Can fiscal austerity be expansionary in present-day Europe? The lessons from Sweden

Abstract

In the aftermath of a deep recession and public budget crisis, a Social Democrat government pursued an ambitious fiscal austerity policy in Sweden in the mid 1990s. Economic advisors were guided by the idea that fiscal austerity would have neutral or expansionary effects on output and employment. In order to avoid large public deficits in the future, the government also introduced radical fiscal rules. The main conclusion in this article is that the fiscal austerity measures in the mid 1990s delayed the Swedish economic recovery and that neither these measures nor the radical fiscal rules were responsible for Sweden’s impressive macroeconomic performance in the following years. The positive economic development in Sweden up until the Great Recession was driven by export, profit and technology, reflecting an international upswing and the country’s flexible exchange rates and industrial composition. The floating exchange rate, together with independent monetary policy and luck, explain why Sweden could avoid a sharp decline in GDP growth during the global financial and EMU crises. The demanding fiscal rules restricted the possibilities and willingness of the non-socialist government to respond to high unemployment with an expansionary fiscal policy.