The center-right government in Sweden has presented a new budget for 2024. It is an ambitious document that aspires to both fight inflation and facilitate economic growth.
One of the positive elements of the budget is that it strives for increased stability and predictability in government regulations and taxes. These are essential to any government that wants the private sector of the economy to grow and thrive.
The Swedish government will receive much-needed help from an international economy that is showing signs of stability and resiliency. In the past week, important central-bank decisions shifted the economic outlook for Europe and America slightly in the positive direction.
On Wednesday, September 12th, the Federal Reserve made the correct decision and abstained from raising its benchmark Federal Funds rate. They left their policy-setting federal funds rate at 5.33%, the midpoint of a 5.25-5.50% bracket. This will be good for the U.S. economy, which has shown remarkable resilience this year, and which—thanks to the Fed’s thoughtful monetary policy—may avoid a recession in the coming winter.
The Fed’s decision was not surprising. Back on August 2nd, I noted that the timing of their July rate hike suggested that the Federal Reserve was “done for the year” raising interest rates.
Their decision to stay flat for now seems to have been met with calm by the American debt market. On Wednesday, there were no noticeable moves in interest rates on U.S. Treasury securities; the changes that did happen, such as a moderate rise in yields on notes maturing in 1-7 years, were well in line with recent trends.
This is good news for the American economy, but it is also good news for Europe. Interest rates on euro-denominated sovereign debt correlate strongly with interest rates on U.S. debt. Figure 1 reports the rates (or yields) on the 10-year U.S. Treasury note and the corresponding euro-denominated instrument:
Figure 1
Sources: U.S. Treasury, Eurostat
One of the most important non-EU central banks is the Bank of England. Its policymaking is less correlated with the dollar than that of other European central banks. The reason is in good part that the British currency and debt market are considered inherently strong and reliable.
That said, it does not hurt the Bank of England when the Federal Reserve makes good policy. The Fed’s September 20th decision was no exception. In an apparent anticipation of the outcome of the Federal Open Market Committee’s meeting, the Bank of England’s Monetary Policy Committee, MPC, decided on the same day to keep its policy interest rate unchanged:
At its meeting ending on 20 September 2023, the MPC voted by a majority of 5-4 to maintain the Bank Rate at 5.25%. Four members preferred to increase Bank Rate by 0.25 percentage points, to 5.5%.
This decision reinforces the signal of economic stability that the Federal Reserve sent out. It is likely that in both America and Britain, interest rates will now stabilize and may start coming down a bit in the near future.
At the same time, the close vote by the MPC is a signal that the Bank of England has a long way to go before it will consider any interest rate cuts. It is nevertheless refreshing for the British economy that its central bank did not raise the rate at this point. Again, stable interest rates convey a sense of stability that Europe’s economies are in bad need of.
The Swiss National Bank made its own contribution to that stability when on September 21st it decided to leave its policy rate at its current level of 1.75%.
As important as these central-bank decisions are, they are not the only voices in the room. In a sign of institutional weakness, on September 14th the European Central Bank decided to raise its three policy-governing rates by 0.25 percentage points. Those rates are now in the 4-4.75% range. On September 20th the Norwegian central bank decided to raise its policy-setting rate from 4% to 4.25%. The Swedish central bank, the Riksbank, followed suit with a decision on Thursday to raise its policy governing rate by 0.25 percentage points to 4%.
Both Norway and Sweden operate with relatively small currencies, but that is no reason for them to mimic all moves by the ECB. Nevertheless, that is what they just did, and their motive was a noble one: to fight inflation.
In this case, monetary tightening is only part of the inflation-fighting effect of the rate hike. Another effect is to stabilize and hopefully appreciate their currencies vs., primarily, the euro. In the past year, the Swedish and the Norwegian kronas have fallen vs. the euro. Norway first:
- In August 2022, one euro bought just below NOK10;
- In August 2023, one euro bought approximately NOK11.50.
The depreciation of the krone resulted in inflation being imported into the Norwegian economy. Products imported from the euro zone became 15% more expensive simply due to the weakening of the Norwegian currency. That price increase came on top of ‘regular’ inflation. Therefore, in line with its efforts to reduce inflation in the country, it makes sense for the Norwegian central bank to maintain the parity between its interest rate and the three ECB rates.
Sweden has also suffered a currency depreciation vs, the euro, but slightly less dramatic than the Norwegian krone’s decline:
- At the end of August 2022, one euro bought SEK10.70;
- At the end of August 2023, one euro bought SEK 11.84.
The Swedish central bank, the Riksbank, is responding resolutely to this currency depreciation. Erik Thedéen, the new president of the Riksbank, has taken a more restrictive policy stance than what was customary under his predecessor, Stefan Ingves. Where Mr. Ingves pursued an accommodating monetary policy, Mr. Thedéen is more focused on the strictly monetary function of the central bank.
