The NIER s Conceptual Framework for Fiscal Policy

The NIER s Concepual Framework for Fiscal Policy OCCASIONAL STUDIES NO 16, MARCH 2008 PUBLISHED BY THE NATIONAL INSTITUTE OF ECONOMIC RESEARCH (NIER)

The NATIONAL INSTITUTE OF ECONOMIC RESEARCH (NIER) prepares analyses and forecass of he Swedish and inernaional economy and conducs relaed research. The NIER is a governmen agency accounable o he Minisry of Finance and is funded largely by he Swedish governmen. Like oher governmen agencies, he NIER has an independen saus and is responsible for he assessmens ha i publishes. The Swedish Economy conains analyses and forecass of he Swedish and inernaional economy. I is he English summary of he repor in Swedish, Konjunkurläge. The Saisical Appendix, a comprehensive se of ables wih numerical daa, is issued ogeher wih Konjunkurläge. Lönebildningsrapporen is an analysis of he economic condiions for wage formaion in Sweden. The Repor on Wage Formaion is a summary of Lönebildningsrapporen in English. The Economic Tendency Survey is he join designaion for wo repors, he Business Tendency Survey and he Consumer Survey, which presen he curren views of business and consumers, respecively, on he sae of he economy. In he Occasional Sudies series, he NIER publishes repors based on sudies or oher assignmens. Research findings are published in he Working Paper series. Our publicaions can be downloaded from he NIER s home page, www.konj.se. KONJUNKTURINSTITUTET, KUNGSGATAN 12-14, BOX 3116, SE-103 62 STOCKHOLM TEL: +46 8 453 59 00 FAX: +46 8 453 59 80 E-MAIL: KI@KONJ.SE HOMEPAGE: WWW.KONJ.SE ISSN 1650-996X

Preface This repor describes how he Naional Insiue of Economic Research (NIER) reaches is fiscal policy assessmens, in regard o he rade-off beween he goal of sabilizaion and arges for public finances, for example. Also provided in he repor is a heoreical and empirical review of he lieraure on fiscal policy. This repor may be revised subsequenly in ligh of new heoreical, empirical and pracical knowledge. New versions will be published on he NIER s home page. The NIER is deeply graeful o Torben Andersen, Jesper Hansson, Yngve Lindh and seminar paricipans from he Minisry of Finance and he Swedish Fiscal Policy Council for heir consrucive commens on previous versions. The repor was wrien by Göran Hjelm.

Conens Chaper 1 Inroducion...5 2 Definiions...10 3 Basic Assumpions for a Fiscal Policy wih a Flexible Exchange Rae...32 4 Fiscal Policy Difficulies and Opporuniies...37 5 The Fiscal Policy Reacion Funcion: a Trade-off beween he Surplus Targe and Resource Uilizaion...59 6 Appendices...81 7 References...95 1

Conens Chaper and Secion 1 Inroducion...5 1.1 Presenaion and Suggesions o Readers...7 1.2 Delimiaions...8 2 Definiions...10 2.1 Acual and Cyclically Adjused Ne Lending...11 2.1.1 The Surplus Targe...12 2.2 Fiscal Policy...13 2.3 Expansionary and Conracionary Fiscal Policy...15 2.3.1 The Time Dimension Makes a Difference...16 2.4 Acive and Passive Fiscal Policy...18 2.5 Fiscal Policy and Resource Uilizaion: Some Rules of Thumb...20 2.6 Economic Effecs of he Repo Rae Level, of he Level of General Governmen Ne Lending, and of he Change in These Two Facors...22 2.7 Pro- and Counercyclical Fiscal Policy...26 2.8 Permanen and Temporary Fiscal Policy...27 2.9 Business Cycle...28 2.9.1 Conceps...28 2.9.2 Causes...30 3 Basic Assumpions for a Fiscal Policy wih a Flexible Exchange Rae...32 3.1 Moneary Policy Response o Fiscal Policy...33 3.2 Auomaic Sabilizers...34 4 Fiscal Policy Difficulies and Opporuniies...37 4.1 Argumens agains Fiscal Policy...37 4.1.1 Decisions Delayed by Time-Consuming Process of Decision-Making...37 2

4.1.2 Asymmery in Poliical Decision-Making...38 4.1.3 Time-Consisency Problems...39 4.1.4 Models for Opimal Moneary and Fiscal Policy...40 4.1.5 Uncerainy abou Resource Uilizaion and Ne Lending in Real Time 41 4.2 Argumens for Fiscal Policy...43 4.2.1 Impoence of Moneary Policy...43 4.2.2 Rapid Impac on Demand...44 4.2.3 Many Tools...44 4.2.4 Fiscal Policy Objecives Require a Fiscal Policy...45 4.3 Fiscal Policy Should Be Transparen and Based on Rules...45 4.3.1 Targes and Rule-Based Fiscal Policy...46 4.3.2 Transparency...46 4.3.3 Incenive Srucure ha Encourages Targe Achievemen...46 4.4 Ideas of Oher Counries and Organizaions abou Fiscal Policy...47 4.5 Macroeconomic Effecs of Fiscal Policy: Muliplier Analysis...49 4.5.1 Theory...50 4.5.2 Empirical Findings...52 4.5.3 Calibraion Decisions in Macromodels...55 4.5.4 The NIER s View on he Fiscal Policy Muliplier...56 5 The Fiscal Policy Reacion Funcion: a Trade-off beween he Surplus Targe and Resource Uilizaion...59 5.1 Fundamenal Conflics of Objecives: a Two-by-Two Table...60 5.2 Fiscal Policy Reacion Funcion: Mehod and Resuls...62 5.2.1 Choice of Variables in he Reacion Funcion...62 5.2.2 Reacion Funcion or Loss Funcion?...66 3

5.2.3 Choice of Parameers in he Reacion Funcion...67 5.3 Reasons no o Follow he Fiscal Policy of he Reacion Funcion...74 5.3.1 Abnormal Cyclical Siuaions...75 5.3.2 Sligh Deviaions from Targes...76 5.3.3 Avoid Fiscal Policy of Minimal or Grea Magniude...77 5.4 Applicaion of he Reacion Funcion in Acual Economic Siuaions...77 6 Appendices...81 6.1 Fiscal Policy and Resource Allocaion: Examples and Rules of Thumb...81 6.1.1 Example. 1: Fiscal Policy Tha Affecs Acual bu no Poenial GDP 81 6.1.2 Ex.2: Fiscal Policy Tha Affecs Acual and Poenial GDP...83 6.2 Cyclical Variaions and Welfare...86 6.3 Fiscal Policy Reacion Funcion. Firs Ieraion...88 6.4 Fiscal Policy Model: Effecs on Ne Lending and he Oupu Gap...89 6.4.1 The Oupu Gap and Ne Lending wih Fiscal Policy Excluded...90 6.4.2 Appropriae Fiscal Policy According o he Reacion Funcion...93 7 References...95 4

1 Inroducion The Naional Insiue of Economic Research (NIER) commens regularly on he sance of fiscal policy in is quarerly publicaion The Swedish Economy. Beginning wih he issue of January, 2008, forecass of fuure fiscal policy are made for he purpose of improving forecass for boh he real economy and he general governmen secor. For he years in he forecas period where no cenral governmen budge has been adoped or (proposed), he fiscal policy forecas normally consiss of he NIER s opinion on an appropriae fiscal policy sance in view of he Governmen s fiscal and sabilizaion policy objecives. 1 To ensure ha he NIER s assessmens are consisen, ransparen and pedagogically presened, his Special Sudy explains he basis for he NIER s assessmens. While sabilizaion is he sole purpose of moneary policy, a fiscal policy may be followed for several differen reasons. One way o classify hese is he following: (i) income redisribuion policy, (ii) efficiency, (iii) sabilizaion of resource uilizaion and (iv) budge policy arges (such as he surplus arge and he expendiure ceiling). When he NIER forms an opinion on an appropriae sance for fiscal policy, he focus is on he rade-off beween (iii) sabilizaion and (iv) general governmen ne lending in relaion o he surplus arge. The rade-off, however, is no always wihou problems, as objecives ofen conflic. The wo-by-wo diagram presened below shows he four basic combinaions ha may arise. 1 For a year for which a cenral governmen budge has been proposed (or adoped), is conen deermines he fiscal policy forecas. For his year, however, he NIER can recommend ha fiscal policy be realigned in a cerain direcion in cases where he cenral governmen budge deviaes subsanially from wha he NIER considers o be an appropriae fiscal policy. Despie a possible recommendaion, he cenral governmen budge proposed (or adoped) will normally be he NIER s forecas. As noed in he main ex, he fiscal policy forecas normally consiss of he NIER s assessmen of an appropriopriae fiscal policy sance for he years for which no cenral governmen budge has been proposed (or adoped). The laer presupposes ha he Governmen will subsequenly reach he same assessmen of an appropriae fiscal policy sance as he NIER for hese years. See he special analysis The NIER s Fiscal Policy Forecass (only in Swedish) in The Swedish Economy, January 2008, for a deailed descripion of his in pracical applicaion. 5

Ne lending High Low Resource High Conflicing objecives Raise axes/cu expendiure uilizaion Low Cu axes / raise expendiures Conflicing objecives If he expendiure ceiling so permis. In wo of he combinaions, resource uilizaion and ne lending give he same fiscal policy signal; his simplifies he fiscal policy assessmen, alhough ha simple signal does no in iself provide any guidance on he magniude of he desired change in fiscal policy. Cases where objecives conflic are far more difficul, for example when measures ha would improve resource uilizaion would unfavourably impac ne lending in relaion o he surplus arge. I is imporan o emphasize, however, ha wih he surplus arge formulaed as an average over an economic cycle, here are fewer poenial conflics beween objecives han if he surplus arge applied o a single year. 2 The presen Special Sudy resuls in an explici fiscal-policy reacion funcion ha on average reflecs he NIER s preferred fiscal policy sance in various fiscal and cyclical 2 The surplus arge is designed o improve, on average, he chances ha fiscal policy acion will be aken a he righ ime. Assume ha resource uilizaion in period (he curren year, for example) is regarded as balanced, whereas in period + 1 i is expeced o be srained. If average ne lending wih an unchanged fiscal policy is esimaed o fall shor of he surplus arge in boh of hese periods, here is reason o wai unil +1 before aking acion o srenghen he budge. The explanaion is ha boh objecives (full resource uilizaion and he surplus arge) call for a conracionary policy in period +1; hus, he wo objecives do no conflic for his period. 6

siuaions. 3 I should be emphasized, hough, ha his reacion funcion is only an aid in he NIER s assessmen of he appropriae sance for fiscal policy. Each economic siuaion is unique, calling for siuaion-specific consideraions ha canno be capured in a model. On he oher hand, he fiscal policy reacion funcion is inended o play a cenral role as a seering oar in he deerminaion of an appropriae fiscal policy sance no leas in order o ensure ha assessmens will be consisen over ime. The reacion funcion also promoes ransparency and serves a pedagogical purpose, parly because reasons should normally be provided for any deviaions from he fiscal policy proposal generaed by he reacion funcion. 1.1 Presenaion and Suggesions o Readers Chaper 5 presens he fiscal policy reacion funcion, which is he NIER s insrumen for deermining he appropriae rade-off beween he surplus arge and full resource uilizaion in differen fiscal and cyclical siuaions. The rade-off (i. e. he NIER s preferences) is based on he fiscal policy analysis presened in Chaper 2 4. More specifically, he firs sep in his Special Sudy is o define a number of imporan fiscal policy conceps in Chaper 2 ha are subsequenly used hroughou he sudy and in he NIER s oher publicaions. Chaper 3 discusses he role ha fiscal policy can play in an economy wih a flexible exchange rae and an inflaion arge. Here, in addiion, commens are provided on he relaionship beween moneary and fiscal policies and is effec on he NIER s fiscal policy assessmens. Chaper 4 analyzes he advanages and disadvanages of fiscal policy 4 in a discussion on fiscal policy rules and ransparency. Also provided is a brief overview of he 3 This approach has been inspired by Svensson s (2007) suggesion of exracing and formalizing he moneary policy preferences of decision-makers on moneary policy (in Sweden, he Execuive Board of he Riksbank, he counry s cenral bank), in oher words, primarily on he rade-off beween he inflaion arge and balanced resource uilizaion in various cyclical siuions. 4 As shown in Secion 2.2, he concep of fiscal policy refers o changes in general governmen ne lending ha remain afer adjusmen for he effecs of auomaic sabilizers. In he lieraure, his is cusomarily ermed acive/discreionary/srucural fiscal policy. As discussed in Secion 2.4, he concep of fiscal policy is subdivided ino an acive and a passive componen, wih he difference consising in he degree o which poliical decisions can be linked o he fiscal policy sance observed. 7

