Summary.

There was no growth in GDP at all in the fourth quarter of last year, but in recent months confidence has been improving at firms and among households. Recovery will take time, however, both in Sweden and elsewhere. Unemployment will remain just above 8 percent until the end of 2014. A stronger krona and modest pay increases will hold down inflation. Even so, the Riksbank is not expected to lower the repo rate this year, but to let it remain unchanged at 1 percent until early in 2015. Fiscal policy will be expansionary this year but will have to be tightened in the period ahead if the surplus target is to be achieved. In combination with a growing number of elderly people in the population, this will probably require tax increases.

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SIGNS OF IMPROVEMENT AFTER A WEAK ENDING TO 2012

GDP in Sweden stagnated in the fourth quarter of last year (see Diagram 1). However, the tendency was somewhat less weak than expected, and the confidence indicators in the Economic Tendency Survey have subsequently risen. The upturn is from a low level, and the aggregate Economic Tendency Survey indicator is still 5 units below its mean value, but the tendency nevertheless suggests that growth will be slightly stronger in the period ahead (see Diagram 1). After increasing by 0.8 percent last year, GDP will go up by 1.3 percent this year. This lacklustre growth means that demand for labour will increase more slowly than supply; unemployment will therefore rise a bit further in 2013.

INTERNATIONAL RECOVERY REMAINS SLUGGISH

GDP fell in the euro area and was unchanged in the United States in the final quarter of last year. The economic tendency indicators have shown an upturn since the autumn of 2002 but are still at low levels in most areas of the world (see Diagram 2). This suggests that growth will be subdued in the first half of 2013, but thereafter growth will be gradually higher. Fiscal policy will be tightened further in both the euro area and the US, cur tailing the upswing in GDP growth.

In the euro area there are still many elements of uncertainty" that limit the willingness of households and firms to invest. At press time for this report, it is still uncertain whether the efforts to provide a support package for Cyprus can be brought to a successful close. The proposal for a one-time tax on bank deposits understandably raises the question how far the deposit guarantees extend in other euro countries. If this concern takes hold, it may cause a new wave of financial turbulence in other European countries with shaky government finances, with negative consequences for the development of the real economy.

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GDP in the euro area will stop decreasing after the first quarter, but to increase only slowly for the rest of the year. Growth will be so weak that unemployment, which is already record high (see Diagram 3), is expected to continue rising somewhat during 2013.

In order to reduce unemployment in southern Europe, cost levels in those countries must be lowered compared to northern Europe and probably the rest of the world as well. During the period since the euro was introduced, unit labour costs have risen much faster in most other countries of the euro area than in Germany (see Diagram 4). After 2008, however, the tendency has been the reverse in most countries. Ireland, Spain, and Portugal have been able to lower their unit labour costs, while the rate of increase in Germany has gone up. In France and Italy, unit labour costs are no longer rising more rapidly than in Get many, but they probably need to fall relative to Germany in order to become competitive again. In a somewhat longer perspective, relative unit labour costs in all these countries are still considerably higher compared to Germany than in 2000. Many challenges remain before cost levels have been adjusted sufficiently and unemployment begins to drop in the hardest-hit countries.

RECOVERY CONTINUING IN THE UNITED STATES

In the US, growth is stronger, and recovery continues despite a significantly tighter fiscal policy: tax increases equivalent to 1.25 percent of GDP at year-end and automatic expenditure reductions of 0.4 percent of GDP are to be implemented during the year. But the expansionary monetary policy will help housing construction to increase from a low level, and household consumption will grow- more rapidly. Economic recovery will thus proceed. Unemployment, however, is still high and is not expected until 2015 to be down at the threshold level of 6.5 percent set by the Federal Reserve, the US central bank, as a condition for beginning to raise the federal funds (policy interest) rate.

LITTLE BOOST FOR THE SWEDISH ECONOMY FROM OTHER COUNTRIES

For Sweden, the slow recovery in other countries means that domestic demand will be more important as a driving force for the economy than in recent economic upturns. Exports, which were up by about 1 percent last year, will show the same lacklustre increase this year. This will curb manufacturing output, which decreased last year and remains below the levels before the financial crisis (see Diagram 5). Moreover, the spare production capacity is found primarily in manufacturing. It will not be put to use before 2014, when international demand and thus exports will begin to grow more rapidly.

