    55.8    56.2    55.4    54.4
Net lending                              103      25       9      30      50
Percent of GDP                           4.6     1.1     0.4     1.2     1.9
1Including tax to the EU.
Sources: Statistics Sweden and NIER.


The principal reason for the improvement in net lending in the
next few years is that expenditure will be increasing more slowly
than GDP. One cause is that economic recovery will tend to
reduce expenditure on labour-market allowances etc. In addi-
tion, central-government expenditure will be held back by the
expenditure ceiling, while local-government expenditure will be
limited by the balanced-budget requirement. Furthermore, ex-
penditure related to ill-health is beginning to decrease in propor-
tion to GDP, while the upward adjustment of pensions in 2004
and 2005 will be relatively modest.
    It is estimated that the ceiling on central-government expen-
diture will be overrun by SEK 5 billion this year and 1 billion
next year if no further action is taken.
    As a consequence of the weak economy, local-government
tax revenue is increasing less rapidly than before; this develop-
ment, together with continually rising expenditure, has put local-
government finances under pressure. Local-government taxes
70 Public Finances




                                                             were raised by an average of 0.65 percentage point this year, and
                                                             an additional increase of 0.20 percentage point is forecast for
                                                             next year. Thus, local-government activity will continue to ex-
                                                             pand, and the number of persons employed in local government
                                                             will go up by about 8 000 between 2002 and 2003.
                                                                 The number of persons receiving sick pay, activity benefits or
                                                             disability benefits is continuing to increase. However, the trend
                                                             has been interrupted in cases of short-term illness, which are
                                                             now decreasing. This development may be due to the various
                                                             steps taken to make the sick-listing process more thorough and
                                                             precise.



                                                             Fiscal Policy


Diagram 134 Fiscal Policy                                    Shift in Fiscal Policy
Percent of GDP
  1.0                                                  3.0   Fiscal policy has been highly expansionary in recent years. Since
                                                             1998, unfinanced increases in expenditure, in addition to tax cuts
  0.0                                                  2.5   of SEK 20 billion to 40 billion, have been implemented each
                                                             year. For the period 1998–2002, these measures add up to about
 -1.0                                                  2.0
                                                             SEK 150 billion and are thus roughly equal in amount to the
                                                             programme for reforming government finances in the mid-
                                                             1990’s.11 Nevertheless, general-government net lending increased
 -2.0                                                  1.5
                                                             until 2001 because of strongly rising employment.
                                                                 In recent years, however, employment has no longer been
 -3.0                                                  1.0
        01                 03                     05         going up; this development, together with a higher number of
         Policy-dependent change in net lending
         Output gap
                                                             sick-listed persons, means that no margin is left for unfinanced
         GDP growth                                          increases in expenditure or for tax cuts. This year, general-
Sources: Statistics Sweden and NIER.                         government net lending will be less than two percent of GDP
                                                             even after adjustment for cyclical effects (see the next section).
                                                             For net lending to reach two percent when the output gap closes
                                                             in 2005, a tight fiscal policy will be required. If current rules for
                                                             taxes and transfer payments remain unchanged, fiscal policy will
                                                             be appropriately restrictive.
                                                                 Certain reforms, primarily in health and nursing care, schools
                                                             and care of the elderly and handicapped, will be implemented in
                                                             the next few years as well. But the rising trend in general-
                                                             government consumption will slacken, and transfer payments to
                                                             households will increase more slowly than nominal GDP. The
                                                             shift in fiscal policy under current rules is shown in Table 29.
                                                             The policy-dependent change in net lending is negative and will
                                                             thus stimulate demand through 2003, but will be positive begin-
                                                             ning in 2004, thereby curbing demand.




                                                             11 See also the box captioned ”Expenditure Cuts and Reforms 1994–2004” in

                                                             The Swedish Economy – March 2003.
                                                                                                                            Public Finances 71




Table 29 Fiscal Policy                                                         Diagram 135 Fiscal and Monetary Policy
Percent of GDP, current prices
                                                                                               2.5                                                          2.5
                                      2001    2002    2003    2004    2005
                                                                                               2.0                                                          2.0




                                                                               tightening
Net lending, level                      4.6     1.1     0.4     1.2     1.9
                                                                                               1.5                                                          1.5
Change, percentage points               1.1    –3.5    –0.7     0.8     0.7
Adjusted change
                  1
                                        0.2    –3.0    –0.3     0.8     0.7                    1.0                   2004                                   1.0
                                                                                                                                                  2005
of which:                                                                                      0.5                                                          0.5




                                                                               Fiscal policy
Economy-dependent                       0.5    –0.9     0.0     0.1     0.3                    0.0                                                          0.0
Policy-dependent                       –0.4    –2.0    –0.3     0.7     0.5                           2003
                                                                                               -0.5                                        2001             -0.5
1Adjusted for temporarily high business taxes in 2001 and the change in 2003                   -1.0                                                         -1.0
concerning pensions.




                                                                               expansive
Source: NIER.                                                                                  -1.5                                                         -1.5

                                                                                               -2.0                                                         -2.0
                                                                                                                                        2002
                                                                                               -2.5                                                         -2.5
The expansionary fiscal policy in 2001–2003 has been followed                                      -1.0      -0.5              0.0       0.5             1.0
                                                                                                             lower          Repo rate   higher
at a time of low resource utilization (see Diagram 134). This
                                                                               Note: By fiscal policy is meant the policy-dependent
year, fiscal policy is still slightly expansionary, while monetary             change in general-government net lending.
policy is stimulating the economy via a lower repo rate (see Dia-              Source: NIER.

gram 135). In coming years, the output gap will close; during this
time, the repo rate will be raised and fiscal policy under current
rules will become somewhat restrictive. Cyclically adjusted net
lending will end up at 2.5 percent in 2005, a level somewhat
above the surplus target. For purposes of stabilization policy,
this higher level is justified since growth will then be high, the
output gap will be closing and the inflation rate will be about
2 percent. According to the NIER’s assessment, fiscal and
monetary policies, including the anticipated central rate of SEK
9.00 to the euro, will thus be well balanced from the standpoint
of the national economy.
72 Public Finances




   EMU Rules of Fiscal Policy                                         through restrictions on national freedom of action,
                                                                      and partly through political procedures that make
   Once Sweden becomes a member of the monetary                       fiscal policy a matter of concern for the EU’s mem-
   union, domestic monetary policy can no longer be                   ber countries.
   used to stabilize the economy. Fiscal policy will then                 The Maastricht Treaty stipulates five conver-
   be the instrument that remains for countering mac-                 gence criteria that the member countries must fulfil
   roeconomic disturbances specifically affecting the                 to move to the third phase16 of the EMU, which
   Swedish economy and for achieving national targets                 includes adoption of the euro as a common cur-
   of stabilization policy. If fiscal policy is to be used            rency.17 The convergence criteria are as follows:
   as an effective means of stabilization, it is critical             • A deficit in a member country’s public finances
   that it will be conducted with margins that provide                must not exceed 3 percent of GDP.
   sufficient manoeuvring room during severe eco-                     • The consolidated gross debt of the general-
   nomic slumps. It is therefore important to provide a               government sector must not exceed 60 percent of
   set of rules and an institutional framework that will              GDP.18
   ensure a responsible fiscal policy.                                • Long-term interest rates (rates on five-year cen-
       In this box, the principal provisions of the Maas-             tral-government bonds) must not exceed by more
   tricht Treaty and the Stability and Growth Pact are                than 2 percentage points the average of the corre-
   described. In addition the reasons for fiscal-policy               sponding interest rates in the three countries with
   restrictions and a comparison of Sweden’s public                   the lowest inflation.
   finances with what is required are presented.                      • The exchange rate must be stable in relation to the
                                                                      euro for at least two years before accession to the
                                                                      monetary union.
   Fiscal Policy Targets and Norms                                    • Inflation must be no higher than 1.5 percentage
                                                                      points above the average for the three countries
   Fiscal and budgetary policy in Sweden is guided by                 with the lowest inflation.
   two overall targets: central-government expenditure                    The criteria applicable to deficits in public fi-
   must not exceed the established ceiling, and public                nances and to gross debt still apply after the transi-
   finances must show an average surplus of 2 percent                 tion to the EMU’s third phase.
   of GDP over a business cycle.12 The primary objec-                     The purpose of the Stability and Growth Pact is
   tive of these rules is to reduce Sweden’s indebted-                to ensure that member countries will continue their
   ness so that the country can afford the expenditure                efforts to observe budgetary discipline after the
   required to meet the needs of an aging population                  common currency has been adopted. The member
   and to provide a margin both for so-called auto-                   countries participating in the monetary union are
   matic stabilizers and for discretionary fiscal policy.13           committed to respecting the medium-term target of
       In addition to the ceiling on central-government
   expenditure and the budget-surplus target, fiscal
   policy is governed by commitments to the EU and
   the other member countries. The Maastricht
   Treaty14, together with the Stability and Growth
   Pact15, provides a framework for fiscal policy, partly             16 The third phase of the EMU means that the common