hinking on fiscal policy in oher counries and in inernaional organizaions. Finally, he chaper presens a heoreical and empirical review of he effecs of fiscal policy on he economy (a so-called muliplier analysis). The findings from Chaper 2-4 are hen used in Chaper 5, where he reacion funcion akes specific form. The Special Sudy concludes wih a number of appendices in Chaper 6. Finally, some suggesions for furher reading: The arge group for his Special Sudy consiss of economiss and news reporers on economic affairs who follow he NIER s fiscal policy assessmens. Alhough reading he enire Special Sudy is recommended, he more iniiaed migh omi Chapers 3 4. However, all should read Chaper 2, on definiions, parly because fiscal policy conceps are someimes used incorrecly in economic debaes, and parly because he NIER s definiions of cerain cenral conceps differ from hose cusomarily found in he lieraure. 1.2 Delimiaions In his concepual framework for fiscal policy, he approach is pragmaic hroughou. The ools of analysis used are designed o funcion in he NIER s siuaion, which is characerized, among oher hings, by imperfec informaion and limied ime beween daa processing, analysis and publicaion. From a welfare sandpoin, no opimal fiscal policy is developed in he Special Sudy (see, for example, Benigno and Woodford, 2005, for such an approach when i comes o moneary and fiscal policy). As is discussed in Secion 4.1.4, he lieraure on opimal moneary and fiscal policy, compared o oher fiscal-policy heory, is relaively new, and i is sill an open quesion wha policy-relevan conclusions i will ulimaely reach. Insead, a so-called revealed preference approach is followed; i gives senior personnel a he NIER an opporuniy o indicae heir preferences abou he rade-off beween full resource uilizaion and achievemen of he surplus arge in ficiious and real-life experimens. In hese experimens, he relaionship beween moneary and fiscal policy has been aken ino accoun in several ways. One is ha he calibraion of he fiscal policy muliplier was adjused in view of moneary policy responses o fiscal policy. Also, he effecs of fiscal policy on resource uilizaion were calculaed in he developmen of he reacion funcion, obliging paricipans o 8

consider (implicily) he effecs of fiscal policy on inflaionary pressure. Wih his approach, a fiscal policy reacion funcion was developed (see Chaper 5). 5 5 I should be noed ha he deviaion, if any, from he so-called expendiure ceiling is no considered in he presen sudy. The analysis of an appropriae fiscal policy sance considers resource uilizaion, he level of general governmen ne lending in relaion o he surplus arge and he level of cyclically adjused ne lending (see Chaper 5). 9

2 Definiions To pu i simply, moneary policy is conduced for he purpose of sabilizaion, he arges for Sweden being 2-percen inflaion and sable resource uilizaion. As fiscal policy has several objecives, i is imporan o esablish wha ype of fiscal policy is involved in he presen Special Sudy. One possible classificaion of he differen aims of fiscal policy measures is he following: 1. Income redisribuion policy governed by value judgmens. 2. Effors o improve efficiency increase he long-erm producion capaciy of he economy, for example, hrough infrasrucure, educaion and he design of he ax and benefi sysems. 3. Sabilizaion policy achieve a high and sable level of resource uilizaion. 4. Sae of public finances mee he surplus arge (can be viewed as a policy of income redisribuion beween generaions). 6 no o exceed he expendiure ceiling.. Iems 1 and 2 require specificaion of which ax raes and ypes of expendiure should be changed; his is ouside he scope of he NIER s assignmen. 7 When he NIER 6 Since he surplus arge is expressed as an average over an economic cycle, i may be viewed as an inermediae arge designed o promoe he desired developmen of he deb raio; see also Secion 2.1.1 below. 7 As for Iem 2, he NIER coninually assesses wheher fiscal policy measures affec efficiency. For he years when no cenral governmen budge has been proposed or adoped, i. e. he years when he NIER s opinion on an appropriae sance for fiscal policy consiues he forecas (see Foonoe 1), he NIER also divides he proposed change in general governmen ne lending ino expendiure and revenue; see he special analysis The NIER s Fiscal Policy Forecass (only in Swedish) in The Swedish Economy, January 2008. 10

expresses an opinion on he sance of fiscal policy in his and oher publicaions, reference is made o Iems 3 and 4, i. e., consideraions of sabilizaion policy, as well as he sance of fiscal policy in relaion o esablished arges for general governmen finances (such as he surplus arge and expendiure ceilings). 8 I should be noed even a his early juncure ha he NIER regards boh resource uilizaion and he surplus as symmerical. This means ha i is equally imporan, in principle, o use sabilizaion policy o moderae he endency of GDP, wheher above or below rend. Also, fiscal policy should, in principle, be adjused so ha ne lending on average neiher exceeds nor falls shor of he surplus arge over an economic cycle. The primary reason for he NIER s symmerical approach is ha he Governmen s objecives of full resource uilizaion and surpluses in general governmen finances are expressed symmerically. Thus, in he presen sudy he NIER makes no assessmen as o wheher he objecives in hemselves are opimally designed. 2.1 Acual and Cyclically Adjused Ne Lending Acual ne lending ( FS ) is normally separaed ino a cyclically dependen componen (so-called auomaic sabilizers, AS ; see Secion 3.2 for a more deailed discussion) and a componen ha is no dependen on he cyclical phase of he economy (socalled cyclically adjused ne lending, KS ), i. e: FS = KS + AS. (1) Ofen FS is expressed in relaion o (nominal) GDP ( Y ), and KS in relaion o (nominal) poenial GDP ( Y ).Equaion (1) can hen be expressed as: FS KS Y AS Y Y Y Y =. +, can be furher divided ino wha is ermed in he lieraure as discreionary, srucural or acive fiscal policy, The change in acual ne lending, Δ ( FS / Y ) (2) 8 The NIER does no normally express any opinion on an appropriae level for expendiure ceilings. In he forecas of fuure fiscal policy, however, he esablished expendiure ceiling consiues a resricion in he classificaion of changes in cyclically adjused ne lending as expendiure or revenue. 11

(( KS )( ) ( / Y Y / Y KS / Y / )) 1 Y 1 Y 1 1 auomaic sabilizers, ( AS / Y ) Δ, i. e: 9, and he change in he conribuion of FS FS 1 KS Y KS 1 Y 1 AS AS 1 = + Y Y 1 Y Y Y 1 Y 1 Y Y 1 FS KS Y KS 1 Y 1 AS Δ =. +Δ Y Y Y Y 1 Y 1 Y (3) As discussed in he nex secion, he change in cyclically adjused ne lending in proporion o poenial GDP is an imporan indicaor for deermining wheher fiscal policy has an expansionary or a conracionary effec on he economy. To faciliae his analysis, he NIER s definiion of KS / Y is shown below in Equaion (4): 10 N U Ti, Bi, + = i= 1, i KS G U G r D. (4) Y B Y Y U Y Ti, / B i, is he implici ax rae for he ax i; ( B ) i, / Y is he equilibrium value of he ax base B i, in proporion o nominal GDP 11 U ; G is unemploymen compensaion; U, U is unemploymen and equilibrium unemploymen, respecively; G is general governmen expendiure (in addiion o unemploymen compensaion), and rd is he cos of ineres. 2.1.1 The Surplus Targe Since 2000, fiscal policy has been subjec o he objecive of meeing he so-called surplus arge. This means ha general governmen finances are o show a surplus, 9 As discussed in Secion 2.2, he NIER has chosen o refer o his par of fiscal policy, i. e. he par remaining afer adjusmen for auomaic sabilizers, simply as fiscal policy. 10 See Braconier and Forsfäl (2004) for a deailed descripion. 11 A specific example may provide furher clariy: le T i, sand for paymens of income ax, and B i, for he relevan ax base of earned income. This means ha ( Ti, / B i, ) is he implici income ax B Y is earned income as a share of GDP. rae and ha ( i, / ) 12

currenly argeed as an average of 1 percen of GDP, over an economic cycle. 12 The surplus arge plays a cenral role in he NIER s concepual framework for fiscal policy, since ha arge and full resource uilizaion are he wo primary objecives of fiscal policy ha are evaluaed by he NIER. Chaper 5 shows how he balance should be sruck, according o he NIER, beween he surplus objecive and full resource uilizaion in various fiscal and cyclical siuaions. In he spring budge bill of 2007, he Governmen specified how i inended o inerpre he surplus arge in planning fiscal policy. The Governmen would use hree indicaors: (i) a cenred moving average over seven years, aking ino accoun he hree preceding years and he hree following years, ogeher wih he curren year; (ii) cyclically adjused ne lending (see Equaion (4)) in paricular years; (iii) hisorical average general governmen ne lending since he arge was inroduced in 2000. In he NIER s opinion, indicaors (i) and (ii) are mos relevan, 13 and hey are herefore included explicily in he fiscal policy reacion funcion developed in Chaper 5. 2.2 Fiscal Policy The NIER has chosen o use he concep of fiscal policy for changes in general governmen ne lending ha are no dependen on changes in he conribuion of socalled auomaic sabilizers. The laer refer o changes in ax revenue and expendiure ha depend on he level of economic aciviy (see Secion 3.2 for a more deailed descripion). The concep of fiscal policy hus applies o facors ha resul in changes in cyclically adjused ne lending in proporion o poenial GDP, i. e. 12 The surplus arge was 2 percen of GDP in he period 2000 2006. According o a decision by Eurosa, he EU office of saisics, he premium pension sysem (PPM) as from 2007 is repored in he household secor insead of he general governmen secor as before. As he ne lending of he PPM is equivalen o abou 1 percen of GDP, he surplus arge was changed o 1 percen. 13 As from 2000, average ne lending will reflec o a diminishing exen average ne lending during he curren economic cycle, and o an increasing degree deviaions from he surplus arge in previous economic cycles. Such hisorical deviaions from esablished arges are capured in he siuaionspecific consideraions (see Secion 5.3) ha are no included in he NIER s reacion funcion. 13

( KS Y ) Δ / 0. 14 As discussed in Secion 2.4 below, hese facors may be acive or passive in naure; he former may involve changing a ax rae, whereas he laer would consis in no increasing general governmen expendiure a he same rae as he growh in poenial GDP. I is imporan o analyze boh ypes of facors, as he NIER assesses he sance of fiscal policy (i. e. wheher a paricular fiscal policy is expansionary or conracionary) in relaion o resource uilizaion (no GDP growh); see Secion 2.3. However, separaing general governmen ne lending ino auomaic sabilizers (i. e. he par dependen on he developmen of economic aciviy) and a remainder (i. e. he par dependen on facors oher han economic aciviy, such as poliical decisions) is no simple ask. In pracice, various mehods are used o eliminae he effecs of auomaic sabilizers on general governmen ne lending. 15 Organizaions like he EU, he IMF and he OECD agree on defining wha he NIER erms fiscal policy as he change in so-called primary cyclically adjused ne lending as a share of poenial GDP. 16 Cyclically adjused ne lending is he general governmen ne lending ha would have resuled wih he economy in cyclical balance, i. e., wih full resource uilizaion. However, he NIER includes ineres revenue and coss in cyclically adjused ne lending; see Equaion(4). The main reason for doing so is ha effecs of ineres are included in evaluaing he surplus arge and ha a change in ne ineres mus herefore be considered when oher fiscal policy decisions are aken for he purpose of meeing he arge. 14 Various conceps are used in he inernaional lieraure. Three of he mos common ones are discreionary/srucural/acive fiscal policy. 15 See Blinder and Solow (1974) for an early bu rigorous review of differen ways o idenify fiscal policy. The aricle also discusses he rade-off beween he simpliciy of measures used and heir relevance. 16 The mos commonly used erm in English is primary cyclically adjused budge balance, CAB, where primary refers o he exclusion of ineres revenue/coss, whereas in he NIER s measure, ineres revenue and coss are included (see Equaion (4) in Secion 2.1). 14