With the weak tendency in manufacturing, investment in that sector will decrease this year, but recently households have become more optimistic about the development of the housing market, so that an upturn may come there very soon.

Domestic demand has shown a stronger tendency, thus helping production of housing and services to recover fully since the financial crisis, even if the levels at the end of 2012 will not fully reach their trend rate of increase. Growth in demand is being sustained this year by household consumption expenditure. The low inflation and increased pensions will contribute to a relatively large increase in real disposable incomes. At the same time, pessimism about the development of the economy has diminished, and the confidence indicator has risen nearly to its historical mean (see Diagram 6). Consumption is therefore expected to increase by 2.5 percent this year, which is the principal reason why GDP will increase by more than 1 percent this year.

DIFFICULT TO STIMULATE DOMESTIC DEMAND

Sweden's public finances are in good condition, but as in the other OECD countries, there are substantial demographic challenges. (1) Thus, there is not much of a fiscal policy margin for permanently stimulating domestic demand. Monetary policy has its limits, too, since the repo rate is already low. Household saving, on the other hand, is currently at a record high (see Diagram 7), so that the average household has a substantial margin for increased consumption. Some decrease in saving is probable when uncertainty about the development of the economy subsides and unemployment begins to drop; so-called precautionary saving will then decrease. But for domestic demand to keep driving recovery, household saving must continue to fall during 2015-2017. The distribution of saving among different age and income groups is skewed, and the demographic tendency of an increasingly large proportion of elderly persons, who normally save less, is also indicative of a downturn in the average saving ratio. But the decrease in the saving ratio may proceed more slowly than in the forecast. The level of saving in 2017, however, is not remarkably low by historical standards.

A STRONGER KRONA

The effective nominal rate of exchange as measured by the KIX is now almost as strong as before the fixed exchange rate was abandoned in November 1992 (see Diagram 8). The broad KIX index includes Sweden's 32 most important trading partners, some of which are emerging economies where the average inflation rate is higher than in Sweden. In some of these countries, there have been periods of extremely high inflation and rapid weakening of the nominal rate of exchange (for example, Mexico in 1995 and Turkey in 2001). Thus, the fact that the "krona has strengthened in nominal terms compared to the currencies of these countries does not mean very much for competitiveness or purchasing power. The bilateral nominal exchange rate against the euro and the dollar, whose inflation has been more like our own, is still weaker than in 1992 (see Diagram 9).

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In real terms the "krona is still some 25 percent weaker than in 1992 compared to Sweden's 32 principal trading partners (see Diagram 8). The emerging economies have had, and will continue to have, higher productivity growth than in Sweden. The krona will therefore continue to depreciate in real terms against the currencies of these countries. However, this will take place primarily through more rapidly, increasing prices in the emerging economies--in nominal terms, therefore, the KIX is not expected to change very much.

UNEMPLOYMENT TO LEVEL OUT JUST ABOVE 8 PERCENT

Unemployment has continued rising and is just over 8 percent, but there are now signs that the increase is slowing (see Diagram 10). However, there will be no clear downturn until early" in 2015, and when unemployment has dropped to its estimated equilibrium level in 2017, Sweden will have had an abnormally high unemployment rate for over 8 years.

The weakness of the labour market will limit the rate of pay increases to just under 3 percent in 2013-2015. The pay negotiations currently in progress have not yet provided any indication of a significantly higher or lower rate of pay, increases than in this assessment.

LOW PRICES OF IMPORTS RESULT IN LOW INFLATION

Inflation as measured by the CPIF has hovered around 1 percent since the end of 2011 and is showing no signs of an upward shift any time soon (see Diagram 11). At the end of 2013, a gradual upturn will begin as the effects of a stronger krona wear off and prices of imports show a stronger tendency. With rising resource utilization, inflation will gradually go up later on. As measured by the CPIF, however, inflation will not reach its target rate of 2 percent until 2016.

UNCHANGED REPO RATE DESPITE LOW INFLATION

A majority of the Riksbank's Executive Board have signaled clearly that they are not disposed to reduce the repo rate further given the current economic outlook, even though inflation is well below its target and unemployment shows no signs of decreasing in the year ahead. To judge by the pricing on the forward market, investors on financial markets believe that the repo rate will remain unchanged at 1 percent for roughly one year (see Diagram 12). With inflation not decreasing further in the near future and unemployment leveling out roughly according to the Riksbank's latest forecast, the NIER's assessment is that the repo rate will most likely not be changed this year.

