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: firstname.lastname@example.org, 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.