2.3 Expansionary and Conracionary Fiscal Policy The NIER has chosen o define wheher a paricular fiscal policy is expansionary or conracionary according o is effec on resource uilizaion (no GDP growh) 17, i. e: Definiion: Fiscal policy is expansionary (conracionary) when i leads o an increase (decrease) in resource uilizaion. Previously, he NIER defined expansionary and conracionary fiscal policies according o heir effec on GDP growh, as many inernaional organizaions and exbooks sill do. I urns ou, hough, ha he overall choice of erminology for describing fiscal and moneary policy is more inuiive wih he NIER s definiion in cases where fiscal policy also affecs poenial GDP. The following example is illusraive: 18 Assume ha a fiscal policy measure, or se of measures, is expeced o increase poenial GDP more han acual GDP in he shor run (and hus o reduce resource uilizaion and inflaionary pressure). Assume furher ha he exbook definiion would be used and hus ha his fiscal policy measure would be considered expansionary on accoun of he higher GDP growh. The NIER would hen sae in is published opinion ha an expansionary fiscal policy should be mached wih an expansionary moneary policy; he reason for he laer would be ha resource uilizaion de faco was expeced o decrease because of he fiscal policy in his imaginary case, despie higher GDP growh. If he NIER s definiion is applied insead, he reasoning is ha he conracionary fiscal policy (because poenial GDP increases more han acual GDP in he shor run) should be accompanied by a more expansionary moneary policy. Consequenly, he NIER has found i preferable from a pedagogical sandpoin o focus on resource uilizaion when assessing he expansionary/conracionary effec of fiscal policy acions on he economy. An alernaive jusificaion for he use of resource uilizaion as a yardsick for measuring he expansionary degree of fiscal policy is ha sabilizaion policy, and hus he 17 Thus, he effecs of so-called auomaic sabilizers on resource uilizaion (see Secion 3.2) are no considered in deermining wheher fiscal policy is expansionary or conracionary. 18 See he special analysis Effecs of he New Governmen s Economic Policy in The Swedish Economy, December 2006, for a realiy-based analysis of he effecs of fiscal policy on acual and poenial GDP. 15

developmen of he inflaion rae, is in focus in he NIER s analysis. There is a sronger link beween resource uilizaion and he inflaion rae boh heoreically and empirically han beween GDP growh and he inflaion rae. Wih he definiion provided above, an expansionary fiscal policy, all else being equal, is associaed wih higher resource uilizaion and a higher inflaion rae. The NIER regards he change in cyclically adjused ne lending in proporion o poenial GDP, Δ ( KS / Y ), as an significan indicaor of he effec of fiscal policy on resource uilizaion in a paricular year. In he normal case, an improvemen in his ne lending, ( KS Y ) Δ / > 0 (due for example, o lower general governmen expendiure and/or higher ax raes), means ha resource uilizaion decreases; see Secion 2.5 and Appendix 6.1. The reason is he assumpion of a Keynesian muliplier in he shor run. Conversely, resource uilizaion normally increases when ( KS Y ) Δ / < 0. The fac ha a fiscal policy measure can increase (decrease) GDP growh, i. e. wha exbooks erm an expansionary (conracionary) policy, is referred o by he NIER in several differen ways, such as fiscal policy reinforces (curbs) growh in demand or fiscal policy provides a posiive (negaive) conribuion o GDP growh. Finally, i should be noed ha in cases where fiscal policy is no considered o affec poenial GDP, he NIER s definiion coincides wih he one cusomarily used in he lieraure. 2.3.1 The Time Dimension Makes a Difference The NIER s erminology for he expansionary or conracionary effec of fiscal policy on he economy refers primarily o how he change in cyclically adjused ne lending in proporion o poenial GDP is expeced o affec resource uilizaion in he curren year. The choice of period depends on he kind of analysis o be performed concerning he effecs of fiscal policy. In Diagram 1 a ficiious example is used o illusrae his poin. 16

Diagram 1 Assessmen of he degree o which fiscal policy is expansionary/conracionary: Ficiious example Percen of GDP and poenial GDP, respecively 1.0 1.0 0.8 0.8 0.6 0.6 0.4 0.4 0.2 0.2 0.0 0.0-0.2-0.2-0.4-0.4-0.6 01 05 09 13 17 Cyclically adjused ne lending Oupu gap 21-0.6 25 Source: NIER. Diagram 1 refers o an economy where cyclically adjused ne lending has been consan a 1 percen beween periods 1 and 14 (see solid line). The oupu gap has been zero during he period, owing parly o he sabilizing funcion of moneary policy (see Secion 2.6 for a discussion on he link beween fiscal and moneary policy). In period 15 17, measures are aken ha cause ne lending o deeriorae by 0.5 percenage poin per year (gradually higher general governmen expendiure, for example), whereas measures o improve ne lending by 0.5 percenage poin are implemened in period 18. The degree o which fiscal policy is expansionary or conracionary during periods 15 18 can be described in a leas hree differen ways: 1. In he aggregae, fiscal policy has had an expansionary effec on he economy during periods 15-18, as resource uilizaion (see dashed line) was higher on average han i would have been wih no changes in cyclically adjused ne lending. 2. In he aggregae, fiscal policy in periods 15 18 has had a neural effec, in principle, on resource uilizaion in period 18, as resource uilizaion wih fiscal policy included is basically he same as resource uilizaion wih fiscal policy excluded. The reason is parly ha he effecs of he fiscal policy applied in periods 15 17 have subsided because of a diminishing muliplier (due o moneary policy, among oher facors; see Secion 2.6), and parly ha he expansionary fiscal policy in periods 15 17 is counered by he conracionary policy in period 18. 3. Fiscal policy in period 18 (i. e. he improvemen in cyclically adjused ne lending ha year) has a conracionary effec on resource uilizaion in period 18, since resource uilizaion in his period would have been higher if he 17

effec of he increase in cyclically adjused ne lending his period had been excluded. The NIER s use of he conceps of expansionary and conracionary fiscal policies (see Secion 2.3 above) refers generally o iem 3 above; i. e, he focus is on how fiscal policy in a paricular year is expeced o affec resource uilizaion in he curren year and in he coming forecas period. The reason for his is ha he old fiscal policy (i. e. he one conduced in periods 15 17 in Diagram 1) has already been incorporaed ino he assessmen of resource uilizaion and ne lending in coming periods (period 18 and subsequen periods in Diagram 1). 19 When he NIER deermines an appropriae fiscal policy for a forecas period, consideraion is given o he effecs of he fiscal policy conduced unil he year before he sar of he forecas period and having effecs during he forecas period. Of course he NIER may also analyze he aggregae effec of fiscal policy on resource uilizaion during a paricular hisorical period when here is a need for such an analysis (i. e. in alernaive 1 above). The choice of language, however, is no clear-cu. The conracionary policy, according o iem 3 above, could also be expressed by saing ha fiscal policy shifs in a less expansionary direcion (or nearly neural direcion), as he aggregae effec of fiscal policy in periods 14-17 is slighly expansionary or neural in period 17. The language used may be especially imporan o consider a urning poins in resource uilizaion and fiscal policy; see also he discussion in Secion 2.7, where procyclical and counercyclical policies are defined. 2.4 Acive and Passive Fiscal Policy The fac ha he NIER uses resource uilizaion as a yardsick makes i is necessary o consider boh acive and passive fiscal policies in order o ell wheher fiscal policy is expansionary or conracionary. As noed above, he NIER deermines wheher a paricular fiscal policy is expansionary in a given year according o he 19 Quie possibly, he old fiscal policy decisions were designed o affec he change in cyclically adjused ne lending during he forecas period. In his ficiious example, however, i is assumed ha fiscal policy decisions affec only he change in cyclically adjused ne lending in he curren year. Of course, he level of cyclically adjused ne lending is dependen on changes prior o he forecas period. 18

change in cyclically adjused ne lending in proporion o poenial GDP. Use of Equaion (3) yields he following expression: 20 KS FS AS Y Δ Δ Δ Y Y Y Y. (5) Acive fiscal policy decisions, like changes in ax raes and expendiure ( Ti, / B i, and G, respecively, in Equaion (4)) of course affec KS / Y. Bu he absence of fiscal policy decisions, or a passive policy, also influences KS / Y. An analysis of Equaion (4) shows, for example, ha he following facors impac KS / Y even hough no acive fiscal policy decisions have been aken: 21 Changes in poenial GDP, Y, and equilibrium unemploymen, U : If G is held consan (i. e. a passive decision), an improvemen in Y from one year o he nex means ha KS / Y increases. Changes in ax bases, Bi, / Y : Srucural changes may mean ha one ax base (such as household consumpion) increases o he derimen of anoher ax base (such as oal earnings). Since implici ax raes ( Ti, / B i, ) differ, KS / Y will change, given no change in Ti, / B i, (i. e. a passive decision). Change in he real rae of ineres, r : This affecs he ne cos of general governmen deb and hereby KS / Y. A feaure common o hese passive changes in KS / Y is ha unlike acive changes in ax raes and expendiure, hey do no necessarily affec acual GDP in he shor run. Bu since he NIER has chosen o define an expansionary/conracionary fiscal policy in erms of resource uilizaion, i is 20 The approximaion applies if ( Y 1 Y 1) ( Y Y ) / / / 1. 21 I should be noed, however, ha he passive changes below may be he direc or indirec resuls of poliical decisions. For example, changed replacemen levels in he unemploymen insurance sysem can affec equilibrium unemploymen and poenial oupu in he longer run. The differences beween acive and passive policy is hus no always crysal-clear. Wha he NIER means by acive is ha decisions by poliicians quie probably have a direc effec on resource uilizaion, as would be he case, for example, wih a change in he ax rae or or in general governmen expendiure. However, he NIER considers he disincion beween acive and passive o be imporan, no leas for pedagogical reasons when fiscal policy is under discussion. 19

imporan o analyze boh acive and passive fiscal policies and heir effecs on acual and poenial GDP. An illusraive example follows: Assume ha poenial GDP is revised upward afer a new esimae of poenial produciviy. Assume furher, for he sake of simpliciy, ha all GDP componens excep general governmen consumpion increase direcly and o he same degree. In his example, a passive decision no o increase general governmen consumpion has wo effecs. Firs, here is an increase in KS / Y. 22 Second, here is a decrease in resource uilizaion, as acual GDP increases less han poenial GDP. The passive policy (i. e. no increasing G when Y increases) means ha resource uilizaion decreases, which according o he discussion in Secion 2.3, means ha fiscal policy is conracionary. Thus, in his example, he following applies: where y, ( y ) Δ ln > 0 ( KS Y ) Δ / > 0 ( y y ) Δ ln ln < 0 y are real poenial and acual GDP, 23 respecively. The following secion discusses he condiions under which ( KS / Y ) Δ can be used o indicae wheher fiscal policy (boh acive and passive ) is expansionary or conracionary in regard o resource uilizaion, i. e. wha link here is beween ( KS / Y ) Δ( ln y ln y ). Δ and 2.5 Fiscal Policy and Resource Uilizaion: Some Rules of Thumb A quesion frequenly raised in The Swedish Economy and in general public debae is wheher fiscal policy has an expansionary or conracionary effec on he economy. As discussed in Secion 2.3 (including Secion 2.3.1) above, he NIER usually focuses on how changes in fiscal policy ( acive and/or passive ) affec curren and forecas 22 In oher words, according o Equaion (4), he derivaive wih respec o poenial GDP is posiive, ( ) KS Y Y >. / / 0 23 Upper-case leers are used for nominal quaniies, lower-case leers for real quaniies. 20

resource uilizaion. In connecion wih he auumn budge bill, here is consequenly considerable ineres in analyzing wheher he new policy proposed (ha is, he changes in fiscal policy) will have an expansionary or a conracionary effec on he economy. Differen fiscal policy measures of course have differen effecs on he economy and on resource uilizaion. 24 Therefore, o answer he quesion wheher he fiscal policy measures in a budge bill affec resource uilizaion posiively or negaively generally requires deailed analysis of he expeced effec of he various changes. There is neverheless a need for a fiscal policy indicaor ha can summarize wheher fiscal policy is expansionary or conracionary. For his purpose he NIER uses he change in cyclically adjused ne lending in proporion o poenial GDP, Δ ( KS / Y ) (i). Two seps are required in he analysis: he relaionship beween fiscal policy ( acive and passive; see Secion 2.4) and ( KS / Y ) Δ and (ii) he relaionship beween Δ ( KS / Y ) and ( ln y ln y ) Δ. As shown in Appendix 6.1, higher axes and/or lower expendiure mean ha ( KS / Y ) 0 base consiues 30 percen of poenial GDP, hen ( KS Y ) Δ >. If, for example, a ax rae is raised by 1 percenage poin and is ax Δ / 100 = 0.3. If general governmen consumpion or ineres expendiure is reduced by 1 percen of poenial GDP, hen ( KS Y ) Δ / 100 = 1.0. 25 In he normal case, he NIER assumes a posiive muliplier in he shor run; in oher words, simulaing demand affecs oupu posiively for a few years (see Secion 4.5.4 for a deailed discussion). If a muliplier of 0.75 percen is assumed, he ax increase above means ha GDP (and he GDP gap) decreases by 0.750.3=0.225 percen in he firs year. Wih he decrease in expendiure by one percenage poin, GDP (and he GDP gap) are reduced by 0.751.0=0.75 percenage poin. 24 Anoher way o express his is ha fiscal policy insrumens have differen mulipliers; see Secion 4.5 for a discussion of heoreical and empirical findings. 25 In hese examples, i is assumed ha poenial GDP is no affeced by he fiscal policy measures. As discussed in Appendix 6.1, inerrelaionships become somewha more complicaed if fiscal policy measures also affec poenial GDP. 21

