Summary of the forecast.

The Swedish economy has begun to recover. GDP will grow by 2.6 per cent this year and just over 3 per cent next year. Unemployment will start to fall after a slight delay but will not reach equilibrium levels until 2017. Growth in the euro area has also picked up, but considerable downside risks remain. Inflation is low in large parts of the world, and the leading central banks' policy rates will remain very low until at least mid-2015. The Riksbank will postpone a first increase in the repo rate until the third quarter of 2015, but CPIF inflation will still not hit 2 per cent until 2017. General government net lending will show a deficit of 2 per cent of GDP this year, and tight fiscal policy will be needed in subsequent years to meet the surplus target.

TENTATIVE RECOVERY HAS BEGUN

Sweden had the fastest-growing GDP in the whole of the EU in the final quarter of 2013. The rise of 1.7 per cent over the previous quarter marked a turnaround in the economy (see Diagram 1). Both exports and consumption grew much more quickly than in previous quarters. This very strong growth was driven partly by temporary stock effects and supplies of defence materiel to the military, however, and so growth will be much weaker in the first quarter of 2014.

The NIER's Economic Tendency Survey is also signalling weaker growth at the beginning of 2014, but the slowdown is expected to be temporary. Despite falling in February and March, the economic tendency indicator is at a level compatible with GDP growth slightly above the historical average. Although temporary factors are expected to result in weak growth in the first quarter of 2014, the Economic Tendency Survey and other information suggest that the economic recovery that began in the fourth quarter of 2013 will continue.

Exports have started to grow more strongly after performing poorly in the first half of 2013. The outlook for exports is increasingly bright, with GDP growth continuing to accelerate in the US and the euro area. This picture is supported by firms reporting a clear rise in export orders in the Economic Tendency Survey.

Household consumption will grow more quickly this year, due to decreased uncertainty about the labour market, expansionary monetary policy and reductions in household taxation. The fifth earned-income tax credit and the tax cut for the over-65s will increase household disposable income by SEK 15 billion this year, or 0.8 per cent. The Riksbank's lowering of the repo rate in December will further boost consumption.

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TEMPORARY DETERIORATION IN THE SWEDISH LABOUR MARKET

Employment growth has been weak in recent months, and unemployment has begun to rise again (see Diagram 2). Indicators such as firms' employment plans and new vacancies suggest, however, that employment growth will pick up. The relationship between the labour market and GDP growth now appears somewhat more normal than it was for much of 2013, when employment grew unusually strongly relative to GDP growth. The normal pattern is for GDP to affect employment and unemployment with a certain time lag. Unemployment held around 8 per cent last year, but will begin to fall back more tangibly as GDP grows more quickly.

With GDP growth averaging 2.8 per cent in 2014-2017, unemployment is forecast to drop to 6.5 per cent in 2017, which is in line with the NIER's assessment of equilibrium unemployment in that year (see Diagram 2). For this level of unemployment to be realised, there is a need for both demand for labour to increase and matching in the labour market to improve. Since a substantial proportion of the unemployed are in weak groups (1) that find it harder to gain employment, active labour market initiatives will be required for a long period.

BRIGHTER OUTLOOK FOR THE US AND EURO AREA

The cold winter has put a damper on economic activity in the US, with GDP growth slowing at the end of last year and expected to hold around 0.5 per cent in the first quarter this year (see Diagram 3). Housing investment has performed particularly poorly, but there are now signs of it picking up later this year. Fiscal policy will be less contractionary this year, and wages will begin to rise more quickly as unemployment creeps down. This will pave the way for more rapid growth in household consumption.

Confidence in the euro area economy is continuing to improve. Substantial tax increases and spending cuts have begun to impact on public finances, and most euro countries are on the right track in terms of government finances. This can be seen, for example, from reduced government bond spreads between the countries with the weakest government finances and Germany (see Diagram 4). Household and business confidence has also improved and is above the historical average, which indicates that GDP is set to grow more quickly.

In the euro area as a whole, GDP grew by 0.3 per cent in the final quarter of 2013, with all of the larger countries reporting positive growth. Fiscal policy will need to remain contractionary, and there are still major imbalances in the euro area. Several countries have problems with competitiveness and need to cut cost levels relative to Germany. Due to the common currency, this adjustment will take time. There is a need for a period of low wage growth and structural rationalisation. This process will put a damper on growth. It is most likely that the recovery will continue, with the result that unemployment slowly begins to head downwards in 2014.

Downside risks continue to dominate, however. The banking system is poorly capitalised, and if the upcoming stress-testing by the European Central Bank (ECB) reveals weaker balance sheets than expected, fresh turmoil could break out in financial markets. The ongoing conflict between Russia and Ukraine could also escalate rapidly, potentially with major consequences for economic developments, but confidence in financial markets has been affected to a surprisingly limited extent to date.