                                                                      currency is adopted and that responsibility for monetary policy
                                                                      is transferred to the European Central Bank. Sweden has been a
   12 Introduced in 1997 and 2000, respectively. See The Swedish
                                                                      participant in the first two phases of EMU collaboration since
   Economy – March 2003, pp. 68–72.                                   1995. These phases include ensuring the fully free movement of
   13 The automatic stabilizers can be described as the changes in    capital, institutional changes to strengthen the independence of
   tax payments and general-government expenditure that               national central banks, provisions that prohibit a central bank
   automatically occur with variations in the level of economic       from financing a deficit in public finances and budget-policy
   activity. A discretionary fiscal policy, by contrast, means that   commitments to avoid excessive deficits in public finances and
   action is taken to change tax rates and general-government         excessive indebtedness.
   expenditure for stabilization purposes.                            17 Reviews to ensure that these criteria are met are conducted
   14 The EU treaty (the Maastricht Treaty) took effect on            on the basis of reports from the Commission and the European
   1 November 1993.                                                   Central Bank (ECB).
   15 The Council of Europe (consists of the heads of state and       18 The terms ”gross consolidated debt” and “central-

   government of the EU countries) agreed on the pact at the          government debt” are defined in The Swedish Economy – March
   summit conference in Amsterdam in the summer of 1997.              2003, p. 80.
                                                                                                                          Public Finances 73




approximate balance19 (or a surplus) in public fi-                           terms-of-trade-effect,24 on the other hand, is an
nances and to submitting a stability programme to                            example of a negative consequence of an expan-
the Council and the Commission.20 The Stability and                          sionary fiscal policy that tends to worsen the situa-
Growth Pact authorizes the EU to impose sanctions                            tion of other countries. A fiscal-policy expansion in
on a participating member country that fails to take                         one country leads to increased demand for domesti-
the measures necessary to end a situation of exces-                          cally produced goods and services and thus to raise
sive deficits.21 The initial sanction, an interest-free                      their prices. As a result, these domestically produced
deposit22 with the Union, can be transformed into a                          items become more expensive for foreign consum-
fine if an excessive deficit is not corrected in the                         ers.
ensuing two years. This possibility of imposing for-                             The fiscal policy in one country also affects both
mal sanctions is what distinguishes the fiscal-policy                        the level of interest rates in the monetary union and
restrictions on the member countries of the mone-                            the exchange rate if the country is so large that its
tary union from the provisions applicable to the                             policies influence capital and foreign-exchange mar-
countries outside the union.                                                 kets. If an expansionary fiscal policy and growing
                                                                             government debt in a member country lead to a
                                                                             higher inflation rate in that country, this develop-
Justification for Fiscal Policy Restrictions                                 ment will cause the ECB to respond to the extent
                                                                             that the average inflation rate of the entire euro
The fundamental justification for fiscal-policy re-                          zone is increased. Thus, the other member countries
strictions in the third phase of the EMU is that                             will also be affected by a higher level of interest
national fiscal policies will then affect the other                          rates and a stronger currency.
member countries to a higher degree than if the                                  The focus of the Stability and Growth Pact on
national currency and monetary policy are retained.                          budgetary discipline in each member country can be
With largely the same interest rates in all the mem-                         regarded as a simple form of mechanism for fiscal-
ber countries of the monetary union, fiscal-policy                           policy co-ordination, in the sense that it limits a
impulses will not be dampened by interest-rate and                           country’s freedom to conducting a policy that leads
exchange-rate reactions to the same extent as out-                           to excessive deficits. At present, there is no other
side the monetary union. In the literature, these                            formal co-ordination of fiscal policy in response to
reactions are customarily referred to as ”import-                            cyclical fluctuations, for example; however, there
leakage effects” and ”terms-of-trade-effects”. 23                            are no formal obstacles to such co-ordination, ei-
    An expansionary fiscal policy leads to an in-                            ther.
crease in domestic demand and in turn to increased
imports from other countries. The size of this ”im-
port leakage” is related partly to the degree to which                       Public Finances in Sweden
the economies are open, and partly to the manner in
which fiscal-policy expansion takes place. The                               Table 30 shows general-government net lending in
                                                                             Sweden and the country’s consolidated gross debt.
                                                                                 Net lending is positive every year and hence
19 The exact meaning of ”approximate balance” is not specified;              considerably higher than the deficit limit of minus
rather, there is an assessment based on conditions in each                   3 percent of GDP.
member country in respect to the cyclical variability of general-                Consolidated gross debt according to the Maas-
government finances, the uncertainty of the forecasts, the debt
situation and the demographic trend.                                         tricht criterion was equivalent to 52.4 percent of
20 According to the same model, the countries that do not take               GDP in 2002, well below the EU’s upper limit of 60
part in the third phase of the EMU are to present a programme                percent for participation in the European Monetary
for convergence.
21 On the other hand, there are no sanctions against countries               Union.
that fail to meet the debt requirement.                                          As previously mentioned, budget policy in Swe-
22 As for amount, the deposit consists of a fixed portion
                                                                             den is guided by the expenditure ceiling and the
equivalent to 0.2 percent of GDP and a variable portion
                                                                             surplus target. Observing these two budget-policy
equivalent to 0.1 percent of GDP for each percentage point by
which the deficit exceeds 3 percent of GDP.
23 For a thorough discussion on the external and internal effects

of fiscal policy, see Stabiliseringspolitik i valutaunionen (Stabilization   24 Terms of trade are calculated as the relationship between the

Policy in the Monetary Union), SOU 2002:16.                                  export-price index and the import-price index.
74 Public Finances




   targets contributed to substantial surpluses in gen-
   eral-government finances during the international
   economic slump, giving Sweden relatively strong
   general-government finances that fulfil the conver-
   gence criteria even in a weaker economy.

   Table 30 Net Lending and Consolidated Gross
   Debt
   Billions of SEK, percent of GDP, current prices
                         2001    2002   2003   2004   2005
   Net lending            103      25      9     30     50
   Percent of GDP          4.6    1.1    0.4    1.2    1.9
   Consolidated gross
   debt                  1 232 1 227 1 277 1 313 1 323
   Percent of GDP         54.4   52.4   52.8   51.8   49.6
   Source: NIER.
                                                                                                                Public Finances 75




Fiscal and Budget Policy Targets


Improvement in Cyclically Adjusted Net Lending

The economy is currently soft, with a low level of resource utili-
zation, limiting the revenue of the general-government sector
from employer contributions and income taxes. At the same
time, expenditure for unemployment is relatively high. These
conditions hold net lending down.
    Cyclically adjusted net lending is a measure of what general-
government net lending would have been under current rules
with a normal level of resource utilization and a normal compo-
sition of GDP. Parliament’s net-lending target is a surplus of 2
percent of GDP over a business cycle. Cyclically adjusted net
lending can be used to evaluate the surplus target, but in princi-
ple, if an active stabilization policy is followed, it will be less than
2 percent of GDP in an economic downturn and greater than 2
percent of GDP in an economic upturn.