In he normal case, he following hus applies: ( KS Y ) ( y y ) ( KS Y ) ( y y ) Δ / > 0 Δ ln ln < 0 Δ / < 0 Δ ln ln > 0, (6) In oher words, if cyclically adjused ne lending as a share of poenial GDP improves, he effec on resource uilizaion will be negaive; i. e. he fiscal policy measure will have a conracionary effec on he economy. The converse applies if cyclically adjused ne lending deerioraes in proporion o poenial GDP. In an acual forecasing environmen, i is of course necessary o analyze he reason for ( KS / Y ) since ( KS / Y ) facors ha are more passive in naure. As discussed in Secion 2.4, ( KS Y ) Δ in order o deermine he effec on resource uilizaion. This is so Δ usually depends boh on a package of acive measures and on Δ / 0 may depend, for example, on changes in he relaive size of ax bases and in he real rae of ineres. Since neiher of hese changes is likely o affec resource uilizaion, he relaionship in (6) will no always apply. 2.6 Economic Effecs of he Repo Rae Level, of he Level of General Governmen Ne Lending, and of he Change in These Two Facors Moneary and fiscal policy are he primary insrumens of sabilizaion policy and can be used o increase or decrease economic aciviy. A change in sabilizaion policy hrough hese wo insrumens can have he same qualiaive effec on he economy in he shor run, alhough he channels followed differ. Boh a reducion in he policy ineres rae (i. e. moneary policy) and an increase in general governmen expendiure (i. e. fiscal policy) will generally increase resource uilizaion. However, here is an imporan difference beween how he level of he policy ineres rae and he level of general governmen ne lending, respecively, can affec resource uilizaion in he economy in he medium o long erm. Wih moneary policy, no only changes, bu also he level of he policy ineres rae (or acually he level of he real rae of ineres), are of pivoal significance. Since a cenral bank has a monopoly on prining money, i can conrol he supply and hus he price of money, i. e. he real rae of ineres. If he cenral bank reduces he policy ineres rae in a conracionary economy so ha he real rae of ineres is below wha is considered is equilibrium posiion, he real cos of borrowing o agens in he economy 22

decreases. As long as he level of he real rae of ineres is below wha is considered is equilibrium posiion, moneary policy can have effecs in real erms, i. e. a posiive influence on acual GDP growh. 26 Since moneary policy is no assumed o have any effecs on poenial GDP, a lower real rae of ineres means ha resource uilizaion in he economy, all else being equal, will increase. Wih fiscal policy, he analysis is differen. The level of acual or cyclically adjused ne lending does no necessarily affec resource uilizaion, especially no if a paricular level of ne lending lass for an exended period. Two facors inerac o bring abou his resul. Firs, agens in he economy are assumed o consider he ne lending of he general governmen secor in heir own decisions on saving and ne lending, and increasingly so he longer he ime elapsed afer a change o a new level of general governmen ne lending. A decrease (increase) in general governmen ne lending is hus counered parly by an increase (decrease) in he ne lending and saving of he privae secor. This means ha he new level of general governmen ne lending will have a gradually diminishing effec on resource uilizaion. In he lieraure, he degree of so-called Ricardian equivalence is frequenly discussed. Perfec Ricardian equivalence is an exreme case, one feaure of which is ha a change in axes levied does no affec resource uilizaion even in he shor run, as he privae secor changes is behaviour o he same exen in he opposie direcion. In he NIER s opinion, Ricardian equivalence is no a reasonable assumpion for he shor and medium erm. However, here may be elemens of such behaviour ha limi he macroeconomic effecs of he level of ne lending chosen by he general governmen secor. This brings us o he second facor. The second reason why he level of general governmen ne lending probably has no significan effec on resource uilizaion in he medium erm is he role of he cenral bank (he Riksbank in Sweden) in he economy. Even if a change in fiscal policy leading o a new level of ne lending could be assumed o affec household consumpion in he medium erm because of imperfec Ricardian equivalence, he Riksbank is required o seek balanced resource uilizaion. A specific example will clarify his argumen. If ne lending exceeds he curren surplus arge for a ime and his in iself (which is hus no cerain) has a conracionary effec on demand 26 Fiscal policy is assumed no o reac o he moneary policy followed; see Secion 3.1 for a discussion. 23

(because of lower household consumpion, for example), he Riksbank will adjus ineres raes so ha balanced resource uilizaion is achieved afer a period of adjusmen. The higher general governmen ne lending will have no effec on resource uilizaion in he medium or long erm (and hus, according o he NIER s definiion in Secion 2.3, will no be conracionary). To pu i anoher way, he NIER s assessmen is ha he shor-erm fiscal policy muliplier is posiive, whereas he muliplier in he longer run is zero. The laer is also a frequen resul when macroeconomic simulaion models are used; see Bergvall e al. (2007) and Harrison e al. (2005). The discussion above can be exemplified by he surplus objecive, i. e. ha he ne lending of he general governmen secor should average a se percenage, currenly 1 percen, of GDP over an economic cycle. This objecive was inroduced in 2000. The Governmen has proposed ha he arge rae apply for he curren erm of office, bu has also indicaed ha i would be desirable o mainain ha rae hrough 2015. Given he above view on he effecs of fiscal policy, he average level of resource uilizaion in 2000 2015 would probably no be appreciably differen han if, for example, he Governmen s arge were 1 percen of GDP over an economic cycle insead of +1 percen, see Diagram 2 below. Diagram 2 Level of ne lending does no necessarily affec resource uilizaion: Ficiious example Percen of GDP and poenial GDP, respecively 1.0 1.0 Diagram 3 Change in ne lending affecs resource uilizaion: Ficiious example Percen of GDP and poenial GDP, respecively 1.0 1.0 0.0 0.0 0.0 0.0-1.0-1.0-1.0-1.0-2.0-2.0-2.0-2.0-3.0 00 02 04 06 08 10 12 14-3.0-3.0 00 02 Source: NIER. 04 06 08 10 12 High general governmen ne lending Low general governmen ne lending Oupu gap 14-3.0 Source: NIER. High general governmen ne lending Low general governmen ne lending Oupu gap incl. change in ne lending Oupu gap excl. change in ne lending Bu, for example, if in 2008 he Governmen wih no warning announced ha ne lending was o decrease by 0.5 percenage poin, resource uilizaion would be affeced in he shor run. This would come abou via he wo facors discussed above, 24

i. e. parly because agens in he economy would gradually (bu no necessarily compleely) adap o he new level of general governmen ne lending, and parly because he Riksbank would ac o bring he economy back o full resource uilizaion. Realisically, however, he effec of his change in ne lending in 2008, wihin reasonable limis, would no be dependen on he original level of ne lending. In oher words, resource uilizaion would improve equally in he wo cases, as general governmen consumpion would permanenly increase by 0.5 percen of GDP; see he diagram above. 27 The direc explanaion for he resul above is he assumpion ha he long-run fiscal policy muliplier in regard o resource uilizaion is zero; his assumpion, as menioned above, is warraned by anoher assumpion, namely ha he Riksbank in he long run can sabilize resource uilizaion (in his case) afer a fiscal policy disurbance. 28 Alhough reasonable in fairly normal economic siuaions, his assumpion is no always valid. If for example nohing had been done o reverse he highly negaive endency of ne lending in Sweden a he ouse of he 1990 s, here could have been a relaively long-lasing negaive effec on resource uilizaion. In his case, he uncerainy of agens in he economy abou he susainabilily of public finances could have affeced household consumpion and privae-secor invesmen negaively, and on accoun of he uncerainy, i would have been difficul o influence agens hrough moneary policy. As noed in Secion 2.3.1, he effecs of previous fiscal policy on general governmen ne lending and resource uilizaion are incorporaed ino he forecass made. For his reason, he NIER s analysis usually focuses on how he Governmen s fiscal policy in budge bills during he forecas period affecs hese variables and on he NIER s view 27 There is reason o believe, however, ha cerain non-lineariies are presen, especially since he iniial level of ne lending is highly negaive (see Secion 4.5.2 for a discussion). Under normal circumsances, hough, i is a reasonable approximaion ha he iniial level of ne lending is wihou consequence for he effecs of fiscal policy measures on resource uilizaion. For a more horough discussion on he macroeconomic effecs of fiscal policy (so-called muliplier analysis), see Secion 4.5 28 Fiscal policy may of course have long-erm effecs on he economy,whereas moneary policy only affecs he shor-run developmen of he economy. Examples of fiscal policy measures wih possible long-erm effecs are invesmens in infrasrucure, educaion and he design of he sysems of axes and benefis. However, fiscal policy in general has no long-erm effecs on resource uilizaion (i. e. he difference beween acual and poenial oupu). 25

of he appropriae pah for fiscal policy given he fiscal objecives for resource uilizaion in he economy. 2.7 Pro- and Counercyclical Fiscal Policy In he debae on he economy, a so-called counercyclical fiscal policy is ofen advocaed. This erm refers o he quesion wheher he change in cyclically adjused ne lending as a share of GDP should have he same sign as he change in resource uilizaion, i. e: KS = f ln ln. y y Y + A counercyclical policy means ha ( KS Y ) ha ( KS / Y ) 0 example. (7) Δ / < 0 in an economic downurn and Δ > in an economic upurn; see Diagram 4 below for a sylized Diagram 4 Counercyclical fiscal policy Ficiious example Percen of poenial GDP 2 2 1 1 0 0-1 -1-2 -2-3 -3 01 03 0507 09 111315 1719 21 232527 29 3133 35 37 Oupu gap Cyclically adjused ne lending (% of po. GDP) Source: NIER. Assume ha all changes in KS / Y are dependen solely on changes in labour marke programmes, ha he number paricipaing in programmes when here is full resource uilizaion (i. e. when he oupu gap is zero) is 100 000, and ha ne lending is hen zero. When he oupu gap deerioraes beween periods 0 and 4, he number enrolled in programmes gradually increases as a resul of poliical decisions; his means ha KS / Y progressively worsens. In period 4 he number of programme paricipans is highes, say 150 000. When he economy eners an upswing in period 5, he number 26

of programme paricipans gradually decreases, and when he oupu gap is wides in period 10, he number is a is lowes, say 50 000. 29 I is worh noing from his simple example ha he definiion of a counercyclical fiscal policy in Equaion (7) means ha policy is changed in a more conracionary direcion, i. e. ha ( KS Y ) Δ / > 0, when he economic upurn begins in period 5 even hough he economy is sill conracionary. However, because of fiscal policy as a whole during he conracionary phase in periods 1 7, he GDP gap will be less negaive han would oherwise have been he case (see also he discussion in Secion 2.3.1). Alhough a counercyclical fiscal policy, as defined above, is reasonable as an average over a longer period, i need no be he bes policy in each specific siuaion. Assume, for example, ha average ne lending for period 4 in Diagram 4 was 3 percen of GDP (equivalen, for example, o a programme enrolmen capaciy of 10 000), i. e. clearly above zero, which is assumed o be he arge in he example. Since he oupu gap in he same period is negaive, an expansionary policy is called for in regard o boh objecives (i. e. full resource uilizaion and he surplus arge/number of programme paricipans), no a conracionary policy as in Diagram 4 above. In his siuaion, here is no reason for a conracionary policy in period 4. Insead, resource uilizaion can be resored o balance more quickly wih he aid of an expansionary fiscal policy (here, increasing programme enrolmen capaciy) he laer means, a he same ime, ha ne lending will move oward he surplus arge. The NIER s rade-off beween sable resource uilizaion and he surplus arge in differen fiscal and cyclical siuaions is illusraed concreely in Chaper 5. 2.8 Permanen and Temporary Fiscal Policy As described in he inroducion o Chaper 2, he NIER discusses and assesses fiscal policy on he assumpion ha i has wo purposes: one of hese is sabilizaion, he oher is o achieve se arges for general governmen finances. In regard o sabilizaion, fiscal policy measures given ha he arges for general governmen 29 A procyclical policy, by conras, would mean ha KS / Y improves (worsens) in an economic downurn (upurn). By analogy o he example in he ex, he number paricipaing in labour-markerelaed programmes would decrease during periods 0 o 4 ec. 27

finances have been me should be emporary in naure, i. e. o srenghen he economy when i is conracionary and o curb i when i is expansionary. As for he surplus arge, he opposie applies; permanen changes in ne lending are required if i is above or below he arge a he ouse. The NIER s analysis is based on he cenral governmen budge proposed or adoped for he year for which here is one (see foonoe 1). This means, for example, ha all enaced changes in axes and expendiure are o be considered permanen unless specifically designaed as emporary (i. e. ha hey are o be reversed a a given poin in ime). Depending on he cyclical and fiscal siuaion, on he oher hand, an appropriae fuure fiscal policy (which is no found in a proposed or adoped cenral governmen budge). according o he NIER s assessmen may be boh permanen and emporary. Secion 4.5 discusses he macroeconomic effecs of fiscal policy; where he effecs are shown o vary depending on wheher agens in he economy consider he change in fiscal policy permanen or emporary. 2.9 Business Cycle The erm business cycle and is various phases are ofen referred o in debaes, as in his Special Sudy as well. To aid in following he discussion, he relevan conceps are defined in his secion. Moreover, here is a brief discussion of he prevailing view of why economic cycles arise. This is of cenral imporance for undersanding boh he possible uses and he limiaions of sabilizaion policy. 2.9.1 Conceps Diagram 5 below shows he differen phases of an economic cycle. 28

Diagram 5: Phases of he Business Cycle GDP Downurn Upurn Poenial GDP Peak Acual GDP Trough Peak Trough Time Posiive Negaive Posiive oupu gap oupu gap oupu gap A posiive (negaive) oupu gap means ha acual GDP exceeds (is less han) poenial GDP. An economic upurn means ha resource uilizaion in he economy is rising; his is equivalen o saying ha acual growh exceeds poenial growh. The opposie applies in an economic downurn. However, he definiion of business cycle is no so obvious. Normally he erms peak-o-peak or rough-o-rough are used in sylized exbook examples, where cycles are symmerical. Bu in realiy, an economic cycle is ofen asymmeric; hus, peak-o-peak may mean ha he accumulaed oupu gap during his period deviaes from zero. For example, he economy may have been more expansionary han conracionary, during he period. I may also be worh emphasizing ha for sabilizaion policy, wha maers is he expeced developmen of he business cycle, since sabilizaion policy mus be designed in reference o his informaion. As discussed below, expecaions seldom prove correc, as flucuaions in he economy depend largely on exogenous disurbances, which are unforeseeable. 29