LOW INFLATION IN MANY PARTS OF THE WORLD

Inflation in Sweden is very low. As measured by the CPIF (consumer price index with constant mortgage rates), it was just 0.4 per cent in February, its lowest since 1998 bar a single month in 2004 (see Diagram 5). There are no signs that inflation is about to rise in the near term, and slow growth in unit labour costs and a certain strengthening of the krona mean that inflation will remain low in 2014 before rising slowly in 2015.

Inflation is also low in the euro area and the US. Apart from the sharp fall during the financial crisis in 2009, similarly low levels of inflation have not been seen since the start of the new millennium. In the US, where the economy is clearly in recovery, the Federal Reserve is continuing to taper its purchases of assets, but a first interest rate hike is not expected until mid-2015 (see Diagram 6). The ECB has left its policy rate unchanged at recent meetings, but has also made it clear that further monetary stimulation may be required to boost growth and push up inflation. The ECB will not start to raise its policy rate until 2016.

RIKSBANK POSTPONES RATE INCREASES

In the Riksbank's latest forecast, published in February, CPIF inflation reaches 2 per cent at the end of 2015. It is unlikely to rise that quickly, however, and so the Riksbank will not raise the repo rate as early or as quickly as indicated (see Diagram 7). In the NIER's forecast, the first hike comes in the third quarter of 2015, with the repo rate then being raised relatively slowly. The repo rate will then average just 2.0 per cent in 2017 when the output gap closes (see Diagram 8). This is an unusually low level by historical standards, but can be explained by low interest rates outside Sweden and an unusually long period of weak resource utilisation, which has put a damper on inflation and inflation expectations. The repo rate therefore needs to be unusually low to avoid an excessively strong krona and push inflation up towards the target level.

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Since the real economy is performing more or less as expected, and the inflation forecast has been revised down, it would be natural for monetary policy to be made more expansionary. If this adjustment is not made, there is a risk of inflation expectations falling further, and they are already some way below the inflation target of 2 per cent (see Diagram 9). The NIER believes that it would be appropriate to lower the repo rate at the next monetary policy meeting in April. This would accelerate the economic recovery, help inflation return to the target level more quickly, and so increase the credibility of the inflation target.

The Riksbank has stated repeatedly over the past year that it is keeping the repo rate slightly higher than motivated by inflation and resource utilisation alone, in order to reduce the risks associated with an excessive ratio of household debt to disposable income. The repo rate is something of a blunt instrument for managing debt levels, however. According to the Riksbank's analysis, substantial changes in the repo rate would be needed to have any appreciable effect on the debt-to-income ratio. (2) The NIER does not therefore believe there is currently any reason for monetary policy to be influenced by household debt. A cut in the repo rate in April would also make it possible to start raising it again earlier, so reducing the risk of households revising down their long-term expectations for mortgage interest rates to unrealistically low levels.

TIGHT FISCAL POLICY NEEDED TO MEET SURPLUS TARGET

General government net lending was negative at -1.3 per cent of GDP last year (see Diagram 10) and will fall further this year to -2.0 per cent of GDP, due mainly to the tax reductions for households introduced at the start of the year. Net lending has been in decline for several years, due partly to the weak economy and partly to active decisions to cut taxes.

Even allowing for the weak economic climate, net lending will still be negative this year. Cyclically-adjusted net lending is forecast to be -1.3 per cent of potential GDP in 2014, which means that contractionary fiscal policy will be required in future years to meet the surplus target.

The fiscal policy forecast for 2015 includes discretionary decisions on tax increases for households of SEK 10 billion and an equivalent increase in general government consumption. This forecast is associated with considerable uncertainty, but reflects statements by representatives of both the government and the opposition indicating that only fully funded measures will be introduced in 2015. Cyclically-adjusted net lending will increase somewhat nevertheless as a result of the automatic stabilisers.

In the NIER's medium-term forecast, the public sector commitment is assumed to hold at 2015 levels. This means that new decisions on expenditure increases totalling SEK 53 billion on transfers, investments and consumption will be made in 2016-2018. To finance this additional expenditure and still return net lending to 1.2 per cent of GDP in 2018, as would be required to meet the NIER's interpretation of the surplus target, tax increases of SEK 100 billion will be needed in the central government sector. In the forecast, the local government sector is also forced to raise taxes by SEK 8 billion to finance an increased need for welfare services and satisfy the balanced budget requirement.

Over the past decade, general government consumption and investment have grown at roughly the same rate as forecast for 2014-2018, but transfers to households have risen much more slowly. This trend could conceivably continue for a while, so reducing the need for tax increases, but at some point, for example, the ceiling for unemployment insurance will need to be raised so that protection is not excessively eroded.

It is important to remember that these calculations are based on the NIER's assessment of sustainable employment and potential GDP. With more optimistic assumptions for these variables, the need for tax increases is smaller.