Table 31 Cyclically Adjusted Net Lending
Percent of GDP
                                      2001     2002    2003    2004    2005
Actual net lending                       4.6     1.1     0.4     1.2        1.9
Cyclically adjusted net lending          3.0     0.9     1.0     1.9        2.5
Actual primary net lending               6.5     3.0     1.7     2.4        3.0
Cyclically adjusted primary net
lending                                  4.9     2.9     2.3     3.1        3.6
Output gap                             –0.3    –0.3     –0.7    –0.6       –0.1
Note: Interest is excluded from primary net lending in order to show the
underlying tendency.                                                              Diagram 136 Actual and Cyclically Adjusted
Sources: Statistics Sweden and NIER.                                              Net Lending
                                                                                  Percent of GDP and percent of potential GDP
                                                                                     5                                                     5
This year, cyclically adjusted net lending will be less than
                                                                                     2                                                     2
2 percent of GDP. As an effect of a tighter fiscal policy, cycli-
                                                                                     0                                                     0
cally adjusted net lending will gradually improve, reaching
2.5 percent of GDP in 2005 (see Table 31 and Diagram 136).
Thus, the existing rules of the tax and transfer-payment systems                    -5                                                     -5

provide for cyclically adjusted net lending in excess of the two-
percent target.                                                                    -10                                                     -10
    This year and next year, cyclically adjusted net lending will be
higher than actual net lending because of a negative output gap
                                                                                   -15                                                     -15
and high unemployment. In 2005, the higher level of adjusted                             91     93     95     97     99     01   03   05
                                                                                              Actual net lending
net lending will be due to GDP-composition effects, with the                                  Cyclically adjusted net lending
wage component of GDP smaller than normal                                         Sources: Statistics Sweden and NIER.
76 Public Finances




Diagram 137 Difference Between Actual and                        (see Diagram 137). 25 In the long run, the wage component is
Cyclically Adjusted Net Lending                                  expected to approach its historical average, and the negative
Percent of GDP
  2.0                                                     2.0
                                                                 composition effect to disappear. Thus, actual and adjusted net
                                                                 lending will gradually converge.
  1.5                                                     1.5
                                                                     As a result of the economic downturn, general-government
  1.0                                                     1.0    net lending has also decreased in many other countries (see Ta-
  0.5                                                     0.5
                                                                 ble 32). In the Maastricht Treaty, there is a convergence crite-
                                                                 rion26 providing that the deficit in public finances must not ex-
  0.0                                                     0.0
                                                                 ceed 3 percent of GDP. Having reformed its public finances,
  -0.5                                                    -0.5   Sweden has met this criterion since 1996. However, euro coun-
                                                                 tries like France and Germany, which are governed by the same
  -1.0                                                    -1.0
          01                    03                  05           restrictions of the Stability and Growth Pact on deficits, are
              Total difference
              Composition effect                                 having problems in limiting their deficits to 3 percent.
              Effect of unemployment gap
              Effect of output gap

Note: The total difference consists of the composi-              Table 32 General Government Net Lending in Different
tion effect, the effect of the unemployment gap, the
effect of the output gap and nonrecurring effects.
                                                                 Countries
Source: NIER.                                                    Percent of GDP. Countries ranked in order of net lending in 2003.
                                                                                                     2000     2001      2002     2003      2004
                                                                 Norway                               15.0     14.8      12.8     11.3      10.7
                                                                 Finland                               6.9       5.1      4.7       3.1      2.9
                                                                 Denmark                               2.5       2.8      1.8       1.6      1.9
                                                                 Sweden                                3.4       4.6      1.1       0.4      1.2
                                                                 United Kingdom                        3.9       0.8     –1.3     –1.9      –2.2
                                                                 EU                                    0.7     –1.1      –2.0     –2.3      –2.2
                                                                 Italy                                –0.7     –2.7      –2.5     –2.4      –2.8
                                                                 Euro zone                             0.1     –1.6      –2.3     –2.5      –2.4
                                                                 France                               –1.4     –1.5      –3.2     –3.6      –3.3
                                                                 Germany                               1.1     –2.8      –3.6     –3.7      –3.3
                                                                 United States                         1.4     –0.5      –3.4     –4.6      –4.2
                                                                 Japan                                –7.4     –6.1      –7.1     –7.7      –7.8
                                                                 Sources: OECD, June 2003 and NIER.



                                                                 Further Expenditure Cutbacks Needed This Year to
                                                                 Meet the Ceiling on Central Government Expenditure
Diagram 138 Expenditure Subject to Ceiling,                      Except for interest, all expenditure of the central government
Expenditure Ceiling
Billions of SEK, current prices                                  and the national old-age pension system is subject to the ceiling
  900                                                     900    on expenditure. Expenditure covered by the ceiling will be de-
                                                                 creasing in proportion to GDP for the rest of the forecast pe-
  850                                                     850    riod (see Table 33). Among the reasons are that the rise in
                                                                 health-insurance expenditure is slowing, expenditure for unem-
  800                                                     800
                                                                 ployment compensation is decreasing and central-government
                                                                 consumption is increasing more slowly.
  750                                                     750
                                                                     The expenditure ceilings have not been overrun since their
  700                                                     700
                                                                 introduction in 1997 (see Diagram 138). For some time, how-
                                                                 ever, the risk has been clear that expenditure would exceed the
  650                                                     650
                                                                 ceiling in 2003. Steps have also been taken to limit expenditure.
         97            99            01        03
              Ceiling on central-government expenditure
                                                                 25 The method of calculating cyclically adjusted net lending is described in the
              Expenditure subject to ceiling
                                                                 box captioned ”Cyclically Adjusted Net Lending” in The Swedish Economy –
Sources: National Financial Management Authority
and NIER.
                                                                 March 2003.
                                                                 26 See the box captioned ”EMU Rules of Fiscal Policy”.
                                                                                                          Public Finances 77




Disbursements of SEK 4 billion in acreage subsidies to farmers
and portions of the EU contribution of SEK 3.2 billion were
advanced to 2002 in order to reduce expenditure in 2003. The
compensation of central-government authorities for increases in
prices and wages has been limited, and investments in infrastruc-
ture have been postponed. In addition, the period of sick pay
financed by employers has been extended from 14 to 21 days;
the replacement level for sick pay has been lowered, and the
announced increase in the ceiling on sick pay and parental-leave
allowances has been deferred.

Table 33 Ceiling on Central Government Expenditure
Billions of SEK and percent of GDP
                                     2001     2002     2003     2004     2005
Total expenditure subject to
ceiling                               786      812      827       857      879
Percent of GDP                       34.7      34.7     34.3     33.8     33.1
Ceiling on central-government
                                                                                 Diagram 139 Central Government Budgeting
expenditure                           791      812      822       856      890
                                                                                 Margin
Budgeting margin                         5        0       –5       –1       11   Billions of SEK, current prices

Note: The expenditure ceiling for 2005 has not yet been set by Parliament, but     25                                           25
is a calculation-based draft taken from the Government’s spring budget pro-
posal.                                                                             20                                           20

Sources: National Financial Management Authority and NIER.
                                                                                   15                                           15


                                                                                   10                                           10
Other measures, more of an accounting nature, include design-
ing financial support to result in reduced revenue rather than                      5                                           5
increased expenditure. Examples include the following: the em-
ployment subsidy to local government – SEK 3.9 billion this                         0                                           0

year and 3.8 billion in 2004; costs of government sheltered work                    -5                                          -5
– SEK 400 million this year and 800 million in 2004; and the
recently enacted investment subsidy for certain residential con-                   -10
                                                                                         97        99         01      03
                                                                                                                                -10

struction.                                                                       Sources: National Financial Management Authority
                                                                                 and NIER.
    Despite the steps that have been taken, expenditure is ex-
pected to overrun the ceiling by SEK 5 billion this year. The
conclusion is that further action is required before the end of
this year to keep expenditure below the ceiling (see Table 33 and
Diagram 139).
    Since some of the measures take effect on July 1, the effect
of the expenditure cutbacks will be much greater in 2004 than in
2003. It is estimated that expenditure will then exceed the ceiling
by SEK 1 billion.
    In the spring budget proposal there is a calculation-based
draft of an expenditure ceiling for 2005. In the draft, the expen-
diture ceiling is maintained at a constant level in proportion to
GDP. Expenditure subject to the ceiling is expected to be SEK
11 billion below the ceiling in 2005.
78 Public Finances