2.9.2 Causes There are wo basic explanaions for business cycles; hey can be summarized in he following conceps (see Burda and Wyplosz, 2001): endogenous cycles exogenous cycles. Endogenous cycles are explained by he fac ha he economy does no sar from equilibrium. The developmen of he business cycle (i. e. he oupu gap) afer is saring poin is deermined by he inernal dynamics of he sysem (i. e. is no affeced by exogenous forces) and can ake one of hree basic pahs, where he oupu gap may: 1. vary decreasingly unil i disappears, i. e. reaches zero and says here 2. vary around zero wih consan force, i. e. never reaches zero, and is flucuaions around zero mainain he same magniude 3. vary around zero wih ever-increasing force, i. e. unil exploding ou of he paern. Since he hree variaions above are inconsisen wih empirical economics, he concepion of cycles as endogenous is generally discarded in favour of exogenous cycles. The laer are explained by he coninuous exposure of he economy o exogenous disurbances (or shocks) ha cause economic aciviy (and hus he GDP gap) o vary over ime. Examples of such shocks are: animal spiris (a erm used by Keynes for opimism/pessimism) innovaions new producs new work mehods wars, naural disasers behavioural changes (for example, in he propensiy o save or o paricipae in he labour force). Moneary and fiscal policy canno preven hese disurbances, as hey are exogenous. This means ha sabilizaion policy canno be expeced o eliminae economic cycles, for he shocks ha cause hem canno be foreseen by governmens or cenral banks. 30

Insead, he ask of sabilizaion policy is o alleviae he cyclical flucuaions ha resul from hese exogenous disurbances. 31

3 Basic Assumpions for a Fiscal Policy wih a Flexible Exchange Rae This chaper discusses several basic assumpions for fiscal policy ha concern Sweden s curren moneary policy regime wih a flexible exchange rae and an inflaion arge. Cerain advanages and disadvanages of fiscal policy are presen regardless of moneary regime; hese are analyzed in Chaper 4. One cenral assumpion is ha moneary policy offers greaer poenial han fiscal policy for sabilizing resource uilizaion wih a flexible exchange rae han wih a fixed exchange rae. In a sandard IS/LM model, fiscal policy generally has less impac on resource uilizaion wih a flexible exchange rae since fiscal policy expansion (conracion) pushes ineres raes up (down) and appreciaes (depreciaes) he currency. Consumpion, invesmen and ne expors are hen affeced negaively (posiively), hereby couneracing he effec of he fiscal policy measure on resource uilizaion (see, for example, Krugman and Obsfeld, 2000). For his reason, he ask of sabilizaion policy under he curren moneary policy regime in Sweden is enrused chiefly o moneary policy. In highly simplified models wihou price rigidiy, demand is affeced solely by moneary policy when he exchange rae is flexible. Fiscal policy measures are neuralized, even in he shor run, by higher ineres raes and an appreciaed exchange rae. Under more realisic assumpions, as in he macromodels of he Bank of England and he NIER (see Harrison e al., 2005, and Bergvall e al., 2007), wih rigidiy of prices and wages in he shor run, here is a emporary fiscal policy effec on demand, bu less so han wih a fixed exchange rae. 30 One conclusion, herefore, is ha fiscal policy should be used less for sabilizaion purposes in Sweden han in counries like hose belonging o he euro zone; see he STEMU Sudy, SOU (2002:16). 30 See Andersen and Holden (2002) and Frenkel and Razin (1996), among ohers, for heoreical conribuions, as well as Hemming e al. (2002) for an empirical overview of he macroeconomic effecs of fiscal policy. 32

As underscored in Chaper 2, fiscal policy has oher purposes han jus hose of sabilizaion policy. As far as he NIER is concerned, aside from he aim of sabilizaion, he focus is on he surplus arge. Consequenly, here are siuaions where general governmen finances require fiscal policy even when sabilizaion does no. How he deviaion of general governmen ne lending from he surplus arge affecs he NIER s fiscal policy assessmens is described in deail in Chaper 5, where he concepual framework is given concree form. 3.1 Moneary Policy Response o Fiscal Policy Fiscal policy, of course, is no conduced in a vacuum, and in assessing is macroeconomic effecs, consideraion should be given o he moneary policy response. Theoreically, sabilizaion policy may be viewed as a game wih wo players, he Riksbank and he Swedish Parliamen. Differen assumpions may be made abou he rules of he game. One of hese is ha he players ac simulaneously, resuling in wha is known in he lieraure as he Nash soluion; see Lamberini (2006). Parly because major fiscal policy decisions in he form of budge bills are reached raher infrequenly, whereas moneary policy decisions are aken fairly ofen, fiscal policy is more likely o be a so-called Sackelberg leader; see Lamberini and Rovelli (2003). This means ha fiscal policy makes he firs move, and moneary policy responds, implying ha poliicians consider he moneary policy response when deciding on fiscal policy measures. By conras, he Riksbank does no consider possible fiscal policy responses in is decisions. In he presen Special Sudy, ha relaionship beween fiscal policy and moneary policy is assumed o exis. As a pracical maer, his means ha when he NIER s assesses he effec of fiscal policy on he economy (he so-called muliplier), i considers he reacion of moneary policy o fiscal policy. Increased general governmen expendiure and/or lower axes generally call for a somewha more conracionary moneary policy han wihou an expansionary fiscal policy. The converse is rue wih reduced expendiure and/or higher axes. The effec on he economy will hus be somewha more limied han if moneary policy did no reac o fiscal policy. The NIER s assessmen of he effec of fiscal policy on he economy is reaed in Secion 4.5. I should be noed, moreover, ha in he ficiious and acual examples presened o senior NIER personnel for heir views in revealed-preference exercises (see Chaper 5), he effecs of he proposed fiscal policy on resource uilizaion were calculaed; hus, inflaionary pressure was implicily aken ino accoun. 33

3.2 Auomaic Sabilizers Alhough his Special Sudy focuses on he governmen budge afer adjusmen for he effecs of so-called auomaic sabilizers, i is imporan o keep in mind ha much of he cyclical effec of general governmen finances on he economy is due o auomaic sabilizers. An increase in demand leads o higher ax revenue and lower expendiure on iems like unemploymen benefis, curbing he increase in demand. Similarly, a decrease in demand resuls in lower ax revenue and higher expendiure on unemploymen benefis and he like, slowing he decrease in demand. These effecs arise when here is no change in provisions for expendiure and axaion, hus explaining he erm auomaic sabilizers. Auomaic sabilizers hus end o sabilize demand. Sweden s general governmen ne lending appears o be among he mos cyclically sensiive in he enire OECD (see van der Noord, 2000 for an empirical analysis). 31 Variaion in such variables as GDP and consumpion is reduced, enhancing individual welfare since a regular flow of consumpion is generally preferred over an erraic one (see, for example, Andersen, 2005). However, since individuals probably dislike variaions in general governmen consumpion as well, his variable is no appropriae for use as an auomaic sabilizer. In principle, i would be good o have auomaic counercyclical variaions 32 in general governmen invesmen. For example, he general governmen secor could inves more in infrasrucure in a conracionary economy han in an expansionary one, an advanage being ha he marginal cos is lower in he former siuaion. However, because he decision process is proraced, here is a subsanial risk ha he auomaic change will come a he wrong ime for he economy. In he discussion above, one argumen cied in favour of auomaic sabilizers was ha individuals prefer a regular flow of consumpion o an uneven one. This means ha economic cycles should be minimized even when hey are believed o be symmerical so ha here is no effec on he magniude of accumulaed oupu. Anoher advanage of auomaic sabilizers and sabilizaion policy is ha he presence of so-called non-lineariies in he economy may mean ha economic cycles 31 Auomaic sabilizers, however, canno disinguish beween emporary and permanen changes in he economy, a shorcoming ha can lead o problems; more on his subjec a he end of he secion. 32 See he definiion of counercyclical policy in Secion 2.7. 34

are asymmeric and resul in lower accumulaed oupu. Wih his asymmery, he oupu gap (i. e. acual oupu in relaion o poenial oupu) is more negaive in a conracionary economy han posiive in an expansionary economy. Such a siuaion arises if prices and wages are more flexible upward han downward. 33 Auomaic sabilizers are faser acing no only compared o he res of fiscal policy, bu also compared o moneary policy decisions. Furhermore, auomaic sabilizers are auomaically symmerical; in oher words, general governmen ne lending improves in principle jus as much when resource uilizaion increases as when i decreases. I is imporan o remember, hough, ha precisely because auomaic sabilizers are auomaic, here is a danger ha economic disurbances, which afer a number of years prove o be (unexpecedly) permanen, may lead o imbalance in governmen budges. If for example a drop in employmen is considered emporary, he cos of unemploymen compensaion is assumed o increase in he shor run bu no in he long run. If he decrease subsequenly urns ou o be permanen, he income-replacemen rae will have o be lowered if he cos of unemploymen benefis is o remain he same as i was iniially. Flucuaions in resource uilizaion ha resul from variaions in demand are hus dampened by auomaic sabilizers. By conras, auomaic sabilizers may accenuae flucuaions in resource uilizaion due o variaions in supply. For example, hey may reard a long-run increase in demand afer an upward shif in labour supply or produciviy (see Blanchard, 2000). In addiion, auomaic sabilizers in hemselves may have repercussions on supply, for example, via he elasiciy of he aggregae supply curve, negaively affecing is sabilizing influence on resource uilizaion (see Bui e al., 2003). According o Andersen (2005), however, he effecs on supply are minor in he shor run, when he impac on demand predominaes. In he NIER s opinion, higher auomaic sabilizers make resource uilizaion in he aggregae is more sable. The conclusion, herefore, is ha from a sabilizaion sandpoin, srong auomaic sabilizers are desirable. 34 As noed 33 See, for example, Bergvall and Dillén (2005) and Eliasson (2001) for an analysis. 34 As discussed in greaer deail in he STEMU sudy on sabilizaion (SOU, 2002:16), auomaic sabilizers could be srenghened by a general increase in axes and expendiure, as well as by more progressive income axaion. In he NIER s opinion, however, such changes should be guided primarily by he views of Parliamen on effeciveness and income redisribuion, raher han consideraions of economic sabilizaion. 35

above, auomaic sabilizers enhance welfare in he economy by smoohing cyclical flucuaions. Oher elemens of fiscal policy adoped for reasons of sabilizaion have his same purpose. I is imporan o emphasize, hough, ha srong auomaic sabilizers enail subsanial flucuaions in general governmen ne lending because of he variabiliy of resource uilizaion. Even hough here is no problem in heory (on he conrary, here is he posiive effec of moderaing cyclical flucuaions), i is difficul as a pracical maer o know wheher a change in ne lending is cyclically caused or more permanen in naure. The reason is he difficuly (paricularly in real ime) of deermining he level of resource uilizaion and, accordingly, he magniude of cyclically adjused ne lending (see Secion 4.1.5 for some examples). Srong auomaic sabilizers hus make i an exacing ask o measure resource uilizaion as accuraely as possible. 36

4 Fiscal Policy Difficulies and Opporuniies As explained in Chaper 1, he concepual framework presened here is inended o describe a consisen and ransparen rade-off beween he surplus arge and full resource uilizaion in differen fiscal and cyclical siuaions. The analysis in his chaper serves as a foundaion for developmen of he fiscal policy reacion funcion in Chaper 5. More specifically, he presen chaper consiss of he following four pars: argumens for and agains using fiscal policy as a ool of sabilizaion policy (Secion 4.1-4.2). argumens for a fiscal policy ha is ransparen and based on rules (Secion 4.3). presenaion of views in oher counries and organizaions on when fiscal policy should be used (Secion 4.4). heory and empirical findings on he macroeconomic effecs of fiscal policy, socalled muliplier analysis (Secion 4.5). 4.1 Argumens agains Fiscal Policy Numerous well-known argumens agains fiscal policy are found in all inroducory exbooks on macroeconomics; see, for example, Burda and Wyplosz (2001). These argumens are menioned below ogeher wih some disadvanages less horoughly discussed in economic debaes. 35 4.1.1 Decisions Delayed by Time-Consuming Process of Decision-Making Normally he processes of reaching and implemening decisions are more imeconsuming for fiscal policy han for moneary policy. Afer a sabilizaion problem has been idenified, i is necessary o negoiae a poliical majoriy before a decision can be aken. Once a decision is made, i mus be implemened. Wih changes in 35 The disadvanages of fiscal policy due o Sweden s flexible exchange rae and inflaion arge were discussed in Chaper 3 and are no reaed here. 37

axaion, i is someimes necessary for echnical reasons o wai unil he following fiscal year, delaying he measure furher. Changes in governmen expendiure are usually adminisered by some auhoriy, such as he Labour Marke Board or he Naional Road Adminisraion. Bu expanding labour marke raining and/or he sysem of roads requires planning and projecing, which may ake considerable ime. As a consequence, a measure designed o sabilize resource uilizaion may in fac desabilize i because of he ime lag in is adopion and implemenaion. 36 4.1.2 Asymmery in Poliical Decision-Making A desire for re-elecion is a naural feaure of he poliical sysem. Economic heory and empirical findings show ha his facor enails a subsanial risk of sysemaic budge deficis and hus of increasing indebedness. From he 1970 s unil he mid- 1990 s, hese effecs were prevalen in a majoriy of OECD counries, including Sweden. I was herefore necessary from ime o ime o resore order in public finances, and here was a need for a se of fiscal policy rules in Sweden, he EU and elsewhere ha would preven recurrence of he hisorical paern. In his connecion, reference is also made o so-called poliical cycles. Voers are assumed o be shorsighed in heir hinking and o reward (i. e. voe for) poliicians who promise unfinanced ax cus or increases in expendiure during elecion campaigns. Asymmery in poliical decision-making, leading o deficis, may also be due o srong lobbies ha succeed in obaining more expendiure or lower axes for heir own ineress wihou a corresponding reducion of expendiure or increase in axes for oher groups. Thus, owing o he naure of he poliical sysem, fiscal policy feaure sysemaic deficis in general governmen finances. For his reason, i is arguable ha he poliical sysem should no conduc fiscal policy for sabilizaion purposes. Bu as discussed in Secion 4.3, here are mehods for reducing problems of asymmery. 36 However, once fiscal policy measures have been aken, hey rapidly affec demand in he economy. Wih moneary policy, he opposie is rue; decisions are quickly reached, bu i akes longer for hem o impac demand (see Secion 4.2.2 for furher discussion). 38

