During the financial crisis, the best single piece of advice I received was: “Use Sweden’s playbook.” Sweden faced a severe financial crisis in the early 1990s and had managed it–through a combination of guarantees, capital injections, and good bank / bad bank separations–about as well as one could hope.
As our attention turns from the financial crisis to our looming fiscal crisis, that advice continues to be useful. When its financial crisis ended, Sweden found itself on an unsustainable fiscal trajectory, yet found a way to pull itself out. As Jens Henriksson wrote in a fascinating paper (“Ten Lessons about Budget Consolidation“) in 2007:
In its Economic Outlook of December 1994 the OECD projected that the Swedish public debt would explode. By the year 2000 the public debt was expected to hit a record 128 percent of GDP. Today we know that the gross debt for 2000 turned out to be less than half that figure at 53 percent. And within a few years the budget deficit, from a high of over 11 percent of GDP, turned into a large surplus.
How did Sweden do it? You should read Henriksson’s paper for all ten lessons, but two particularly important ones are:
- Set clear, easily communicated budget goals (e.g., specific deficit targets that get the government debt under control).
- Combine deficit-reducing measures into a single package so that it’s perceived as shared sacrifice, not as targeting specific interests.
These lessons are useful both for domestic politics and for world capital markets. Clear goals with shared sacrifice can, in the hands of strong political leaders, establish a commitment to budget consolidation, easing the path to success at home:
As a politician you can never explain why you need to cut pensions alone. But if, at the same time, you cut child benefits and unemployment insurance and raise income tax for the richest, you are on safe ground. The idea is to not single out the losers.
At the same time, clear, credible commitments will be rewarded by world capital markets through lower interest rates, which can help offset some of the contractionary effects of tightening the budget. (Henriksson’s description of Swedish politics at the time occasionally sounds like parts of the Clinton years, when the opinions of the bond market loomed large).