Diagram 140 Result Excluding Nonrecurring                                 More Municipalities and County Council Districts in
Revenues and Costs                                                        Financial Balance This Year
Billions of SEK, current prices
  6                                                                  6
                                                                          The Local Government Act provides that municipalities and
  4                                                                  4    county-council districts must meet a financial-balance require-
  2                                                                  2
                                                                          ment that prohibits them from showing a deficit in their budgets
                                                                          for a coming year. If a local government has a deficit, the latter
  0                                                                  0
                                                                          must be offset by an equivalent surplus within two years.
  -2                                                                 -2       Last year, 37 percent of local governments reported deficits.
  -4                                                                 -4
                                                                          The number was somewhat larger than in 2001, when 32 percent
                                                                          showed a negative result. Out of 20 county-council districts, 13
  -6                                                                 -6
                                                                          had a negative result in 2002, and for all county-council districts
  -8
           00                    02               04
                                                                     -8   as a whole the deficit was about SEK 7 billion.
            Municipalities                                                    At year-end, more municipalities and county-council districts
            County-council districts
                                                                          implemented relatively large tax increases to put their finances in
Sources: Statistics Sweden and NIER.
                                                                          order. Consequently, the average result is expected to be close to
                                                                          zero this year, with fewer local governments showing a deficit.
                                                                          This year and in the years to follow, measures to improve effi-
Diagram 141 Compensated Sick-Days                                         ciency and reduce expenditure will slow the rise in costs. In
Percentage change from preceding year, monthly
values                                                                    combination with a forecast increase of 0.20 percentage point in
  40                                                             40       local-government tax rates in 2004, the measures will mean that
                                                                          a larger proportion of municipalities and county-council districts
  30                                                             30       can be expected to achieve a positive result that year.
                                                                               The aggregate result of municipalities will be positive
  20                                                             20
                                                                          through 2004. As a consequence of reduced central-government
  10                                                             10
                                                                          subsidies, however, the result will deteriorate somewhat and turn
                                                                          negative in 2005 (see Diagram 140). The aggregate result of the
       0                                                         0        county-council districts will be negative this year but positive in
                                                                          2004 and 2005. Consequently, a majority of county-council dis-
  -10
            98                    00                   02
                                                                 -10
                                                                          tricts are expected to compensate for previous deficits, thereby
                Net, recalculated to full-time                            meeting the balanced-budget requirement in 2005.
                Full-time
                Part-time

Source: National Social Insurance Board.

                                                                          Ill Health Target Still Far Off

Diagram 142 Number of Persons Receiving
                                                                          The net number of sick-pay days compensated by the social-
Compensation for Sickness Absence, Full-                                  insurance offices is continuing to decrease (see Diagram 141),
yeaar Equivalents
Thousands
                                                                          for reasons including an increased proportion of part-time sick-
  800                                                            800      listings and fewer short-term sick-listings. The growing practice
                                                                          of prescribing part-time sick-listing indicates that the debate on
  600                                                            600
                                                                          the problems of long-term sick-listing, and awareness of these
                                                                          problems, have influenced the sick-listing process even before
                                                                          the rules have actually been changed. However, long-term sick-
  400                                                            400
                                                                          listings are continuing to go up. Almost half the cases of com-
                                                                          pensated illness in April this year concerned persons who had
  200                                                            200
                                                                          been sick-listed for more than a year.
                                                                               The number of sick-pay days compensated by the social-
       0
           93       95      97        99     01     03      05
                                                                 0        insurance offices is expected to continue decreasing slightly in
                Sick-pay and rehabilitaion benefits                       the next few years (see Diagram 142). As from July 1, the re-
                Sickness benefit (disability pension)
                Total                                                     placement level has been slightly reduced, and the period of
Source: NIER.                                                             employer-financed sick pay extended from two to three weeks,
                                                                                                                   Public Finances 79




thus lowering the cost to central government. In June, Parlia-                    Diagram 143 Compensated Sick-Days
                                                                                  Millions
ment decided to introduce a more rigorous sick-listing process
                                                                                  100                                                            100
entailing, for instance, an increase in part-time sick-listing and
co-ordinated planning through talks between the insured indi-                      90                                                            90

vidual, physicians and the social-insurance office.                                80                                                            80
    The number of approved applications for sickness and activ-
                                                                                   70                                                            70
ity benefits has decreased this year compared to the same period
last year, partly as a effect of the new rules introduced on Janu-                 60                                                            60

ary 1 this year; according to these new rules, the former sickness                 50                                                            50
pension was replaced by sickness and activity benefits. The
                                                                                   40                                                            40
number of persons receiving these benefits, however, is ex-
pected to increase by 4.6 percent this year since the number of                    30
                                                                                        93        95    97    99       01        03    05   07
                                                                                                                                                 30

benefit applications approved still exceeds the number of cases                               Compensated sick-days
                                                                                              Target
where benefits are terminated, for example because the individ-
                                                                                  Note: Number of part-time sick-days is recalculated
ual concerned has begun to receive an old-age pension.                            to full-time equivalent. The rules were changed dur-
    Overall, ill-health is continuing to increase (see Diagram                    ing the period but had previously been constant
                                                                                  between April 1998 and June 2003.
142). The cost to central government will rise by almost SEK 6.2                  Sources: National Social Insurance Board and
                                                                                  NIER.
billion, or by 7 percent, between 2003 and 2005, though expen-
diture will be decreasing slightly in relation to GDP (see Table
36).
    As indicated in Diagram 143, further steps are necessary if
the target of reducing ill-health by half is to be reached by
2008.27 The Government has also announced that new proposals
will be presented.


Goal of Reducing Number of Welfare Recipients by
Half Will Not Be Attained

Owing to a weaker labour market, the number of persons aged
20–64 and receiving social-welfare benefits has increased once
more after dropping from 140 000 to 92 000 between 1997 and
2002. During this period, employment rose strongly, and the
unemployment rate fell to about 4 percent. Subsequently, both
employment and the number of places in labour-market pro-
grammes have decreased, contributing to a renewed increase in                     Diagram 144 Number of Welfare Recipients:
the unemployment rate and thus in the number of persons on                        Full-Year Equivalent
                                                                                  Thousandsl
welfare. The goal of the Government and Parliament to reduce                        160                                                           160
the number of social-welfare recipients by half between 1999
and 2004 will not be met unless further steps are taken (see Dia-                   140                                                           140

gram 144).
                                                                                    120                                                           120


                                                                                    100                                                           100
27 The ill-health target set by the Government and Parliament means that ill
health – i.e., the number of sick-pay days – is to be halved between 2002 and        80                                                           80

2008. At the same time, the average number of approved applications for
activity and sickness benefits in 2003-2007 is to be lower than the number of        60                                                           60

approved applications for disability pensions in 2002. In regard to both sick-
listing and activity and disability benefits, the demographic trend should be        40                                                           40
                                                                                             94        96     98            00        02    04
taken into account. Since the population in 2008 will include a higher                            Welfare recipients
proportion of older persons in the labour force, it will be acceptable if the                     Target
number of persons on sick leave decreases by somewhat less than half, or if a
                                                                                  Sources: Ministry of Finance and NIER.
somewhat larger number of applications for activity and disability benefits are
granted than in 2002.
80 Public Finances




Diagram 145 Revenue, General Government                               Revenue and Expenditure of the General
Sector
Percent of GDP                                                        Government Sector
80                                                           80



