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How To Get The Balance Right: Fiscal Policy At A Time Of Crisis

 May 07, 2012 10:44 AM


By Anders Borg (1) and Christine Lagarde

Last autumn was a turbulent time for Europe. The debt crisis deepened and financial markets became embroiled in turmoil, driven by fears of widespread restructuring of public debt. The crisis has harmed growth, increased unemployment, and left a large number of people less protected. We are now seeing some signs of stabilization. Most countries are reducing their deficits and even if debt ratios are still rising, the return back to fiscal health has begun.

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The International Monetary Fund and the Swedish Ministry of Finance are hosting an international conference in Stockholm on May 7-8, with the purpose of sharing knowledge and providing guidance on the best way to achieve fiscal consolidation, and on the role that effective fiscal policy frameworks and institutions can play in this endeavor.

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Learning from experience

Sweden provides an interesting case study for countries' current predicament. In the early 1990s, Sweden was rocked by an economic crisis with escalating unemployment, double digit deficits, and a sudden loss of market confidence that raised the cost of sovereign borrowing.

 

In response, Sweden initiated a comprehensive set of reforms. Favorable external conditions helped, but domestic policies played a critical role in the adjustment. Strong fiscal tightening was implemented to regain fiscal sustainability and market confidence. This was accompanied by the effective handling of the crisis in the financial sector, and structural reforms that raised Sweden's competitiveness, long-term growth rates, and real wages. A new fiscal policy framework—founded on a surplus target, a medium-term expenditure ceiling and a comprehensive top-down budget process—has since helped preserve strong public finances and prepared Sweden well for the current crisis.


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