With the repo rate at its current level of 1 percent, monetary policy is expansionary and contributes to the recovery of the economy. According to the NIER's forecast, however, inflation will not rise as rapidly during 2014 as in the Riksbank's forecast, and the repo rate, in contrast to the Riksbank's forecast, will therefore be held unchanged in 2014 as well. Not until the spring of 2015, when the economy is clearly recovering and unemployment has been decreasing for some time, will a series of rate hikes begin. This interest rate policy is consistent with previous patterns in the 2000's.

The principal reason why the repo rate will not be lowered further this year thus seems to be that inflation, in the Riksbank's forecast, is expected to rise rapidly during 2014. The NIER does not share this view, nor do most other analysts, who foresee a lower inflation rate in 2014 and 2015. The expectations of households and firms for the inflation rate one year ahead are around 1 percent (see Diagram 13). Inflation expectations two years ahead, according to Prospera's latest survey, are 1.5 percent.

Another factor emphasized by the majority of the Riksbank's Executive Board is concern that the increasing indebtedness of households may lead to instability later on. The rate of increase in indebtedness, however, has slowed, and the NIER sees no obvious risk that it will increase in the near future. As with the forecast in December, it is the NIER's opinion that the Riksbank should follow an even more expansionary monetary policy that would lead inflation to the target more rapidly and help to reduce unemployment.

DIFFICULT TO MEET SURPLUS TARGET

Fiscal policy will be expansionary this year, which is appropriate given the current weak state of the economy. Cyclically adjusted net lending in general government is expected to be slightly below zero (see Diagram 14). In the forecast for 2014, fiscal policy is given a neutral stance; this is compatible with implementing unfunded measures totaling SEK 15 billion. (2) To meet the surplus target for general government net lending--average net lending of 1 percent of GDP over an economic cycle--it will be necessary to tighten fiscal policy in subsequent years. In an international perspective no comprehensive austerity measures are required, but the reforms that the Riksdag and the Government will implement must be fully financed.

During the period 2000-2008 the old-age pension system generated net lending equivalent to 1 percent of GDP. The surplus target for general government finances was then reached through balanced finances in central and local government. Now saving in the old-age pension system has fallen nearly to zero and is calculated to remain at that level for the next 5-10 years. This calls for stricter requirements for central government net lending in order to meet the surplus target (see the special analysis "The Surplus Target for General Government Finances" in the chapter "Macroeconomic Development and Economic Policy 2013-2017").

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At the same time, the demographic trend, with a rapidly growing number of older people, puts pressure to increase appropriations for health and nursing care. One of the reasons for introducing the surplus target was to strengthen the net wealth position of the public sector in anticipation of the pressure for expenditure resulting from rising proportion of elderly people in the population. Sweden is now in a situation where demographic pressure for expenditure has begun to increase. It may therefore be appropriate to study whether the surplus target should be adjusted t-or the coming 10-year period.

HEAVY PRESSURE FOR TAX INCREASES AFTER 2014

The growing number of younger and older people in the population calls for increased capacity in schools, health care and nursing. With unchanged staffing intensity in these public services, with transfers to households in accordance with the development of hourly earnings, and with public sector investment growing at the same rate as GDP (which taken together can be said to constitute an unchanged public-sector commitment), there arises a financing need of SEK 66 billion through 2017 (see also the special analysis "The NIER's Assessment of the Scope for Reforms" in the chapter "Macroeconomic Development and Economic Policy 2013-2017"). In addition, there will be changes in central government interest expenditure and a need to increase net lending in order to meet the surplus target. if the public-sector commitment according to this definition is to be maintained while at the same time the surplus target is to be achieved and the macroeconomic development follows the NIER's forecast, there will be a need for SEK 74 billion in additional revenue, i. e. tax increases as a practical matter.

However, the Government is considerably more optimistic about the macroeconomic development in the period ahead. In the forecast presented by the Minister for Finance in December, 2012, unemployment will be considerably lower and potential GDP through SEK 100 billion higher in 2017 than in the NIER's current forecast. Tax revenue would then be roughly SEK 50 billion greater and the need for additional revenue correspondingly less. This macroeconomic development, however, is not very probable, according to the NIER. But if it nevertheless proves correct, then there would be no margin for tax cuts if the public commitment were unchanged, given that the surplus target is to be met. The latter is obviously a political question, and the Riksdag may well find it appropriate to reduce the commitment somewhat. Even then, because of the demographic trend, the need for some additional resources would be virtually unavoidable and increases in revenue would be required.