4.1.3 Time-Consisency Problems Since incomes and employmen are imporan o voers, i is reasonable o assume ha poliical paries will ry o bring abou favourable macroeconomic developmen. For good reason, however, individuals are ofen assumed o be relaively shorsighed, and shor-erm improvemen in incomes and employmen may suffice o win voer confidence (compare poliical cycles above). In he shor run, poliicians can simulae incomes and employmen by surprising agens in he economy wih an expansionary fiscal policy. This policy can increase oupu and employmen in he shor run, largely because of a weak endency in real earnings. The explanaion for his weakness is ha nominal earnings are usually bound more srongly by conracs han are he prices charged by firms. If agens in he economy (primarily employees) knew abou he expansionary policy in advance, hey would bargain for higher wages o proec heir real earnings. The expansionary fiscal policy would hen have much less impac (if any a all). Bu poliical decision-makers may gain by firs promising no o pursue an expansionary fiscal policy and hen adoping one anyway. Why is his so? If agens in he economy (primarily employees) believe he promises of poliicians and negoiae a nominal wage based on assurances of no expansionary fiscal policy, and hen, once he labour conrac is signed, poliicians go ahead and carry ou such a policy, here will be posiive shor-erm effecs on incomes and employmen, 37 a phenomenon called ime-inconsisen behaviour. This game beween he agens in he economy and poliical decision-makers has no winner. I risks causing sysemaic deficis in general governmen finances since poliicians, according o he assumpions above, gain from surprising economic agens wih an expansionary fiscal policy ha resuls in a budge defici. 38 37 Barro and Gordon (1983a,b) are sandard references for analysis of ime-consisency problems in moneary policy.. 38 Asymmery and ime-consisency problems may hus lead o sysemaic budge deficis and in urn in o higher general governmen indebedness. The quesion wheher his is a problem in iself is no exensively discussed in his Special Sudy. Here i is only noed ha heavy indebedness has several poenial drawbacks, including higher ineres raes, higher inflaion, a risk of unplanned redisribuion of general governmen consumpion beween generaions and, ulimaely, a risk ha he cenral governmen will have o suspend paymens (see Calmfors, 2005). 39

4.1.4 Models for Opimal Moneary and Fiscal Policy There is relaively recen lieraure on he ineracion beween moneary and fiscal policy in dynamic general equilibrium models. The purpose is o calculae, for differen economic scenarios, 39 which combinaions of moneary and fiscal policy maximize welfare for individuals in he model and can hus be considered opimal. A he forefron of his research, new models are rapidly being developed, incorporaing sep-by-sep a growing number of imperfecions (such as price rigidiy and sluggish capial formaion) and hus providing an increasingly accurae represenaion of realiy. The vigorous pace of advancemen in his lieraure makes i difficul o deermine wha conclusions i will ulimaely reach for fiscal policy. A presen, he conclusion ofen seems o be ha, assuming moneary policy is well managed from a sabilizaion sandpoin, here is basically no need of a fiscal policy for purposes of sabilizaion (see, for example, Annicchiarico e al., 2004, Kirsanova e al., 2006, Muscaelli e al., 2004, and Schmi-Grohé and Uribe, 2006). In hese models, i is mos appropriae o use fiscal policy o ensure ha he deb raio remains sable, whereas using i o achieve full resource uilizaion is no desirable. The resuls, of course, are dependen on he model, and Benigno and Woodford (2003), for insance, show ha fiscal policy can also have welfare-enhancing effecs. One ineresing ingredien in he lieraure on opimal moneary and fiscal policy is how so-called sraegic decision-making involving boh ypes of policy migh work. Sraegic decision-making is presen when one pary (such as a fiscal policy maker) akes ino accoun he oher pary s (he moneary policy maker s) expeced response o a fiscal policy decision. Lamberini (2006), for example, shows ha he macroeconomic oucome is very similar o he preferences of moneary policy makers even in cases where he fiscal policy decision is aken firs. To express i differenly, he moneary policy response, even hough i comes las in he game, is a limiaion for fiscal policy makers, who draw firs. As discussed in Secion 3.1, i is more likely ha moneary policy will respond o fiscal policy, raher han he oher way around. 39 These scenarios are consruced by analyzing he effecs of various economic disurbances, such as supply and demand shocks, on GDP and consumpion, for example. 40

4.1.5 Uncerainy abou Resource Uilizaion and Ne Lending in Real Time When he NIER and oher forecasing insiuions are o form an opinion on curren and fuure economic policy, only so-called real-ime informaion is available. This informaion will be revised subsequenly, parly because of revisions by Saisics Sweden and parly because of revisions in he NIER s assessmens, primarily concerning poenial GDP. The quesion is how wrong real-ime informaion is. Since he concepual framework for fiscal policy presened here leads o a rade-off beween full resource uilizaion and achievemen of he surplus arge, i is of special ineres o sudy how hese variables differ when i comes o real-ime informaion and informaion ex pos. Forni and Momigliano (2004) have sudied how much resource uilizaion (in he form of he so-called GDP gap) differs beween real ime and ex pos. They have used old issues of Economic Oulook for he period 1993 2003 in order o deermine he GDP gap in real ime for each year. These real-ime esimaes are added here for he years 2004 2005. 40 The resuls for Sweden in regard o resource uilizaion and he changes in i are shown in Diagrams 6 7 below. Diagram 6 GDP gap in real ime and ex pos Percen of poenial GDP 2 0-2 -4-6 -8 Diagram 7 Change in GDP gap in real ime and ex pos Percen of poenial GDP 5 4 3 2 1 0-1 -10 1993 1995 1997 Real-ime oupu gap Ex pos oupu gap 1999 2001 Source: OECD Economic Oulook and NIER. 2003-2 -3 1994 1996 1998 2000 2002 Change in real-ime oupu gap Change in ex pos oupu gap Source: OECD Economic Oulook and NIER. 40 Ex pos daa for resource uilizaion are aken from Economic Oulook no. 79, 2006. Unforunaely, he ime series is oo shor o permi saisical analysis. Consequenly, he analysis is descripive in naure. 41

In Diagram 6, i is apparen ha he esimaes in real ime and ex pos have opposie signs only for 1999 and 2001. Based on his simple descripive analysis, i hus appears relaively safe o rely on he sign of resource uilizaion in real ime. However, in he period 1993 1998 i was probably no paricularly difficul o deermine his sign. On average, he absolue deviaion beween real ime and ex pos is jus over 1 percenage poin. Wha abou he sign of he change in resource uilizaion? Diagram 7 above shows his variable in real ime and ex pos. Here he differences prove o be more numerous. In 1996, 1997, 2002 and 2005 he wo esimaes have differen signs for he change in resource uilizaion. Wha, hen, abou he difference beween general governmen ne lending in real ime and ex pos? 41 The surplus arge of 1 percen for average ne lending over an economic cycle was inroduced in 2000. 42 Bu as discussed in Secion 2.1.1, he Governmen, according o he 2007 spring budge bill, inends o use a moving average over seven years (hree years back, he curren year and hree years ahead). I is of ineres, herefore, o sudy average ne lending in real ime and ex pos during he period 2004 2006. Diagram 8 below shows he developmen of average general governmen ne lending in real ime and ex pos. Real ime for 2004 is he forecas made in March of ha year. Real ime for 2005 (2006) is he forecas made for he average for 2004 2005 (2004 2006) in March 2005 (2006). Ex pos is based on he oucome daa available in March 2007. The diagram shows relaively subsanial revisions. I may be noed, for example, ha he real-ime esimae in 2006 of he average for 2004 2006 differs appreciably (0.7 percenage poin) from he ex pos calculaion made in he following year, i. e. 2007. 41 Halle e al. (2007) find ha cyclically adjused ne lending in real ime is no saisfacory as an indicaor, for i is revised raher subsanially ex pos. Here, however, he focus is on average general governmen ne lending since he surplus arge is defined in erms of ha variable; see Secion 2.1.1. 42 When he ne lending arge was inroduced, i was 2 percen of GDP. Bu, as discussed in Secion 2.1.1, he arge was changed o 1 percen in 2007 for saisical reasons. 42

Diagram 8 Average general governmen ne lending in real ime and ex pos Percen of GDP (Excluding PPM) 2.5 2.5 2.0 1.5 1.0 0.5 0.0-0.5-1.0 2.0 1.5 1.0 0.5 0.0-0.5 04 06-1.0 Real-ime Ex pos (from The Swedish Economy, March 2007) Source: NIER. The conclusion from Diagrams 6-8 is ha i is imporan for fiscal policy no o reac o minor deviaions from full resource uilizaion or from he surplus arges. The reason is ha real-ime informaion may be revised considerably afer he fac. Wha qualifies as minor deviaions is discussed in Secion 5.3.2. 4.2 Argumens for Fiscal Policy Because of he many plausible and generally acceped argumens agains fiscal policy, numerous economiss have concluded ha fiscal policy for sabilizaion purposes should be used wih cauion; see, for example, he STEMU sudy (SOU, 2002:16). Neverheless, here are several relevan argumens for fiscal policy, which are presened below. In view of he surplus arge, moreover, fiscal policy is necessary when here is a deviaion from he arge. This means, in urn, ha sabilizaion policy analysis is imporan for ensuring ha measures o reach he surplus arge are aken a he righ juncure in he economic cycle. 4.2.1 Impoence of Moneary Policy The recen experience of Japan, in paricular, bu also of he Unied Saes o some exen, wih an exremely low policy ineres rae (even zero in Japan) and low inflaion (even deflaion in Japan) has led economiss o recommend fiscal policy in response o a siuaion of low demand, a low policy ineres rae and low inflaion (see Feldsein, 2002). Moneary policy has a naural limi, i. e. zero, beyond which i canno be used o increase demand in he economy. In such siuaions, an expansionary fiscal policy will probably have a posiive effec on he economy. 43

4.2.2 Rapid Impac on Demand As discussed above, he decision-making process generally akes much longer for fiscal policy han for moneary policy. Bu once he decision has been operaionalized, fiscal policy affecs demand more rapidly han does a change in he policy ineres rae. The full impac of ha rae change will no occur unil one or wo years laer, whereas demand will be affeced immediaely, in principle, as more nurses are hired, new roads are buil or child allowances are raised. If sabilizaion policy is viewed as consising of four seps (i) idenificaion of problems, (ii) decision, (iii) implemenaion of he decision and (iv) effec on demand moneary policy is faser in seps (ii) and (iii), whereas fiscal policy is faser in sep (iv) once a decision has been implemened. I is uncerain which ype of policy is faser from (i) o (iv). 4.2.3 Many Tools Unlike moneary policy, fiscal policy has many ools a is disposal. I is cusomary o divide governmen expendiure ino consumpion, invesmen or ransfer paymens, and governmen revenue ino income axes, business axes, indirec axes and social securiy conribuions. Wihin hese caegories of expendiure and revenue, here are of course a variey of differen insrumens, offering a number of ways for fiscal policy o sabilize he economy according o is sae a he ime. Allgulin e al. (2003) lis a number of desirable crieria for sabilizaion policy insrumens, among hem hose menioned below. The insrumen should: impac a large porion of he economy allow decisions o be made quickly, o be implemened on an ongoing basis during he curren year and o ake effec wihin a shor ime afer he decision o use i have few or preferably no effecs on income redisribuion or allocaion. have a relaively subsanial effec on demand (i. e. a large so-called muliplier). Based on hese crieria, Allgulin e al. (2003) argue ha changes in VAT and in social securiy conribuions are preferable as ools. While he NIER does no normally express an opinion on he choice of fiscal policy ool, i is of course essenial ha he Governmen and Parliamen carefully consider he design of fiscal policy. 44