60                                                           60

                                                                      Increase in Local Government Taxes
40                                                           40
                                                                      In recent years, general-government revenue28 has decreased in
20                                                           20
                                                                      relation to GDP because of income-tax cuts and less revenue
                                                                      from such sources as capital-gains and business taxes
 0                                                           0
                                                                      (see Diagram 145). This year, direct taxes as a share of GDP
      93       95      97      99        01    03      05             have been increased marginally by higher local-government taxes
           Direct taxes
           Indirect taxes                                             (see Table 34). In relation to GDP, direct taxes (income and net-
           Social-welfare conriburions
           Other revenue                                              wealth taxes) and indirect taxes (taxes on products and output)
Sources: Statistics Sweden and NIER.
                                                                      are currently at about the same levels as in 1993.
                                                                          Since the end of the 1990’s, the tax ratio29 has been decreas-
                                                                      ing because of tax cuts. This year it is 51.8 percent according to
                                                                      the National Accounts, and 52.1 percent when periodized by
Diagram 146 Tax Ratio
Percent of GDP                                                        income year (see Table 34 and Diagram 146). The increase in the
 55                                                              55   periodized tax ratio this year is due partly to higher local-
 54                                                              54
                                                                      government taxes and partly to the elimination of the special
                                                                      basic deduction for pensioners and its replacement by a taxable
 53                                                              53
                                                                      guaranteed pension. Despite a forecast increase of 0.20 percent-
 52                                                              52   age point in local-government taxes in 2004, the tax ratio will
 51                                                              51
                                                                      decline in 2004 and 2005, primarily because the principal tax
                                                                      bases will be growing more slowly than GDP.30
 50                                                              50
                                                                          The proportion of total earnings to GDP will be lower this
 49                                                              49   year than last year and is expected to decrease further in 2004–
 48                                                              48
                                                                      2005 (see Diagram 147). Household consumption expenditure in
       93        95      97      99       01    03      05
                                                                      proportion to GDP has been fairly stable since the mid-1990’s
            Tax Ratio, NA
            Tax Ratio, periodized                                     but is also anticipated to diminish somewhat in 2004 and 2005.
Sources: Statistics Sweden and NIER.                                  This tendency will limit revenue, particularly from the value-
                                                                      added tax. The declining profit trend in the business sector and
                                                                      the weakness of the stock market in recent years have brought
                                                                      both business taxes and capital-gains taxes down from their high
Diagram 147 Principal Tax Bases                                       levels in 2000 (see Diagram 148). The preliminary taxation for
Percent of GDP
                                                                      income-year 2002 indicates that the net amount of capital gains
43                                                           52
                                                                      and losses fell by about SEK 20 billion between 2001 and 2002,
42                                                           51
                                                                      equivalent to a decrease of some SEK 6 billion in tax revenue.31

41                                                           50
                                                                      28 Taxes provide roughly 90 percent of the total revenue of the general-

40                                                           49       government sector. Other revenue consists primarily of income from capital in
                                                                      the form of interest and dividends, as well as the pension contributions
                                                                      included in general-government revenue.
39                                                           48       29 The tax ratio is one of several measures of the tax burden in an economy

                                                                      and is defined as the total revenue of the general-government sector from taxes
38                                                           47       and social-security contributions as a percentage of GDP. See the box
      93       95      97      99        01    03      05
                                                                      captioned ”The NIER’s Definition of the Tax Ratio” in The Swedish Economy –
           Total earnings
           Household consumption expenditure (right)
                                                                      August 2002, pp. 73–75.
                                                                      30 Sweden’s three overwhelmingly predominant tax bases are the following: all
Sources: Statistics Sweden and NIER.                                  output produced within the borders of Sweden, all incomes of households
                                                                      resident in Sweden and all consumption within the borders of Sweden.
                                                                      31 The final taxation will be completed in early December.
                                                                                                                       Public Finances 81




With the economy recovering, household capital gains are fore-                      Diagram 148 Household Capital Gains and
cast to increase by about SEK 9 billion between 2003 and 2005.                      Taxes
                                                                                    Percent of GDP
                                                                                    6                                                                 6

Table 34 Taxes and Contributions, Periodized by Income
                                                                                    5                                                                 5
Year
Percent of GDP                                                                      4                                                                 4

                                            2001 2002 2003          2004 2005
                                                                                    3                                                                 3
Tax ratio according to NA                    54.0    51.8    51.8    51.7   51.4
                1                                                                   2                                                                 2
Periodization                                –2.2    –0.6     0.3     0.0     0.0
Periodized tax ratio                         51.9    51.2    52.1    51.7   51.4    1                                                                 1
of which:
        Household taxes and                                                         0                                                                 0
                                                                                            93       95       97       99      01       03   05
        contributions                        20.2    19.2   20.0     20.0   19.9                 Net capital gains/capital losses
        Direct business taxes                  2.7    2.6     2.6     2.6     2.6                Taxes on net capital gains/capital losses

        Employer contributions               14.7    14.8   14.7     14.6   14.5    Note: In the diagram, capital gains are shown by
        Value-added tax (VAT)                  9.1    9.5     9.4     9.3     9.3   income year. In the National Accounts, capital gains
                                                                                    are reported by tax-assessment year, i.e. one year
        Real-estate tax                        0.9    1.0     1.0     1.0     1.0   later than the income year.
        Taxes on energy                        2.4    2.5     2.6     2.5     2.4   Source: NIER.

        Taxes on alcohol and tobacco           0.8    0.8     0.8     0.8     0.7
        Other indirect taxes                   1.0    1.0     1.0     1.0     1.0
of which:
        to local governments                 15.9    16.2    16.7    16.8   16.7
        to the national pension system         6.0    6.0     5.9     5.9     5.8
        to central government                29.4    28.6    29.1    28.8   28.7
        to the EU                              0.6    0.5     0.4     0.2     0.2
1 Household and business taxes are shown in the table by income year. The
taxes included in the revenue of the general-government sector according to
the NA are different from periodized taxes since the latter are not fully perio-
dized.
Sources: Statistics Sweden and NIER.




General Government Expenditure Decreasing As a                                      Diagram 149 Expenditure, General Govern-
Share of GDP                                                                        ment Sector
                                                                                    Percent of GDP
                                                                                    80                                                            80
General-government consumption, general-government invest-
ment, transfer payments to households and businesses and in-
terest expenditure will be decreasing as a share of GDP in the                      60                                                            60

next few years. As a result, total expenditure will be about
2 percent lower in 2005 than this year (see Diagram 149 and                         40                                                            40

Table 35).
    There are several reasons for the declining proportion of ex-                   20                                                            20

penditure. Among them are the financial restrictions on local
governments (the balanced-budget requirement) and on the                                0
                                                                                            93        95      97       99      01      03    05
                                                                                                                                                  0

central government (the expenditure ceiling), which will mean                                     Transfer payments to households
                                                                                                  General-government consumption
fewer decisions to increase expenditure. Lower interest rates and                                 Other expenditure
                                                                                                  Interest
less central-government debt will cause interest expenditure to
decrease.                                                                           Sources: Statistics Sweden and NIER.
82 Public Finances




                     Table 35 Expenditure of the General Government Sector
                     Percent of GDP
                                                            2001    2002    2003    2004    2005
                     Expenditure                             54.4    55.8    56.2    55.4    54.4
                     General-government consumption          27.2    28.0    28.3    28.1    27.8
                     General-government investment            3.0     3.2     3.2     3.1     3.0
                     Transfer payments to households         18.3    18.6    19.4    19.0    18.5
                     Transfer payments to business            1.7     1.8     1.7     1.6     1.5
                     Interest expenditure                     3.2     3.2     2.5     2.3     2.2
                     Other                                    0.9     1.0     1.1     1.3     1.4
                     Sources: Statistics Sweden and NIER.


                     With the expected improvement in the labour market between
                     2003 and 2005, expenditure on labour-market benefits will be
                     lower (see Table 36). Moreover, the costs of ill-health have now
                     begun to decrease in proportion to GDP. Moreover, in 2004
                     and 2005 pensions will be indexed at a temporarily lower rate
                     than in previous years. Even when adjusted for these temporary
                     shifts in the timing of pension adjustments, and also for an im-
                     proved economy, the underlying expenditure ratio is expected to
                     decrease somewhat in the next few years.

                     Table 36 General Government Transfer Payments to
                     Households
                     Percent of GDP
                                                            2001    2002    2003    2004    2005
                     Transfer payments to house-
                     holds                                   18.3    18.6    19.4    19.0    18.5
                     Old age                                  8.5     8.6     9.2     9.0     8.8
                     Labour market                            1.5     1.5     1.6     1.5     1.4
                     Ill health                               3.5     3.7     3.9     3.8     3.8
                     Handicapped persons                      0.7     0.8     0.8     0.9     0.9
                     Children/education                       2.5     2.5     2.5     2.4     2.3
                     Social-welfare payments                  0.5     0.4     0.4     0.4     0.4
                     Other                                    1.0     1.0     1.0     1.0     0.9
                     Note: Old age = old-age pensions, negotiated pensions and housing allowances
                     for pensioners. Labour market = compensation for unemployment and allow-
                     ances for labour-market training as well as guaranteed wages. Ill health = sick
                     pay and rehabilitation allowances, activity- and disability allowances. Handi-
                     capped persons = occupational-injury insurance, compensation for cost of
                     assistance etc. Children/education = child allowances, parental insurance,
                     maintenance support and study allowances.
                     Sources: Statistics Sweden and NIER.