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Revisions in the Forecast for 2013-2014

This section describes in bullet form the principal revisions of the forecast published in The Swedish Economy, December 2012.

* Somewhat stronger GDP growth in 2013. The end of 2012 was somewhat stronger, and the quarterly growth in the second through fourth quarters of 2013 is also expected to be somewhat stronger (see Diagram 15).

* The higher growth in 2013 is based primarily on somewhat stronger growth in household consumption, but also in gross fixed capital formation.

* The forecast for GDP growth in 2014 is roughly unchanged. Slightly weaker growth in consumption is offset by a stronger increase in exports.

* A somewhat stronger tendency in employment, primarily at the outset of 2013, will mean a more limited upturn in unemployment than in the previous forecast (see Diagram 16). At the same time, Statistics Sweden has made upward revisions in the level of the outcome data for unemployment in 2010-2012.

* The exchange rate has strengthened more than expected, and the forecast for the next two years is slightly stronger.

* A somewhat higher price of oil and higher unit labour costs will offset the anti-inflationary effect of a stronger exchange rate. The forecast for CPIF inflation is virtually unchanged.

* With the Riksbank's announcement, in combination with a lower rate of increase in unemployment than in the previous forecast, the forecast is now that the repo rate will not be lowered further (see Diagram 17).

(1) See "Konjunkturinstitutets berakning av Iangsiktig hallbarhet i de offentliga finanserna" ("The NIER's Estimate of the Long-Term Sustainability of Public Finances"), fordjupnings-pm (brief paper) no. 20, NIER, 2013.

(2) In the current situation, this forecast is highly uncertain. It is based on the NIER's interpretation of statements made by different representatives of the Government.

Table 1 Selected Indicators

Percentage change unless otherwise stated

 2010 2011 2012 2013

GDP 6.6 3.7 0.8 1.3
GDP, calendar-adjusted 6.3 3.7 1.2 1.3
Current account (1) 6.9 7.3 7.0 6.2
Hours worked (2) 2.0 2.4 0.6 0.2
Employment 0.6 2.3 0.7 0.5
Unemployment (3) 8.6 7.8 8.0 8.2
Labour market gap (4) -2.6 -1.5 -1.6 -2.0
Output gap (5) -4.1 -2.0 -2.3 -2.7
Hourly earnings (6) 2.6 2.4 3.1 2.8
Cost of labour, business sector (2) 0.1 2.9 3.2 3.0
Productivity, business sector (2) 5.0 2.4 1.2 1.3
CPI 1.2 3.0 0.9 0.2
CPIF 2.0 1.4 1.0 1.0
Repo rate (7,8) 1.25 1.75 1.00 1.00
Interest rate, 10-year
government bond (7) 2.9 2.6 1.6 2.3
Index for the Swedish krona (KIX) (9) 114.3 107.6 106.1 101.7
GDP, world-wide 5.1 3.8 3.1 3.3
General government net lending (1) 0.0 0.0 -0.7 -1.4
Cyclically adjusted net lending (10) 2.1 1.6 0.4 -0.3

 2014 2015 2016 2017

GDP 2.3
GDP, calendar-adjusted 2.4 3.0 3.1 2.6
Current account (1) 6.0 5.1 4.5 4.1
Hours worked (2) 0.6 1.1 1.2 1.0
Employment 0.4 1.0 1.2 1.0
Unemployment (3) 8.2 7.7 7.0 6.5
Labour market gap (4) -1.9 -1.2 -0.5 0.0
Output gap (5) -2.1 -1.1 -0.1 0.4
Hourly earnings (6) 2.7 2.8 2.9 3.1
Cost of labour, business sector (2) 2.8 2.9 3.0 3.2
Productivity, business sector (2) 2.3 2.2 2.3 2.0
CPI 1.1 1.9 2.4 2.9
CPIF 1.4 1.6 1.8 2.0
Repo rate (7,8) 1.00 1.50 2.25 3.25
Interest rate, 10-year
government bond (7) 3.2 3.8 4.3 4.5
Index for the Swedish krona (KIX) (9) 102.2 103.2 103.0 102.7
GDP, world-wide 4.1 4.4 4.5 4.5
General government net lending (1) -1.1 -0.5 0.3 1.1
Cyclically adjusted net lending (10) -0.4 0.1 0.6 1.2