Moreover, i should be noed ha he many fiscal policy ools may no only be considered separaely, bu also combined in response o specific cyclical siuaions. Feldsein (2002), for example, describes several differen fiscal policy recipes for he Japanese economy which, owing o heir composiion, would no burden he counry s already oversrained budge. 43 4.2.4 Fiscal Policy Objecives Require a Fiscal Policy Fiscal policy is dependen no only on he cyclical siuaion, bu also on he fiscal policy objecives of he Governmen, or more specifically, he expendiure ceiling and he surplus arge for general governmen ne lending of 1 percen on average over an economic cycle. In pursuing hese fiscal policy objecives, however, i is imporan o ake he economic cycle ino accoun, i. e. o deermine when i would be appropriae o ake acion o mee hese objecives (see also Chaper 5). 4.3 Fiscal Policy Should Be Transparen and Based on Rules 44 The review of advanages and disadvanages above shows ha fiscal policy is associaed wih subsanial problems and risks. One conclusion reached by Calmfors (2005), among ohers, is ha if fiscal policy is recommended, i should be accompanied by (i) well-defined fiscal policy arges and rules, (ii) ransparency and (iii) an incenive srucure ha makes i cosly o deviae from esablished rules. As will be apparen from he discussion below, he NIER s concepual framework is designed o provide precisely hese hree ingrediens. 43 One example was ha Japan should emporarily raise he ax rebae on invesmen by 30 percen and hen reduce his rebae by 5 percenage poins per year unil i was eliminaed. This measure would be paid for by a emporary increase in business axes. In he shor run, he combinaion of fiscal policy measures, according o Feldsein (2002), would subsanially improve he incenive for firms o inves and hus help Japan o escape from is predicamen of slack demand and deflaion. A he same ime, he combinaion of measures was neural from a budgeary sandpoin. 44 The discussion in his secion follows he reasoning in Calmfors (2005). 45

4.3.1 Targes and Rule-Based Fiscal Policy Given he problems of asymmery and ime-consisency discussed above, i is essenial ha poliical decision-making be guided by pre-esablished arges. Examples of such arges in Sweden are he expendiure ceiling and he surplus arge. In he EU, here are he arges of he Sabiliy and Growh Pac a maximum budge defici of 3 percen and a ceiling on cenral governmen deb of 60 percen of GDP. These arges can be supplemened by a se of rules prescribing how fiscal policy is o be conduced in various cyclical siuaions. For example, such rules may specify he level of resource uilizaion a which fiscal policy should back up moneary policy in guiding he economy oward full resource uilizaion. Rules can also specify in advance which fiscal policy insrumens should be used, speeding up he decision-making process and hus increasing he likelihood ha he fiscal policy measure aken will influence he economy in he inended cyclical phase. 4.3.2 Transparency One way o improve he chances ha poliicians will acually ry o achieve arges and follow esablished rules is of course o make sure ha hese are well defined and ha heir observance is verifiable; in oher words, arges and rules should be quie clear, i. e. have a high degree of ransparency. The poliical cos of no meeing declared arges is perceived o be higher if voers can easily verify afer he fac wheher hey have been achieved. 4.3.3 Incenive Srucure ha Encourages Targe Achievemen Even if ransparency increases he incenives for poliicians o achieve pre-esablished arges, he sysem of sancions is no always sufficien for ha purpose. Therefore, he Sabiliy and Growh Pac, hough o a lesser exen han before, provides a sysem of sancions including moneary penalies for counries ha fail o mee heir fiscal policy arges. The sysem of sancions need no be moneary. Calmfors (2005) oulines he basic feaures of an independen fiscal policy council ha he Governmen would have o consider. For insance, he Governmen migh have o explain publicly why i is no following he fiscal policy considered appropriae by he council. The formaion of he Swedish Fiscal Policy Council in he auumn of 2007 can hus be viewed as a sep oward ransparency and an improved incenive srucure for fiscal policy. As menioned above, he NIER s concepual framework for fiscal policy is designed o include he hree ingrediens of a successful fiscal policy. The fiscal policy arges 46

(expendiure ceiling and surplus arge) 45 have already been se by he Governmen and Parliamen. The concepual framework, which is presened in concree form in Chaper 5, develops a fiscal policy rule (a so-called fiscal policy reacion funcion) ha deermines in advance how fiscal policy should be conduced in differen cyclical and fiscal siuaions. The esablished arges and he rule can hus be said o provide for greaer ransparency. Wih a higher degree of ransparency and clariy in communicaion by he NIER, he Governmen and Parliamen would be likely o give he insiue s analyses greaer consideraion. The concepual framework would hus help o improve he incenive srucure for achieving fiscal policy arges. 4.4 Ideas of Oher Counries and Organizaions abou Fiscal Policy The advanages and disadvanages of fiscal policy oulined above apply generally o all counries. This means ha he NIER is no alone in aemping o define he role of fiscal policy. I may herefore be of ineres o examine he hinking in oher counries and inernaional organizaions on hese issues. Three such examples follow below. One feaure of fiscal policy shared by hese counries is ha hey have (i) esablished arges for indebedness and/or surpluses, and (ii) resource uilizaion. In he Unied Kingdom, HM Treasury (2005) publishes an annual End of year fiscal repor ha discusses of fiscal policy oucomes and forecass in relaion o esablished fiscal policy arges and policy rules. The fiscal policy arges are he following: The general governmen secor may borrow o finance invesmen, whereas is oher expendiure mus be financed over an economic cycle. Ne general governmen deb in proporion o GDP should be sable over an economic cycle and mainain a pruden level (currenly under 40 percen). Furhermore, fiscal policy should feaure ransparency and openness. This means, for insance, ha fiscal policy arges are o be declared and followed up. In addiion, i should be explained how he arges are o be achieved wih he aid of he fiscal policy rules ha govern he acions aken. 45 The balanced budge requiremen is anoher overall budge policy arge, bu from a fiscal policy sandpoin i is considered subordinae o he surplus arge (i. e. viewed as a means of achieving he surplus arge). 47

I is he view of HM Treasury on fiscal policy ha auomaic sabilizers, ogeher wih moneary policy, should be he primary means of smoohing he level of oupu over an economic cycle. Fiscal policy may be used, bu only in suppor of moneary policy. As defined by HM Treasury, his resricion means ha he change in cyclically adjused ne lending is o have he same sign as he change in he real rae of ineres. Tha poin is illusraed in Diagram 9 by a ficiious example, where resource uilizaion and cyclically adjused ne lending from Diagram 4 in Secion 2.7 are shown ogeher wih he deviaion of he real rae of ineres from equilibrium. Diagram 9 Counercyclical fiscal and moneary policy: Ficiious example Percen of poenial GDP and percenage poins, respecively 2 2 1 1 0 0-1 -1-2 -2-3 -3 01 03 0507 09 111315 1719 21 232527 29 3133 35 37 Source: NIER. Oupu gap Cyclically adjused ne lending (% of po. GDP) Real rae of ineres (deviaion from eq.value) The wo arges above, and he principle ha fiscal policy is o suppor moneary policy, are hardly conroversial in hemselves. 46 Bu realiy is more complex han he ficiious example shown above, as objecives ofen conflic, for example when he deb arge calls for a conracionary fiscal policy whereas resource uilizaion calls for an expansionary fiscal policy. HM Treasury does no discuss which rade-offs will be made when objecives conflic. For he sake of ransparency and consisency, considerable imporance is aached o his issue when he concepual framework akes concree form in Chaper 5. 46 The poin when fiscal and moneary policy are o urn depends on he speed a which hese policies ac on he economy. Probably moneary policy (i. e. he ineres rae) should urn before fiscal policy, as moneary policy has a longer so-called effec lag. 48

The OECD (2003) advocaes a fiscal policy similar o ha of HM Treasury in Diagram 9 above. This policy is defined as counercyclical and means ha an expansionary fiscal policy (for example, a larger number enrolled in labour-markerelaed programmes) should be followed in economic downurns, when acual growh is less han poenial growh, i. e. as Sweden on average conduced fiscal policy in 1980 2004 (see Galí and Peroi, 2003, and Hjelm, 2006). The OECD sudy finds ha many counries follow a procyclical fiscal policy because of heir deb siuaion. Counries wih iniially high deb are forced o ighen fiscal policy in an economic downurn even when he cyclical sae of he economy calls for he opposie policy. The EU Commission (2004) also focuses on he dual role of fiscal policy: o ensure observance of he deb and surplus arges prescribed by he Sabiliy and Growh Pac, and o reinforce (resrain) economic aciviy in a conracionary (expansionary) economy. The EU Commission emphasizes ha a counry should make a special effor o mee he deb and surplus arges in good imes, which are defined as siuaions where oupu exceeds is poenial level. The EU Commission also discusses he uncerainy regarding measures of resource uilizaion and argues ha changes in resource uilizaion should be considered even when he level of resource uilizaion is close o zero. A siuaion of relaively rapid posiive change in resource uilizaion, when he level of resource uilizaion is slighly negaive, should also be considered good imes ha call for a fiscal policy designed o achieve he deb and surplus arges. The conclusion in his secion is ha ne lending and resource uilizaion are in focus in discussions on fiscal policy. When measures inended o achieve a ne lending arge are o be aken, he EU Commission also considers changes in resource uilizaion. Unlike he OECD and he EU Commission, HM Treasury in he UK is relaively explici abou he rade-off beween hese wo arges and holds ha fiscal policy should suppor moneary policy. However, neiher HM Treasury, he OECD nor he EU is explici abou cases of conflic beween he ne lending arge and full resource uilizaion. Nor do hey clearly indicae how rapidly he arges are o be reached, one reason being ha hey ake no posiion on he magniude of fiscal policy measures in various fiscal and cyclical siuaions. 4.5 Macroeconomic Effecs of Fiscal Policy: Muliplier Analysis To achieve he arge of full resource uilizaion, i is of course crucial o deermine he precise effecs of fiscal policy on resource uilizaion, i. e. he size of he so-called 49

muliplier. The purpose is o deermine how much fiscal policy is needed in a given cyclical siuaion. The discussion in his secion is divided ino hree pars. In he firs, here is a brief discussion of economic heory and he diverse resuls in ha area concerning he effecs of fiscal policy. In he second par, here is an overview of empirical sudies ha esimae he effecs of fiscal policy on GDP. Effecs of various insrumens are discussed, as is he dependence of such effecs on he cyclical siuaion. The hird and final par presens how economiss who use macromodels a organizaions like he EU, he IMF and he OECD calibrae he macroeconomic effecs of fiscal policy. 4.5.1 Theory The heoreical answer regarding he size of he muliplier differs depending on which heoreical model is used. The resuls vary beween large posiive mulipliers in Keynesian models, via mulipliers beween zero and one in models wih Ricardian equivalence, 47 o negaive mulipliers in he lieraure on expansionary fiscal conracions. As shown in Chaper 3, a simple IS/LM model, for example, wih a flexible exchange rae implies ha fiscal policy has no macroeconomic effecs in real erms. However, in more sophisicaed models ha incorporae boh nominal and real sluggishness, fiscal policy also has shor-run effecs in real erms in an economy wih a flexible exchange rae; see, for example, Harrison e al. (2005) for a horough descripion of such a model. The mainsream hinking in curren heoreical lieraure appears o be ha fiscal policy can affec he economy in he shor run even when he economy has a flexible exchange rae, and he NIER shares his view. In he heoreical lieraure, he following is also worh noing: Fiscal policy measures considered emporary by agens in he economy have greaer macroeconomic effecs han permanen measures in neoclassical models (see, for example, Andersen, 2005). The reason is ha agens in he economy 47 Temporary ax changes have no effec on GDP in models wih Ricardian equivalence, whereas emporary changes in general governmen consumpion generally have a muliplier of one. The reason for he laer is ha he decrease in household consumpion required o pay for he increase in general governmen consumpion is disribued by consumers over heir enire lifeime. 50

aler heir ne-lending/saving behaviour more when changes are believed o be permanen, hus couneracing he effec of fiscal policy measures on resource uilizaion. 48 In heoreical models wih Keynesian sluggishness, he muliplier is larger for general governmen consumpion and general governmen invesmen han for ransfer paymens and income axes. The reason is ha he former have a direc impac on demand and hus on GDP, whereas he effecs of he laer wo are ransmied via disposable income, which is no fully consumed in he shor run. In addiion, fiscal policy measures generally have greaer effecs on oupu and employmen (i. e. have a larger muliplier) when he oupu gap is negaive compared o he case when he oupu gap is posiive. 49 The reason is ha when he oupu gap is negaive here are spare resources available, which also means ha inflaionary pressure (and hus he NIER s repo rae) need no be appreciably affeced. However, he lieraure on so-called expansionary fiscal conracions conradics his view (see, for example, Berola and Drazen, 1993. Peroi, 1999, and Suherland, 1997). According o ha heory, when counries find hemselves in a fiscal crisis like he one experienced by Sweden in he early 1990 s, reducing general governmen expendiure or raising axes can have a posiive effec on GDP. 50 Alhough here is some empirical suppor for his saemen, especially in he case of cerain counries (see, for example, Giavazzi and Pagano, 1990, and Ardagna, 2004), oher empirical resuls sugges ha he phenomenon is no a general one (see, for example, Hjelm, 2002a,b, 2007, and Lamberini and Tavares, forhcoming). 48 Permanenly lower general governmen consumpion is offse by permanenly higher household consumpion since agens in he economy expec permanenly lower axes. A permanenly lower ax resuls in permanenly higher household consumpion bu has no effec on GDP if general governmen consumpion is permanenly reduced a he same ime. 49 This saemen, however, is difficul o disprove empirically since mos esimaes are made on he assumpion ha he economy is in equilibrium when he fiscal policy measure is aken. 50 The heoreical explanaion for his finding is ha if general governmen expendiure is lowered or axes are raised when cenral governmen finances are in a crisis, here may be a posiive effec on expecaions for he fuure developmen of he economy provided an even more severe fiscal crisis can be avoided laer on. These improved expecaions can resul in higher consumpion and invesmen. 51