                     Convergence Requirements for Government Debt
                     Can Be Met

                     Central-government debt32 is increasing this year as a result of
                     the budget deficit and new principles of valuation applicable
                     beginning in 2003. In proportion to GDP, debt will increase this

                     32 Consolidated central-government debt, i.e. excluding central-government

                     holdings of its own bonds.
                                                                                                              Public Finances 83




year, but will decrease during the remainder of the forecast pe-                  Diagram 150 General Government Debt
                                                                                  Billions of SEK, and percent of GDP
riod (see Table 37 and Diagram 150).
                                                                                  80                                            1500
    Consolidated gross debt according to the Maastricht criterion
will be 52.8 percent of GDP in 2003. Since the upper limit for                    70                                            1200
participation in the European Monetary Union is 60 percent,
this criterion will be met by a substantial margin. 33                            60                                            900


                                                                                  50                                            600
Table 37 Central Government Debt and Gross Debt
Billions of SEK, current prices, and percent of GDP                               40                                            300

                                        2001    2002       2003   2004    2005
                                                                                  30                                            0
Budget balance                             39       1       –33    –36      –5         80 82 84 86 88 90 92 94 96 98 00 02 04
Provided by the Riksbank                   20                                             Central-government debt
                                                                                          Consolidaated gross debt
Transferred from National Pension                                                         Central-government debt (right)
Fund                                       69
                                                                                  Sources: Statistics Sweden and NIER.
Change in value, other                     –4     32        –24     –1      –7
Central-government debt, change         –124     –33         57     37      12


Central-government debt (con-
solidated)                              1 154   1 122   1 178     1 215   1 227
Percent of GDP                           50.9    47.9    48.7      47.9    46.0
Consolidated gross debt                 1 232   1 227   1 277     1 313   1 323
Percent of GDP                           54.4    52.4      52.8    51.8    49.6
Sources: Statistics Sweden, National Debt Office and NIER.




Net Lending of General Government Sub-
sectors
The net lending of the central government has been negative
since 2002. In the next few years, the aggregate net lending of
the municipalities and county-council districts will also be
slightly negative. Thus, the surplus in the general-government
sector will be attributable entirely to the national pension system
(see Table 38).

Table 38 Net Lending of General Government Subsectors
Percent of GDP
                                        2001    2002       2003   2004    2005
Consolidated general-
government sector                         4.6     1.1       0.4     1.2     1.9
Central government                        9.4    –0.6      –1.9    –0.8    –0.0
Municipalities                           –0.1    –0.1       0.0    –0.3    –0.3
County-council districts                 –0.1    –0.2       0.3     0.1     0.1
National pension system                  –4.6     2.0       2.0     2.1     2.1
Sources: Statistics Sweden and NIER.




33   See the box captioned ”EMU Rules of Fiscal Policy”.
84 Public Finances




Diagram 151 Net Assets in the National Pen-                             Net Assets of the National Pension System Increas-
sion System                                                             ing Again
Annual change, percent of GDP
  4                                                                4
                                                                        The net lending of the national pension system is equivalent to
  2                                                                2    about 2 percent of GDP (see Table 39). The revenue of the
                                                                        pension system normally increases at the same rate as earned
  0                                                                0
                                                                        income and is thus relatively stable in proportion to GDP. Nor
 -2                                                                -2   will there be any dramatic changes in pension expenditure in
                                                                        proportion to GDP through 2005.
 -4                                                                -4
                                                                            The higher net lending contributes to the accumulation of as-
 -6                                                                -6   sets in the national pension system, but the weakness of the
 -8                                                                -8
                                                                        stock market since March 2000 has had the opposite effect (see
       95         97        99        01           03        05         Diagram 151). The market value of the financial assets of the
            Net lending
            Change in value of financial assets                         national pension funds and the premium-pension system de-
            Total change in net financial assets
                                                                        creased by about 7 percent of GDP from 2000 to 2002, roughly
Sources: Statistics Sweden and NIER.
                                                                        equivalent to 3.5 years of net lending.

                                                                        Table 39 Net Lending of the National Pension System
                                                                        Billions of SEK, current prices, and percent of GDP
                                                                                                               2001   2002   2003   2004    2005
                                                                        Revenue                                 197    203    206    219     229
                                                                        Percent of GDP                          8.7    8.7    8.5    8.6     8.6
                                                                         Social-security contributions          7.0    6.9    6.8    6.8     6.8
                                                                         Premium pension funds                  0.8    0.9    0.9    1.0     0.9
                                                                         Return on capital                      0.9    0.9    0.8     0.8     0.9
                                                                        Expenditure                             302    155    158    165     172
                                                                        Percent of GDP                         13.3    6.6    6.5    6.5     6.5
                                                                         Pensions                               6.3    6.5    6.4    6.4     6.3
                                                                         Other                                  7.0    0.1    0.1    0.1     0.1
                                                                        Net lending                            –104     48     48     54      57
                                                                        Percent of GDP                         –4.6    2.0    2.0    2.1     2.1
                                                                         of which: NP funds                    –5.5    1.1    1.0    1.1     1.1
                                                                                   PPA                          0.9    0.9    1.0    1.0     1.0
                                                                        Sources: Statistics Sweden and NIER.


                                                                        The indexation of pensions paid and of pension-credit balances
Diagram 152 Pension Levels
Index 2001=100                                                          is now determined by the trend in the incomes of the economi-
 110                                                              110   cally active population. Pensions follow a so-called adjustment
                                                                        index, and pension-credit balances are recalculated according to
 108                                                              108
                                                                        the income index. The strong increase in employment and real
 106                                                              106   wages in previous years led to relatively substantial upward ad-
                                                                        justments of pensions in 2002 and 2003 (see Table 40). Now
 104                                                              104
                                                                        that the labour-market tendency is weaker and the inflation rate
 102                                                              102
                                                                        is low, the upward adjustment is expected to be considerably
                                                                        more modest in 2004 and 2005.
 100                                                              100       Between 2001 and 2005, pensions will have been raised by a
  98                                                              98
                                                                        total of 9.8 percent using the adjustment index. In comparison,
            01                   03                     05
                                                                        upward adjustment by the price-related base amount under pre-
             New method of indexation (adjustment index)
             Former method (price-related base amount)                  vious rules would have increased pensions by only 6.5 percent
Source: NIER.                                                           (see Diagram 152). Thus, the new rules for indexation will raise
                                                                        pensions by an additional 3.3 percent – equivalent to SEK 5
                                                                                                                        Public Finances 85




billion in higher general-government expenditure in 2005 – than
if the pension system had not been reformed.

Table 40 Indexation of Pensions
Index and percentage change, respectively
                                2001    2002       2003              2004        2005
Income index                  103.20   106.16    111.79         115.21          118.35

Adjustment index                          3.3           3.6           1.4          1.1
                          1
of which: Real income                     0.2           3.4           1.4          2.2
                      2
            Norm                          0.4       –1.6             –1.6         –1.6
                  3
            CPI                           2.7           1.8           1.6          0.5
1 Average growth in real income in the three preceding years for all persons
aged 16–64 with pension-qualifying income.
2 In the calculation of the initial amount of the pension, the assumed growth

rate of 1.6 percent is deducted here.
3 CPI in June of the preceding year, annual rate.

Source: NIER.