TIME TO REVIEW THE SURPLUS TARGET

Whatever the need for tax increases in the coming years, there is reason to review the level of the surplus target for general government net lending, currently 1 per cent over a business cycle. The main reason for introducing the target was to reduce the national debt in a period with relatively favourable demographic developments. Sweden's national debt is now one of the lowest in the EU, and the general government sector has positive net financial wealth equivalent to around 20 per cent of GDP. Demographic developments have since turned, and a growing share of elderly people in the population is putting pressure on general government expenditure. Swedish public finances are nevertheless sustainable (see the special analysis "The Long-term Sustainability of Public Finances"). (3) Even with relatively generous projections of general government expenditure and conservative assumptions for the average retirement age, taxes do not need to be raised as far as in the forecast for public finances to be considered sustainable.

It is high time to re-examine the appropriate level of the surplus target in the future. This review should also take account of other factors, such as the need for safety margins for future economic downturns. It is also important for any adjustment of the target to be widely supported so as not to undermine its credibility.

Forecast Revisions 2014-15

This section outlines the principal revisions to the forecast published in The Swedish Economy, December 2013. In general, the revisions of GDP and employment are relatively minor (see Table 2). The forecasts for inflation and the repo rate have been revised down.

* GDP growth in Sweden was higher than anticipated in the final quarter of 2013, which means that the level of GDP at the beginning of 2014 is somewhat higher than expected, and so the average rate of growth in 2014 will be slightly higher.

* Gross fixed capital formation and general government consumption are expected to grow somewhat more quickly in both 2014 and 2015, while stockbuilding will contribute less to demand growth after the surprisingly strong contribution in the fourth quarter of 2013.

* Employment will be somewhat weaker than expected, which means that productivity growth will be higher, putting a damper on growth in unit labour costs.

* Inflation in the euro area has been lower than expected, and the ECB is expected to start raising the refinancing rate later and much more slowly (see Diagram 11). The revised forecast is more in line with market pricing and expectations in a number of surveys.

* The more expansionary monetary policy in the euro area will lead to a somewhat stronger krona.

* Inflation in Sweden has been lower than expected, and the forecast has been revised down, particularly for 2014 and 2015 but also in the longer term (see Diagram 12). This is because unit labour costs grew more slowly than anticipated in 2013, which has also boosted corporate earnings. The stronger krona will also contribute to lower inflation.

* The Riksbank is not expected to begin raising the repo rate until July 2015 (see Diagram 13). The lower inflation in Sweden and lower central bank policy rates abroad, especially in the euro area, mean that the repo rate will be raised much more slowly in 2016-2018 than in the previous forecast.

* One reason why the forecast for general government net lending has been revised down for 2014 and up for 2015 is a reassessment of the timing of the repayment of SEK 5 billion in insurance premiums from AFA to the local government sector.

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(1) Weak groups are defined by the Employment Service as those with only basic education, those with disabilities, those born outside Europe and older people (55-64 years).

(2) See the article "The effects of monetary policy on household debt", Monetary Policy Report, February 2014, Sveriges Riksbank.

(3) See also "Is an Unchanged Public Sector Commitment a Sustainable Commitment?", Occasional Study No. 39, Swedish National Institute of Economic Research, 2014.

Table 1 Selected indicators
Percentage change unless otherwise noted

 2011 2012 2013 2014 2015

GDP, market price 2.9 0.9 1.5 2.6 3.2
GDP, calendar-adjusted 2.9 1.3 1.5 2.7 2.9
Current account (1) 6.2 6.5 6.6 6.1 5.8
Hours worked (2) 2.0 0.7 0.4 1.1 1.3
Employment 2.3 0.7 1.0 0.9 1.3
Unemployment (3) 7.8 8.0 8.0 7.9 7.3
Labour market gap (4) -1.4 -1.5 -1.7 -1.3 -0.8
Output gap (5) -1.5 -1.8 -2.0 -1.3 -0.6
Hourly earnings (6) 2.4 3.0 2.6 2.8 2.9
Labour cost, business
 sector (2) 3.3 3.5 1.8 3.2 3.1
Productivity, business
 sector (2) 1.6 1.3 1.7 2.0 2.0
CPI 3.0 0.9 0.0 0.1 1.2
CPIF 1.4 1.0 0.9 0.7 1.4
Repo rate (7,8) 1.75 1.00 0.75 0.75 1.25
Interest rate, 10-year
 government bond (7) 2.6 1.6 2.1 2.4 2.9
Index for the Swedish
 krona (KIX) (9) 107.6 106.1 103.0 102.5 100.5
GDP, world-wide 3.9 3.2 3.0 3.7 4.0
General government
 net lending (1) 0.0 -0.7 -1.3 -2.0 -0.8
General government
 consolidated gross debt
 (Maastricht debt) (1) 38.6 38.2 41.5 42.4 41.2
Cyclically adjusted
 net lending (10) 1.1 0.2 -1.0 -1.3 -0.5

