Sweden’s Economic Policy Towards COVID

Pre-COVID

Prior to the COVID pandemic, the Swedish economy was among the best performing of the OECD countries.

Driven by strong consumption, investment and exports, GDP had expanded steadily at an average rate of close to 3% from 2014 to 2019. Unemployment declined to 6.3% in 2018 from 8% in 2013. At the same time, Sweden’s government finances were strong. In 2019, the Swedish central government debt-to-GDP ratio was the lowest since 1977 at below 40% (which compared to the OECD average in 2018 of about 68%). In addition, Sweden was running a government budget surplus of 0.6% and 0.8% of GDP in 2018 and 2019, respectively.

The effect of COVID on Sweden’s economy

Then came COVID. As we all know, the pandemic that began in early 2020 has greatly

affected the economies of most countries in the world, Sweden included. The demand shock put Sweden into recession. GDP shrank by about 8% in the second quarter of 2020 and 3% for 2020 overall. While industrial production rebounded after disruptions in supply chains in the spring of 2020 (especially inputs from China that affected the auto industry), service activity remained lower throughout 2020, especially in sectors that require face-to-face interaction. The output gap, which is the difference between actual and potential GDP as a percentage of total GDP, was negative 4.2% in 2020, up from a positive 0.5% in 2019. Of particular concern, unemployment rose to 8.7% in 2020 from 6.3% in 2019, despite the extensive use of a part-time work scheme to save jobs.

However, while Sweden’s economy shrank when the pandemic first developed, the country was not hit as hard as many other countries thanks in part to less onerous COVID rules which allowed most businesses to stay open, and to the fiscal and monetary policies used by the Swedish government. These factors minimized the leftward shift in the aggregate demand curve.

Sweden’s macroeconomic policy response to COVID

Fiscal policy – As noted, Sweden entered the pandemic with gross government debt of 35% of GDP and a government surplus of 0.6% of GDP. That prudent level of debt and small surplus gave the country room to use fiscal policy to dampen the recession.

The government of Sweden tried to tailor the fiscal policy so that the sectors most affected by the pandemic received the highest support per employee. For example, part-time work support, tax deferrals, and reduced social contributions provided significant support to most sectors, while compensation for high sick leave costs benefitted the health and education sectors the most.

The most prominent fiscal measures included the following:

• New part-time work scheme where employers are eligible to receive financial support for investment in the skills of their employees who are working reduced hours.

• Compensation for lost sales. Businesses that lost between 30-50% of sales were eligible to be compensated for up to 70% of their fixed costs, subject to ceilings. This was later increased to up to 100% of fixed costs in 2021 per business per month.

• Reduced employer social contributions, where some costs and taxes were deferred, with only old-age pension contributions payable.

• Increased healthcare spending to cover additional sick leave costs and to help hospitals cope, and for testing, vaccinations, and prevention. Elderly care funding was also increased significantly.

• More funding for education and grants for municipalities.

Sweden spent 8.5% of its 2020 GDP over 2020-2021 on the above fiscal measures to help save jobs and businesses and steady the economy. In addition, the government also provided tax deferrals, increased guarantees, and injected equity in state-owned companies. These liquidity measures cost a further 13.9% of 2020 GDP.

In total, the budget moved from a small surplus in 2019 to a deficit of more than 3% of 2020 GDP in 2020 and 2021, and gross government debt-to-GDP increased to almost 40% in 2020 and 2021 (which was the first increase since 2014).

Government Budget Measures

Liquidity Measures and Capital Injections

Monetary policy – In Sweden, monetary policy was a less useful tool than fiscal policy during the pandemic because the country was already pursuing an expansionary monetary policy pre-COVID, with interest rates very low. Sweden’s central bank, the Riksbank, did step up its bond-buying program to increase the money supply by exchanging bonds for cash. The Riskbank also provided more lending facilities for banks and lowered the collateral banks had to provide when borrowing from the Riksbank. These measures provided liquidity for lending.

Then, at the end of 2021, inflation unexpectantly reached 3.6% due mainly to rising electricity prices. This was the highest inflation since 1993. However, we think the higher inflation is temporary as energy prices are expected to fall. Therefore, Sweden plans to continue with its expansionary monetary policy, only closing some of the lending facilities it set up during the pandemic. A less expansionary monetary policy might be justified if inflation remains high.

Outlook

In summary, the situation with the pandemic remains uncertain, but so far, the Swedish economy has recovered strongly. By the end of 2021, GDP was higher than before COVID, with growth at 3.9% (and it is expected to be well over 4% in 2022). Growth was driven mainly by household consumption which had fallen sharply at the start of the pandemic, but also by investment, both of which were helped by our generous fiscal spending. The fact that Sweden entered the crisis with a fiscal surplus and low government debt, and then was able to use government spending and benefit from the multiplier effect to end the demand shock, has been crucial for the rapid recovery. Strong fiscal support should be maintained until the recovery is certain. If the economy recovers as projected, the government budget should move back towards the surplus target over the medium term. However, if the recovery is weaker than expected, there is room for more expansionary fiscal policy, especially since further monetary expansion is harder given low interest rates.

While the Swedish economy is dependent on the global economy’s continued expansion, the country has done a lot to weather the pandemic.

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