by Don Alexander, MBA
Associate, RSD Solutions Inc.
Sweden experienced a severe banking crisis in the early 1990s. The quick moves by policymakers to resolve the crises and limit contagion have lessons today for the risk management and government policymakers. Swedish authorities deregulated capital markets in the mid-1980s that helped stimulate a rapid expansion of the financial sector and a surge in real estate lending. Highly leveraged financial institutions got caught when monetary policy was tightened and the ERM went into crisis. Lars Calmfors, in a recent VOXEU communique, What Can Europe Learn from Sweden? Four Lessons for Fiscal Discipline (Mar. 12th) talks about some of the lessons. Several Eurozone countries are currently struggling with large budget deficits. Calmfors argues the 1991/93 Swedish fiscal crisis has lessons for today. The use of greater fiscal transparency combined with a high-quality economic policy debate leading to a credible medium-term deficit reduction package may be the optimal policy. This is more important than the formal binding rules and automatic correction mechanism envisaged in the European fiscal compact. There are four lessons from the Swedish experience. First, a fiscal crisis can create a consensus on fiscal discipline. This leads to consensus among various political parties favoring a long-term goal of fiscal consolidation despite temporary macroeconomic deviations. Secondly, comprehensive fiscal reforms can increase the chances of success. The government implemented a number of unpopular structural reforms including controlling discretionary spending, limiting local government deficits, and long-term pension system reforms. Thirdly, fiscal transparency may be more important than formal enforcement as mandated under the European compact. The Swedish government adopted greater fiscal transparency by exposing the budget to reviews from independent agencies and providing a long-term credible plan for keeping the budget balanced. Lastly, one way to limit the deficit is to promote sustained output growth. Fiscal consolidation becomes effective with long-term output growth. The economic recovery was helped by a large real depreciation of the exchange rate. There were two fiscal effects from higher long-term growth: a gradual reduction in the debt-to-GDP ratio and higher growth allowed for tax cuts and targeted expenditures. European politicians and policymakers can learn the importance of addressing risk early or face the risk of a surge in the costs for crisis resolution. This is especially important, since the early 1990s, due to the greater complexity resulted in a greater concentration of institutions and increased interconnections that place a premium on prompt action. The extension of the Sweden experience to risk management offers the following lessons: the need for accurate screening and monitoring risk, prompt recognition of risk, training in risk management for participants, a consensus agreement of all involved parties on risk resolution and prompt action to contain the cost of resolution.
For more information on this, follow the link: www.voxeu.org/index.php?q=node/6368
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