To the Point
Discussion on the economy, by the Chief Economist
Cecilia Hermansson
Chief Economist
Economic Research Department
+46-8-5859 7720
cecilia.hermansson@swedbank.com
No. 5
2010 07 02
July 2, 2010
Time to create growth-oriented fiscal policy
The global recession and financial crisis have put pressure on politicians to
act in a responsible manner. As many advanced countries must consolidate
budgets and reduce debt, demand is likely to dampen. Thus, fiscal policy
must be carried out in a way that sustains growth prospects as much as
possible. This means finding the right balance between cutting expenditures
and increasing taxes, and safeguarding areas that contribute to higher
medium- and long-term growth, viz., infrastructure, education, and
innovation, so that increased productivity can compensate for some of the
loss in demand. There is also a “quality dimension” in the area of growth that
involves looking for more sustainable growth in a social, economic, and
environmental perspective.
The quality dimension of growth
In a prosperous society, the view is from time to time expressed that there is
too much focus on growth. Why would growth and increased consumption
be better than the opposite? some ask. And why so much focus on the details
on GDP growth, when the real issue is how to steer the economy in a
balanced way, away from debt and environmental degradation?
At the same time, actors on the financial markets are concerned with the lack
of growth, and turbulence is increasing. With the debt-stricken advanced
economies, and with the need for deleveraging in both the private and the
public sectors, how can growth be sustained, and - if not - what are the
implications for financial assets?
So, is there too much fuss about growth – or too little?
I believe that growth is important. Without growth, it will be difficult to
safeguard employment and welfare. We must try to measure growth even if it
is difficult, and at the same time bring in the quality dimension. At this stage,
it is not possible to continue building societies in the western world by
increasing debt. Better living standards must come from higher value in
production, and from investments and consumption that lead to sustainable
development. By investing in environmentally friendly technology, the
economy is expanding, and so is growth. There is a market for “responsible
investments (RI) “ that is growing.
The concerns on the financial markets are also valid. The challenge is to
maintain the recovery in the world economy – or the advanced economies –
while withdrawing stimulus measures. At the same time, sovereign debt and
fiscal deficits have reached proportions that creditors are no longer prepared
to support, and therefore budget consolidation is a must for those countries
that are highly indebted and lack a reasonable balance between revenues and
expenditures in their budgets. With austerity measures, growth will be
dampened, and the risk for a new recession increases, especially in Europe.
To the Point (continued)
July 2, 2010

Chart 1: GDP-growth in major economies The quality dimension of fiscal policy

2000-2010
15.0
China
Fiscal policy, too, must have a quality dimension. The challenge going
12.5
Russia forward is to implement economic policies that combine budget consoli-
10.0
7.5
dation with growth-oriented measures. This is quite a task. Studies show that
US India growth is better maintained with cuts in expenditures than increases in taxes.
5.0
Procent

2.5 In the US, politicians have been used to cutting taxes and increasing
0.0
expenditures, but soon they will have to do the opposite. In Europe, the need
-2.5 Japan

-5.0
to consolidate budgets is more accepted, but there is a risk that, for example,
-7.5 Germany Germany – with a decent fiscal stance – becomes too frugal, thereby
-10.0 worsening the prospects for Europe’s economic developments.
-12.5
00 01 02 03 04 05 06 07 08 09
When focusing on reaching reasonable sovereign debt levels, the Maastricht
Source: Reuters EcoWin

criteria threshold of 60% of GDP is often used. The advanced countries are
approaching levels above 100%, so the need to deleverage does exist, espec-
ially when taking into account rising health care expenditures and the nega-
tive impact of demographics on labour markets. Such high levels risk crowd-
ing out the private sector in the medium term and threaten to bring along
higher interest rates. Another and equally important reason for deleveraging
Chart 2: Developments on financial and
commodity markets 2008-2010 is that, if creditors are not prepared to finance a country’s sovereign debt, the
300 lack of new private loans to roll over existing debt could lead to default,
275
Commodity
rescue packages, and debt restructuring. The rescue package for Greece is an
250 index (USD)
example that shows how contagion to other countries creates turbulence.
225
US
200 Government
Bond 10 yr
When countries deleverage and consolidate budgets, growth will be affected
175 negatively since household incomes dampen and demand is held back; this
150 also affects companies and employment. There are those who believe that
125 S&P500 austerity will increase growth prospects, but I believe they have overlooked
100 the fact that it is more difficult to get positive growth effects when all
75
jan apr jul okt jan apr jul okt jan apr
countries simultaneously implement contractionary policies, and when
08 09 10
Source: Reuters EcoWin interest rates already are low. Not all countries can export themselves out of
the crisis when demand weakens all over the world.

The negative effects could remain in the medium and long term, which is
why lower growth would have to be compensated for by higher productivity.
This is also why fiscal policy must be growth oriented. By safeguarding
investments in infrastructure, education, and innovation, there is a possibility
of enhancing growth in the medium term. Value added in production will
come from new technology and ideas, so the budgets for infrastructure and
research need to be safeguarded in both the governments’ and the companies’
budgets. This would be acting, as we said above, “in a responsible manner!”

Cecilia Hermansson

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Cecilia Hermansson
+46-8-5859 7720