 2016 2017 2018

GDP, market price 3.1 2.5 2.3
GDP, calendar-adjusted 2.9 2.7 2.4
Current account (1) 5.3 4.8 4.5
Hours worked (2) 1.4 1.1 0.8
Employment 1.1 0.9 0.8
Unemployment (3) 6.8 6.5 6.2
Labour market gap (4) -0.4 0.0 0.3
Output gap (5) -0.2 0.1 0.3
Hourly earnings (6) 3.1 3.1 3.3
Labour cost, business
 sector (2) 3.1 3.2 3.4
Productivity, business
 sector (2) 1.8 2.0 1.9
CPI 2.3 2.6 2.8
CPIF 1.6 1.9 2.1
Repo rate (7,8) 1.75 2.25 3.00
Interest rate, 10-year
 government bond (7) 3.5 3.9 4.3
Index for the Swedish
 krona (KIX) (9) 99.2 99.5 99.8
GDP, world-wide 4.1 4.1 4.1
General government
 net lending (1) -0.3 0.6 1.3
General government
 consolidated gross debt
 (Maastricht debt) (1) 40.3 38.8 36.8
Cyclically adjusted
 net lending (10) 0.0 0.6 1.2

(1) Per cent of GDP. (2) Calendar-adjusted. (3) Per cent of
labour force. (4) Difference between actual and potential
hours worked, in per cent of potential hours worked. (5)
Difference between actual and potential GDP, in per cent of
potential GDP. (6) According to Short-term Earnings
Statistics. (7) Per cent. (8) At year-end. (9) Index
1992-11-18=100. "Per cent of potential GDP.

Sources: Statistics Sweden, National Mediation Office, the
Riksbank and NIER.

Table 2 Current forecast and revisions compared
to the December 2013 forecast

Percentage change unless otherwise noted

 2014 2015

 March Diff. March Diff.
 2014 2014

International
GDP, world-wide 3.7 0.0 4.0 -0.1
GDP, OECD 2.2 0.0 2.6 -0.1
GDP, Euro Area 1.2 0.1 1.7 0.0
GDP, United States 2.7 0.1 3.2 -0.2
GDP, China 7.5 0.0 7.2 0.0
Federal funds
 target rate (1,2) 0.25 0.00 1.00 0.25
ECB:s refi rate (1,2) 0.25 0.00 0.25 0.00
Oil price (3) 106.7 -0.7 105.1 -1.8
CPI, OECD 1.8 0.0 2.0 0.0

GDP by Expenditure

GDP, calendar-adjusted 2.7 0.2 2.9 0.0
GDP 2.6 0.2 3.2 0.0
Household consumption 2.8 -0.1 2.4 0.0
General government consumption 1.0 0.3 1.9 0.8
Gross fixed capital formation 6.0 0.7 8.2 0.4
Stockbuilding (4) 0.3 -0.2 -0.1 -0.2
Exports 4.4 1.9 5.6 -0.2
Imports 6.0 1.6 6.2 0.0

Labour Market, Inflation,
Interest Rates etc.

Hours worked (5) 1.1 -0.1 1.3 0.2
Employment 0.9 -0.3 1.3 0.3
Unemployment (6) 7.9 0.2 7.3 0.0
Labour market gap (7) -1.3 -0.2 -0.8 -0.1
Output gap (8) -1.3 0.0 -0.6 0.1
Productivity, business
 sector (5) 2.0 0.5 2.0 -0.2
Hourly earnings (9) 2.8 0.0 2.9 0.1
CPI 0.1 -0.4 1.2 -0.7
CPIF 0.7 -0.3 1.4 -0.2
Repo rate (1,2) 0.75 -0.25 1.25 -0.50
Interest rate, 10-year
 government bond (1) 2.4 -0.2 2.9 -0.4
Index for the Swedish
 krona (KIX) (10) 102.5 -1.3 100.5 -1.6
Current account (4) 6.1 0.7 5.8 0.6
General government
 net lending (11) -2.0 -0.4 -0.8 0.2

(1) Per cent. (2) At year-end. (3) Dollar per barrel, annual
average. "Change in per cent of GDP preceding year. (5)
Calendar-adjusted. (6) Level, per cent of labour force. (7)
Difference between actual and potential hours worked, in per
cent of potential hours worked. (8) Difference between
actual and potential GDP, in per cent of potential GDP.
"According to Short-term Earnings Statistics. (10) Index
1992-11-18=100. (11) Per cent of GDP.

Anm. The difference is between the current forecast and the
December 2013 forecast. A positive value denotes an upward
revision.

Source: NIER.