                                                                                         Diagram 153 Revenue, Central Government
                                                                                         Percent of GDP
                                                                                         50                                                      50

Deficit in Central Government Finances                                                   40                                                      40

This year central-government net lending will continue down-                             30                                                      30
ward; revenue in proportion to GDP is falling slightly, while
expenditure is rising. For the remainder of the forecast period,                         20                                                      20

however, expenditure will decrease as a share of GDP, and net
                                                                                         10                                                      10
lending will improve (see Diagrams 153 and 154).
                                                                                          0                                                      0
                                                                                              93       95      97      99         01   03   05
Table 41 Central Government Net Lending and Budget                                                 Direct taxes
                                                                                                   Indirect taxes
Balance                                                                                            Social-welfare contributions
                                                                                                   Other revenue
Billions of SEK, current prices, and percent of GDP
                                                                                         Sources: Statistics Sweden and NIER.
                                       2001     2002      2003        2004       2005
Revenue                                  933     742          748       795       827
Percent of GDP                          41.2    31.7          30.9     31.3       31.0
Expenditure                              720     756           793     815        828
Percent of GDP                          31.8    32.3          32.8     32.1       31.1   Diagram 154 Expenditure, Central Govern-
                                                                                         ment
Net lending                              213     –14           –45      –20        –1    Percent of GDP
Percent of GDP                           9.4    –0.6          –1.9     –0.8       –0.0   50                                                      50
Adjustment items
    Provided by the Riksbank                      20                                     40                                                      40
    Privatization of corporations          0        0           0           0       0
    Transfer from National              –109        9          13           4       2    30                                                      30

     Pension Fund
    Lending, repayment, net              –28      –7          –15       –19       –16    20                                                      20

    Foreign-exchange and debt-           –17     –11           –7        –6         6
                                                                                         10                                                      10
     service losses
    Interperiod adjustments, other       –20        4          21           5       4
                                                                                          0                                                      0
Budget balance                            39        1         –33       –36        –5         93       95      97      99         01   03   05
                                                                                                   Interest
Sources: Statistics Sweden. National Debt Office and NIER.                                         Transfer payments to households
                                                                                                   Central-government consumption
                                                                                                   Other expenditure

                                                                                         Sources: Statistics Sweden and NIER.
86 Public Finances




Diagram 155 Central Government budget Bal-                          By contrast, the budget balance will show its largest deficit in
ance and Net Lending                                                2004, primarily because a very substantial temporary periodiza-
Billions of SEK
250                                                         250
                                                                    tion of interest will limit the budget deficit in 2003 (see Table 41
                                                                    and Diagram 155).
200                                                         200

150                                                         150

100                                                         100     Slower Expansion in Municipalities
 50                                                         50
                                                                    This year’s increase in local-government taxes will temporarily
   0                                                        0       stop the deterioration in municipal finances that started in 2000
 -50                                                        -50
                                                                    (see Diagram 156 and 157). Employment will not be increasing
                                                                    at the same rate as in the late 1990’s. The consequence has been
-100                                                        -100
        97           99        01            03        05           a weakening tendency in tax revenue, which will decrease in
             Budget balance
             Net lending
                                                                    proportion to GDP in 2004 and 2005. In addition, expenditure
Sources: National Debt Office, Statistics Sweden
                                                                    is increasing more slowly than before and is declining somewhat
and NIER.                                                           as a share of GDP. This development, however, does not mean
                                                                    that municipal operations are contracting; on the contrary, mu-
                                                                    nicipal consumption will continue to increase each year, though
Diagram 156 Net Lending, Local Government
Percent of GDP                                                      more slowly.
0.30                                                        0.30        Despite the forecast increase of 0.15 percentage point in the
0.20                                                        0.20
                                                                    tax rate for 2004, municipal net lending will be negative in 2004
                                                                    and 2005. However, net lending is normally less than the ac-
0.10                                                        0.10
                                                                    counting result, which is subject to the balanced-budget re-
0.00                                                        0.00
                                                                    quirement and thus more important as a factor in setting the
-0.10                                                       -0.10   municipal tax rate.
-0.20                                                       -0.20

-0.30                                                       -0.30
                                                                    Table 42 Municipal Finances
-0.40                                                       -0.40   Billions of SEK, current prices, and percent of GDP
-0.50                                                       -0.50                                          2001   2002   2003   2004   2005
        93      95        97   99       01        03   05
             Municipalities                                         Revenue                                 350    372    392    403    416
             County-council districts
                                                                    Percent of GDP                         15.4   15.9   16.2   15.9   15.6
Sources: Statistics Sweden and NIER.                                Expenditure                             352    376    393   409    423
                                                                    Percent of GDP                         15.5   16.1   16.2   16.1   15.9
                                                                    Net lending                              –2     –3     –1     –7     –7
                                                                    Percent of GDP                         –0.1   –0.1    0.0   –0.3   –0.3
Diagram 157 Revenue and Expenditure, Mu-                            Sources: Statistics Sweden and NIER.
nicipalities
Percent of GDP
18.0                                                        18.0
                                                                    In the short run, the strike by the Municipal Workers Union has
                                                                    strengthened local-government finances. The strike meant fewer
17.0                                                        17.0    hours worked, but also fewer persons employed, since no new
                                                                    staff were hired during the conflict.
16.0                                                        16.0
                                                                        The selective central-government subsidies for increasing
                                                                    employment in local government have contributed to the rather
                                                                    rapid rise in expenditure in recent years. The temporary em-
15.0                                                        15.0
                                                                    ployment subsidy will be raised this year by SEK 300 million and
                                                                    has been extended to 2004. For that year, however, the subsidy
14.0
        93      95        97   99       01        03   05
                                                            14.0    will be general in its entirety and thus an employment subsidy in
             Revenue                                                name only. In addition, the basic tax of SEK 200 paid by all
             Expenditure
                                                                    taxpayers will be transferred to the local governments in 2004.
Sources: Statistics Sweden and NIER.
                                                                                                      Public Finances 87




Net Lending of County Council Districts Positive                            Diagram 158 Revenue and Expenditure,
This Year                                                                   County Council Districts
                                                                            Percent of GDP
                                                                            8.5                                           8.5
The net lending of the county-council districts was negative in
2002, but because of tax increases it is expected to be positive            8.0                                           8.0
this year (see Table 43). Both revenue and expenditure will de-
crease as a share of GDP in 2004 and 2005. Since revenue will               7.5                                           7.5

be falling more rapidly, net lending will deteriorate somewhat,             7.0                                           7.0
but is still estimated to be positive (see Diagrams 156 and 158).
The forecast is that the tax rate of the county-council districts           6.5                                           6.5

will be raised by 0.05 percentage point in 2004 to enable them to           6.0                                           6.0
meet the balanced-budget requirement.
                                                                            5.5                                           5.5
                                                                                  93      95     97   99   01   03   05
                                                                                       Revenue
Table 43 Finances of County Council Districts                                          Expenditure
Billions of SEK, current prices, and percent of GDP                         Sources: Statistics Sweden and NIER.
                                       2001   2002   2003   2004    2005
Revenue                                 169    179    196    200     206
Percent of GDP                          7.5    7.6    8.1     7.9     7.7
Expenditure                             172    184    190    198     205
Percent of GDP                          7.6    7.8    7.8    7.8     7.7
Net lending                              –3     –5      6      2       2
Percent of GDP                         –0.1   –0.2    0.3    0.1     0.1
Sources: Statistics Sweden and NIER.


The county-council districts are expected to curb the increase in
their expenditure in 2003–2005, but not to the same extent as
the municipalities. One reason for the difference is the continu-
ing rise in the cost of pharmaceuticals.
Comparison of Fore-
casts
                                                                                   Comparison of Forecasts 91




In this section, certain central parts of the current forecast are
compared with the forecast published by the NIER in June
2003. Supplementing the comparison is a general explanation of
the underlying reasons for the revisions in the forecast and the
discussions that preceded these revisions. The purpose of pre-
senting these analyses, assessments and forecasts is to clarify the
changes and to make the report more readable.
    There are several reasons why forecasts sometimes need to
be revised. First, in some cases there are substantial revisions of
the data on which the analysis is based. One example is the ma-
jor correction of the National Accounts in December of last
year, resulting in a higher level of GDP and a higher rate of
GDP growth. Second, sometimes there are substantial changes
in the economic outlook, even in the short run. One example is
the sharp drop in Swedish exports beginning in the spring of
2001, which led to sizable downward revisions in the volume of
exports and imports as well as in GDP for a number of years
ahead. Other possible reasons for adjusting forecasts are that
new economic-policy decisions have been taken – such as reduc-
ing taxes – or that calculation and forecasting procedures have
been improved.

