How to defeat a crisis. The Swedish way 1

Running Head: Research paper - How to defeat a crisis. The Swedish way

Elena Curova

ECO 203 Principles of Macroeconomics

Pankratz John

Research Paper

March 8, 2013

Abstract (Background)

In this research I describe the macroeconomic situation of the country, compare Sweden’s actions in the 90’s crisis and in the late-2000s Great recession. In the beginning of the paper I analyse Sweden’s economic situation before the crisis of the 90’s. After that I look how this crisis affected economics of Sweden and how did Sweden managed to get through this crisis. Then I examine the “Great recession” in Sweden, causes and outcomes of it. In the comparison I look at how Sweden used its experience from the first crisis in order to operate correctly during the Great Recession. Based on my research I try to answer my research question and conclude whether Sweden has learned something that helped to overcome the recent crisis.

Research Question (Hypothesis)

In relation to my chosen PHENOMENA of surprisingly rapid Sweden recovery from the current crisis, I have formulated my research question: “Did lessons from 1990’s crisis play a major role in the recovery from the current crisis?” In order to answer, I made a consistent research of both crises, analyzed different sources of data and the Swedish government policies’ effects on relevant macro variables. In the end of my report I distinguished main reasons of successful performance.

Overview of Swedish development till 1985

The main story about the Swedish way to success starts in the first part of the 20th century. During the both First and Second World Wars Sweden was a neutral country and did not participate in any military operations. This fact allowed Sweden to increase its exports to war devastated countries. In others words, foreign demand for domestic goods increased significantly, which led to output increase, higher GDP, disposable income, consumption and higher tax revenue. It is very important to notice that both World Wars gave a boost to the Swedish economy and allowed to anchor as an industrial country in the world’s economic map. In the 1930s, this helped Sweden to achieve one of the highest living standards in the whole Europe.

In the beginning of the 1980’s, Sweden had a relatively small, closed economy with a rich welfare, low unemployment, high tax rate and large public sector.

On the threshold of 90’s crisis

After the government elections in 1985, the board of Riksbank abolished quantitative control of lending by commercial banks. This liberalization had a significant, or even more unexpected, effect on all macro variables and huge economy’s boost. Demand for loans increased because there were no barriers to borrow. In other words, it was situation of self-fulfilling expectations, when people were able to borrow unlimited amounts of money and from that create an untrue demand for property and financial equity. At the highest point of the boom, economy was stimulated by extremely high private consumption level. Therefore, people spent more than their disposable income was at that moment. Speaking about increase in domestic consumption, it should be mentioned that in 1985 due to decrease in marginal propensity to consume, oil prices fell, which made the nominal price level decrease. This led to an increase in the purchasing power and the psychological belief that society is better off.

Looking back in time, some important factors should be observed, which lead to such a severe crisis. Both politicians and ordinary people lacked experience and economic knowledge. Speculations and uncontrolled cash flow in financial markets brings a lot of unpredictable consequences and it was the case in Sweden[ CITATION Lar09 \l 1033 ].