(1) Percent of GDP. (2) Calendar-adjusted. (3) Percent of labour
force. (4) Difference between actual and potential hours worked, in
percent of potential hours worked. (5) Difference between actual
and potential GDP, in percent of potential GDP. (6) According to
Short-term Earnings Statistics. (7) Percent. (8) At year-end. (9)
Index 1992-11-18=100. (10) Percent of potential GDP.

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

Table 2 Current Forecast and Revisions Compared to
the December 2012 Forecast

Percentage change unless otherwise stated

 2013

 March

 2013 Diff.
International
GDP, world-wide 3.3 -0.1
GDP, DECD 1.3 -0.1
GDP, Euro Area -0.4 -0.4
GDP, United States 1.8 -0.1
GDP, China 8.1 -0.1
Federal funds target rate (1,2) 0.25 0.00
ECB refi rate (1,2) 0.75 0.00
Oil price (3) 109.3 3.6
CPI, OECD 1.9 0.0
GDP by Expenditure
GDP, calendar-adjusted 1.3 0.5
GDP 1.3 0.5
Household consumption 2.5 0.6
General government consumption 0.9 0.1
Gross fixed capital formation 1.3 0.6
Stockbuilding (4) 0.0 0.2
Exports 1.2 0.1
Imports 2.4 0.3
Labour Market, Inflation, Interest Rates etc.
Hours worked (5) 0.2 0.6
Employment 0.5 0.6
Unemployment (6) 8.2 -0.1
Labour market gap (7) -2.0 0.2
Output gap (8) -2.7 0.2
Productivity, business sector (5) 1.3 -0.2
Hourly earnings (9) 2.8 0.0
CPI 0.2 -0.2
CPIF 1.0 0.1
Repo rate (1,2) 1.00 0.25
Interest rate, 10-year government bond (1) 2.3 0.3
Index for the Swedish krona (KIX) (10) 101.7 -3.3
Current account (4) 6.2 -0.2
General government net lending (11) -1.4 -0.2

 2014

 March

 2013 Diff.
International
GDP, world-wide 4.1 -0.1
GDP, DECD 2.3 0.0
GDP, Euro Area 1.2 -0.2
GDP, United States 2.7 0.0
GDP, China 8.2 -0.4
Federal funds target rate (1,2) 0.25 -0.25
ECB refi rate (1,2) 0.75 0.00
Oil price (3) 107.0 2.4
CPI, OECD 2.0 0.1
GDP by Expenditure
GDP, calendar-adjusted 2.4 0.1
GDP 2.3 0.1
Household consumption 2.7 -0.5
General government consumption 0.7 0.1
Gross fixed capital formation 3.7 0.1
Stockbuilding (4) 0.0 0.0
Exports 4.6 0.4
Imports 5.0 -0.2
Labour Market, Inflation, Interest Rates etc.
Hours worked (5) 0.6 0.1
Employment 0.4 0.3
Unemployment (6) 8.2 -0.3
Labour market gap (7) -1.9 0.3
Output gap (8) -2.1 0.2
Productivity, business sector (5) 2.3 -0.1
Hourly earnings (9) 2.7 0.0
CPI 1.1 -0.1
CPIF 1.4 0.0
Repo rate (1,2) 1.00 -0.25
Interest rate, 10-year government bond (1) 3.2 0.2
Index for the Swedish krona (KIX) (10) 102.2 -1.4
Current account (4) 6.0 0.0
General government net lending (11) -1.1 0.0

(1) Percent. (2) At year-end. (3) Dollar per barrel, annual
average. (4) Change in percent of GDP preceding year.
(5) Calendar-adjusted. (6) Level, percent of labour force.
(7) Difference between actual and potential hours worked,
in percent of potential hours worked. (8) Difference between
actual and potential GDP, in percent of potential GDP.
(9) According to Short-term Earnings Statistics.
(10) Index 1992-11-18=100. " Percent of GDP.

Note. The difference is between the current forecast and
the December 2012 forecast. A positive value denotes an
upward revision.