Table 1 Current Forecasts of GDP in Other Countries
Compared with June 2003
Annual percentage change

                           2003                2004                   2005
                    Aug. -03      Diff.   Aug. -03    Diff.   Aug.-03    Diff.
United States           2.3       0.0        3.4       0.0      3.8          0.2
Japan                   2.0       0.9        1.3       0.6      1.4          0.1
Euro zone               0.7    –0.1          2.1     –0.1       2.7          0.0
  Germany               0.2    –0.1          1.9       0.0      2.2          0.0
  France                0.7    –0.2          2.1     –0.2       2.6          0.0
  United Kingdom        1.9    –0.2          2.5       0.0      2.5          0.0
  OECD                  1.9       0.1        2.7       0.1      3.1          0.1
World                   3.1       0.0        3.8       0.0      3.9          0.0
Note: The differences are between the current forecast and the one in June
2003. A positive value denotes an upward revision.
Source: NIER.




The International Development

The international tendency is generally one of gradual recovery
as forecast in June (see Table 1). This means, for instance, that
the improvement of the global economy – which is being stimu-
lated by an expansionary economic policy, particularly in the US
but also in Europe, and by positive developments on world
financial markets – is considered to be about as strong as was
forecast in June.
92 Comparison of Forecasts




                             Table 2 The Current Forecast Compared to the Forecast
                             in June 2003
                             Percentage change unless otherwise indicated
                                                                2003               2004           2005
                                                          Aug.-03 Diff.      Aug.-03 Diff.    Aug.-03 Diff.
                                           1
                             TCW index                     124.3       0.1    124.8 –0.2        125.3     –0.4
                                       1
                             Repo rate , percent            2.50       0.0     2.75   0.0        3.50      0.0
                             Government bonds,
                                   1
                             5-year                         4.50       0.0     4.70   0.0        4.80      0.0


                             GDP                             1.3       0.0      2.5   0.0         2.7      0.2
                             Household consumption           2.0       0.3      3.3   0.1         2.8      0.5
                             General-government              0.7      –0.2      0.8   0.2         0.5      0.0
                             consumption
                             Gross fixed capital forma-
                             tion                           –1.4       0.2      3.1 –0.3          7.0      0.3
                             Stockbuilding                   0.2       0.0      0.0   0.1         0.0      0.0
                             Exports                         3.8      –0.1      6.5 –0.3          7.1     –0.1
                             Imports                         4.0       0.1      7.3 –0.1          8.2      0.1


                             Employment, number              0.0       0.3      0.1 –0.1          0.4      0.0
                                               2
                             Unemployment                    4.7       0.0      4.6   0.0         4.3      0.0
                             Hourly earnings                 3.5      –0.1      3.5 –0.1          3.7      0.0
                             CPI, annual average             2.0       0.2      0.7   0.2         2.0     –0.1
                             UND1X, annual average           2.3       0.2      0.9   0.3         1.7      0.0
                             Real disposable income          1.9       0.0      1.8 –0.2          1.7     –0.1


                             Manufacturing output            1.5      –0.3      4.5   0.1         5.0      0.1
                                                   3
                             Current account                 3.8      –0.2      4.3 –0.2          4.6     –0.2
                             Central-government
                                            4
                             budget balance                –32.9       0.1    –35.7   1.9        –5.2      4.4
                             General-government
                                           3
                             net lending                     0.4       0.0      1.2   0.1         1.9      0.4
                             1 In December of each year.
                             2 As a percentage of the labour force.
                             3 As a percentage of GDP.
                             4 Billions of SEK.

                             Note: The differences are between the current forecast and the one in June
                             2003. A positive value denotes an upward revision.
                             Source: NIER.


                             Consequently, the new forecast for the international trend as a
                             whole is virtually unchanged, although there are revisions for
                             various countries. The tendency in the euro zone is somewhat
                             weaker than anticipated in June, calling for a small downward
                             adjustment in growth this year and next year. The problems of
                             the German economy appear marginally more serious this year,
                             but as forecast in June, they are expected to diminish gradually.
                             In Finland, growth is being held back by weak exports in the
                             first quarter of this year. The US economy is now considered to
                             be developing somewhat more strongly than in the June fore-
                             cast. The difference is particularly noticeable toward the end of
                             the forecast period and is partly related to the country’s expan-
                             sionary fiscal and monetary policies. The forecast for the Japa-
                                                                    Comparison of Forecasts 93




nese economy has been raised substantially because of greater
domestic demand and higher net exports so far this year.


The Tendency in Sweden

For the Swedish economy as well, the growth forecast is un-
changed for this year, with a certain minor redistribution of the
contributions to growth from different components of GDP
(see Table 2). For example, unexpected weakness in local-
government consumption in the second quarter due to the mu-
nicipal workers’ strike has required downward adjustment of the
forecast for general-government consumption. Unexpectedly
high retail sales in June, have led to a somewhat higher forecast
for household consumption this year. Moreover, to judge from
household consumption so far this year, the interest-rate cuts by
the Riksbank have taken effect a little more quickly and had a
slightly greater impact than anticipated. In view of the more
expansionary monetary policy, together with rising disposable
income, consumption is now expected to increase a bit more
rapidly than in the June forecast.
    The adjustments for next year are also minor. The forecast
for the increase in household consumption is virtually un-
changed. The adjustment upward of the rise in general-
government consumption has been roughly offset by a down-
ward revision for this year due to the strike. The forecasts for
investment and for exports and imports have been adjusted
primarily in light of the weaker outcomes reported by the Busi-
ness Tendency Survey in July, but the changes are very slight.
    The marginal adjustments for this year and next year mean
that total domestic demand and net exports have been increasing
and are expected to continue doing so in accordance with the
June forecast. This means, for instance, that domestic demand
will increase by about 1 percent this year and 2.5 percent per
year in 2004 and 2005. The annual contribution to growth from
net exports will be slightly positive during the period.
    It is harder to forecast the economic tendency in 2005. The
short-term effects on demand of a ”yes” or ”no” to the euro
have been analysed in greater detail (see the box captioned “Cy-
clical Effects of a ‘Yes’ and a ‘No’ to the Euro”). Household
consumption is now forecast to increase by 2.8 percent in 2005,
an upward adjustment by 0.5 percentage point.
    The situation on the labour market is largely consistent with
the forecast in June. This means, among other things, that em-
ployment, which is continuing to decline this year, will begin
increasing slightly in the middle of next year. The increase will
be limited to some extent by rising average hours worked due to
lower sickness absence. The unemployment outlook is un-
changed, with the unemployment rate forecast to drop from 4.7
percent this year to 4.3 percent in 2005.
94 Comparison of Forecasts




                                 Wage increases have been more limited than forecast, par-
                             ticularly in manufacturing. This tendency has led to a downward
                             adjustment of the wage forecasts for this year and next year.
                                 The forecast for prices has been adjusted upward somewhat
                             for this year, one reason being that prices of electricity are no
                             longer expected to recede as much as in the June forecast. This
                             change is related mainly to the low level of the country’s water
                             reservoirs after the dry summer. The forecast for oil prices this
                             year has also been adjusted upward, primarily because of unex-
                             pectedly high prices due to disturbances and disruption of pro-
                             duction in Iraq. Consequently, inflation will be somewhat higher
                             for the rest of this year and early next year. There is still little
                             underlying inflationary pressure, however, and there has been no
                             substantial change in the development of the repo rate consid-
                             ered appropriate by the NIER.
                                 As in the June forecast, the lacklustre tendency of the econ-
                             omy, particularly this year, is expected to cause public finances
                             to deteriorate. The net lending of the general-government sector
                             is forecast to be a modest 0.4 percent of GDP this year, rising to
                             1.2 percent of GDP next year and improving further, to 1.9
                             percent, in 2005. The upward revision in 2005 by 0.4 percentage
                             point is due to primarily to a somewhat higher GDP forecast,
                             entailing greater tax revenue, while expenditure is largely un-
                             changed from the June forecast.

				
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