A central bank can only be successful in fighting inflation if it makes that fight its only policy priority. Since January 1st, when Mr. Thedéen took office, the Riksbank has firmed up its fight against the rapid rise in prices in Sweden. Consequently, inflation—measured with Eurostat’s HICP index—has fallen from an annual rate of 9.6% in January to 4.5% in August. Meanwhile, Mr. Thedéen has aggressively continued with the rate hikes that his predecessor belatedly began executing:
- In May 2022, under Mr. Ingves, the Riksbank raised its policy-governing rate from zero to 0.25%;
- Six months and three rate hikes later, the rate had reached 2.5%;
- Since taking office, Mr. Thedéen has presided over a total of four increases, to the current rate of 4%.
With all this in mind, it is important to also remember that monetary policy cannot fight inflation on its own. In order to be effective over time, it must be accompanied by responsible, conservative fiscal policy.
This is where the new Swedish government budget comes into the picture. In its policy overview, known in Swedish as Finansplanen, the government explains the primary goal of the budget:
The high inflation has harmed the Swedish economy and is the worst enemy of the wage earners, as it leads to a depression of real wages and lowers the value of savings. A high debt ratio and a large share of mortgages on flexible interest rates have made Swedish households and businesses vulnerable to the higher interest rates that accompany inflation.
By placing inflation at the top of the list of the problems to address, Finance Minister Svantesson smoothly aligns her government’s fiscal policy with the Riksbank’s monetary-policy ambitions. Tangibly, this is evidenced by a restraint on government spending—predominantly in the form of increases in agency appropriations that do not quite compensate for inflation—but also in a couple of tax measures aimed at alleviating everyday cost of living for households.
One of the measures adjusts the cost of automotive fuel by adjusting the mandate for reducing carbon dioxide emissions from internal combustion engines. The mandate, which originates in the RED II EU Renewable Energy Directive, forces oil companies to gradually increase the mix of non-fossil ingredients in retail engine fuel. Since these ingredients drive up the cost of gasoline and diesel, the Swedish government hopes that a reduction of the mandate to the lowest levels permitted under RED II will also reduce the cost of fuel at the pump.
This is an intelligent regulatory measure that directly affects the cost of living for households, as well as the cost of operations for primarily small businesses. This effect will be coupled by a two-step cut in the fuel tax, again pursuing the lowest level allowed under EU law.
When a government deregulates the economy, or at least reduces the cost of existing regulations, it creates room for deflation in prices—in other words helps fight inflation—while at the same time freeing up economic resources for entrepreneurs and households to spend, save, and invest more money. These effects are never spectacular in size, but, if done right, they can definitely have a positive impact on the economy.
In addition to being an instrument against inflation, deregulation allows a government to stimulate the economy without the upfront negative effects on its budget that come from tax cuts. If the fiscal situation is too dire to take any tax cut risks, the regulatory instrument can be a way out of a recession.
For these reasons, back on August 23rd I proposed the regulatory policy route as a way for European governments to fend off a new recession. A week later,
German Chancellor Olaf Scholtz and two of his cabinet members released a ten-point plan for boosting the German economy.
Their most ambitious policy goal was—you guessed it—deregulation.
I am happy to see that the Swedish government is following the same route. In addition to the aforementioned reform of the fuel reduction mandate, the 2024 budget notes that in order for businesses to grow and thrive, entrepreneurs
must be able to focus on the core [business] functions. There is a need to reduce permission processes, to make them more predictable and flexible. Therefore, the government is working with reducing the regulatory burden and the administrative costs for businesses.
When regulatory reforms are implemented, the effects are immediate: as soon as the reforms go into effect, businesses can adjust their operations to them. This is especially important for small businesses, where margins are often tight and red-tape compliance can be a major fixed-cost item in their finances.
After eight long years with a hard-left government, Sweden is showing promise of a brighter economic future. It will not materialize immediately, but this new budget marks the beginning of the work to put that promise to work. However, more is needed, on many policy issues.
To that point, I am always happy to see politicians take my advice. Hopefully, going forward, the Swedish government will consider a reform to the country’s model for funding health care. Rather than maintaining the current model with universal, one-size-fits-all tax funding, the Swedish government should consider the Dutch model, where well-managed private insurance plans provide households and businesses with multiple options for health care coverage.
Done right, a reform of this kind could reduce the cost of health care while providing more access and better outcomes. Given the impact of a good health-care system on the rest of the economy, this is a reform well worth considering, especially in the context of stimulating growth, entrepreneurship, and price stability.