The NIER s conclusion based on economic heory is ha fiscal policy has shor-erm Keynesian effecs on he economy, i. e. higher expendiure and/or lower ax raes affec GDP growh posiively wihin he NIER s forecasing horizon. In he longer erm, however, he effec is generally esimaed a zero, alhough here are excepions where measures affec he long-run behaviour of economic agens. The magniude of he shor-erm effec is assessed below wih he aid of informaion from empirical sudies and calibraion decisions in macroeconomic models used hroughou he world. 4.5.2 Empirical Findings According o he heoreical discussion, here are argumens ha he effecs of fiscal policy depend on which fiscal policy insrumen is used. In he empirical lieraure, however, he focus is usually on effecs of he wo mos aggregae measures: general governmen expendiure and revenue. The findings of such sudies are firs shown below. Then reference is made o cerain resuls where general governmen consumpion and general governmen invesmen are reaed separaely. A cenral elemen in he empirical lieraure on esimaing macroeconomic effecs of fiscal policy is he use of mehods designed o idenify unforeseen changes ( disurbances and shocks are alernaive designaions) in fiscal policy variables. Consequenly, differen ypes of srucural ime-series models are ofen used; see Hemming e al. (2002) for an overview. Table 1 below shows a number of such esimaes. Mos are based on daa for he Unied Saes; unforunaely, no sudy is available for Sweden. 51 51 An excepion is a shor appendix wih preliminary findings in Clayes (2007), who concludes ha he muliplier is negaive in Sweden. These preliminary resuls are ineresing bu require more research and a more horough analysis of Swedish daa. 52

Table 1: Empirical Esimaes of Fiscal Policy Mulipliers Tax muliplier 3 Sudy Counry Period 1 Expendiure muliplier 2 1 year 2 years 1 year 2 years Blanchard & Peroi (2002) US 1960-97 0.5 0.5 0.7 0.7 Burnside e al. (2003) US 1947-95 1.0 1.0 -- -- Edelberg e al. (1999) US 1948-93 1.5 1.0 -- -- Gali e al. (2004) US 1954-98 0.7 1.3 -- -- Mounford & Uhlig (2005) US 1955-00 0.3 0.4 0.5 2.1 Peroi (2004) 4 US 1960-01 -- -- 0.1 0.2 Ausralia 1960-01 -- -- -0.4-1.3 Canada 1961-01 -- -- 0.2 0.4 UK 1963-01 -- -- -0.1-0.2 Germany 1960-89 -- -- -0.1-0.1 Peroi (2007) 4 US 1954-05 1.5 1.8 -- -- Ausralia 1959-06 1.3 1.1 -- -- Canada 1961-06 0.2 0.4 -- -- UK 1963-06 0.3 0.3 -- -- Mean value, US 0.9 1.0 0.4 1.0 Mean value, oher counries 0.6 0.4 0.1 0.4 1 Quarerly daa are used in all sudies. Noe ha no all figures are exac, as some are aken direcly from a diagram. 2 A muliplier of 1.0, for example, means ha GDP rises by he same amoun (no percenage) as general governmen expendiure. 3 A muliplier of 1.0, for example, means ha GDP rises by he same amoun (no percenage) as he decrease in ax revenue. 4 The ax mulipliers are aken from Peroi (2004). The expendiure mulipliers are aken from he laes esimaes in Peroi (2007), whose sudy, however, does no include ax mulipliers. Among oher hings, he following may be noed from Table 1: Since raher many sudies are based on US daa, i appears fairly cerain ha he expendiure muliplier in he shor run (one o wo years) is posiive and relaively close o 1.0 in he US. 52 For all counries, fiscal policy mulipliers decrease over ime (no shown in he able; see Hemming e al., 2002). The able shows he average for he respecive period. If periods are divided ino wo pars (for example, 1960 1979 and 1980 2000), he resuls show ha he muliplier is greaer for he firs half of he period han for he second half. For oher counries excluding he Unied Saes (Ausralia, Canada, Germany and he Unied Kingdom) only one sudy is shown here (Peroi, 2004). 53 52 See he noe o Table 1 for a definiion of muliplier. 53

Since he same mehod is used here, he resuls are highly model-dependen and herefore more difficul o inerpre han he findings for he US. Clearly, however, here appears o be a difference beween hese counries and he US; in he former, he mulipliers are generally lower. The ax muliplier is lower in he US in he shor run, whereas he mean value wo years ahead coincides wih he expendiure muliplier. The ax muliplier in he counries oher han he US is negaive, on average, for boh one and wo years ahead. The relaive diversiy of empirical findings is probably one reason for he lack of consensus among scholars in his maer. The following quoaion from a prominen researcher illusraes his siuaion: While mos economiss would agree ha an exogenous 10 percen increase in money supply will lead o some increase in prices afer a while, perfecly reasonable economiss can and do disagree even on he basic qualiaive effecs of fiscal policy (Peroi, 2007, p. 1). The aricles in he lieraure ofen focus on he effecs of general governmen consumpion. A limied number of sudies are available in which srucural imeseries models are used o separae he effecs of general governmen consumpion and general governmen invesmen. In hese models, however, i generally appears ha general governmen invesmen has greaer macroeconomic effecs; see, for example, Heppke-Falk e al. (2006), Kamps (2005), Pereira and Sagalés (2006). As menioned above, no sudies based on Swedish daa are available, hus challenging scholarly and pracically involved economiss o develop such a sudy in he fuure. 54 Since he empirical findings vary subsanially from counry o counry, i is difficul, based on hem alone, o provide a well-founded esimae of he size of he muliplier in Sweden. Moreover, here is he general difficuly in all empirical models of isolaing fiscal policy disurbances and heir effecs on he economy. For his reason, he sudy 53 Oher sudies are available as well; see, for example, Bruneau and Band (1999), Marcellino (2003) and Rebei (2004). The problem, however, is ha i is no possible o deermine he muliplier effecs from hese aricles, bu only he signs of he responses. 54 One excepion is Becker and Paalzow (1996), bu his sudy is no especially informaive on he quesions discussed here. See also foonoe 51. 54

below also examines how pracically involved economiss have calibraed fiscal policy effecs in some of he bes-known and mos commonly used macroeconomic models hroughou he world. 4.5.3 Calibraion Decisions in Macromodels Ye anoher piece of he puzzle is hus he quesion how organizaions like he IMF, he EU and he OECD calibrae heir macroeconomic simulaion models. I is assumed ha hese organizaions have compeen economiss, who have probably drawn relevan conclusions from exising lieraure. Their calibraion decisions are herefore (a leas) as imporan a source of informaion as he (deficien) empirical evidence noed above. Table 2 below shows a compilaion of shor-erm expendiure mulipliers for differen counries where he common feaure is ha he resuls come from macroeconomic simulaion models. Table 2: Shor-Term (approx. 1 year) Mulipliers for General Governmen Expendiure in Macroeconomic Simulaion Models Sudy & Model US Japan Germany France UK Ialy Bryan e al. (1988). Average several mods. 1.4 1.6 1.6 -- -- -- Bryan e al. (1993). Average several mods. 0.9 1.0 0.9 -- -- -- McKibbin (1997). Average several mods. 0.3 -- -- -- -- -- Richardson (1988). OECD Inerlink 1.3 1.2 1.0 -- -- -- Dalsgaard e al. (2001). OECD Inerlink 1.1 1.7 1.1 0.8 -- 1.2 IMF (1996). Mulimod 1.1 -- -- -- -- -- IMF (1998). Mulimod -- 0.8 -- -- -- -- Roeger/Veld (2002). Ques -- -- 0.8 0.9 0.8 0.8 Hun/Laxon (2002). Mulimod -- -- 1.3 1.3 -- 1.3 Barrel e al. (2002). Nigem -- -- 1.0 0.8 0.6 0.7 Mean value 1.0 1.3 1.1 1.0 0.7 1.0 Mean value, oal 1.0 The able is a summary of Tables 1 and 2 in Hemming e al. (2002). The mean values for he respecive sudies are shown. In he majoriy of he sudies, general governmen expendiure corresponds o general governmen consumpion. Among oher hings, he following may be noed from Hemming e al. (2002) and Table 2: All expendiure mulipliers are posiive, and he mean value is approximaely 1.0 for all counries sudied. There are far fewer simulaion sudies for he ax muliplier. In general, however, he mulipliers for ax changes are less in he shor run. In Dalsgaard 55

e al. (2001, OECD Inerlink model), he average shor-erm ax muliplier is 0.5 for Japan, Germany and he US. Differences in moneary regimes (such as a fixed or flexible exchange rae) have relaively lile effec on shor-erm mulipliers (no shown in he able; see Hemming e al., 2002). 55 Long-erm mulipliers are ofen clearly less han shor-erm ones (no shown in he able; see Hemming e al., 2002). According o he analysis above, he large macroeconomic simulaion models are obviously calibraed o highligh shor-erm Keynesian mechanisms. This calibraion is consisen wih he empirical resuls for he US bu hardly so for oher counries. Moreover, fiscal policy mulipliers decrease raher sharply if he 1950 s and 1960 s are omied. One could herefore say ha he economiss responsible for he abovemenioned models overesimae he size of he fiscal policy muliplier in ligh of empirical sudies. Their assessmen need no be erroneous, however, as he empirical esimaes are generaed by models ha are more or less realiy-based. Clearly, however, he prevailing opinion among economiss associaed wih large macroeconomic simulaion models, based on heir aggregae economic experise, calibraes he fiscal policy expendiure muliplier a abou 1.0 in he shor run (roughly one year). The ax muliplier is calibraed a 0.5, on average, for he shor run. 4.5.4 The NIER s View on he Fiscal Policy Muliplier Given he curren sae of research, i is no possible wih any subsanial cerainy o reach a firm opinion on he effec of fiscal policy on he economy especially no for Sweden, as in principle here are no relevan sudies. However, since he NIER makes economic assessmens, i is necessary o declare openly how fiscal policy is believed o affec he Swedish economy. From he lieraure, he NIER has drawn he following conclusions: 55 See Chaper 3 for a discussion on macroeconomic effecs of fiscal policy under differen moneary regimes. 56

When he economy is in cyclical balance (i. e. when he oupu gap is zero), he fiscal policy muliplier for he curren year is generally assumed o be 0.75 when he moneary policy response is aken ino accoun (see Secion 3.1); his applies wih he average mix of fiscal policy measures. As wih he model calibraions in Secion 4.5.3, he average shor-erm expendiure and ax mulipliers are generally esimaed a 1.0 and 0.5, respecively. The muliplier, m, for a fiscal policy measure in year is generally expeced o decrease according o he following paern: m m = + s, s + 1 (8) where s is he number of years afer he fiscal policy measure has been implemened. As a resul, he long-erm muliplier (i. e. as s ) is zero. I should be noed ha here is no direc empirical suppor for he dynamic muliplier represened by Equaion (8), bu, as is apparen from he discussion above, here is no srong empirically suppored alernaive, eiher. In an expansionary economy, he muliplier is esimaed o be lower, and in a conracionary economy, o be higher. There is no direc empirical suppor here, eiher, largely because he empirical esimaes are generaed by models where he economy is in equilibrium. Exacly how much he muliplier is adjused is specific o each siuaion and mus be assessed from case o case. One possible approximaion is obained by using a logisic funcion o represen he muliplier; see Diagram 10 below. 56 56 1/ The logisic funcion is defined according o: m a c /( 1 exp( b( gap r)) ) = + +, where m sands for he muliplier and gap for resource uilizaion (he oupu gap). The relaionship in Diagram 10 is obained wih he following parameers: a = 0; b = 0.5; c = 1.2; = 1.0; r = 0.6. 57

Diagram 10 Example of a fiscal policy muliplier as a funcion of he GDP gap 1.2 1.2 Fiscal policy muliplicaor 1.0 0.8 0.6 0.4 0.2 1.0 0.9 0.7 0.5 0.3 0.2 0.0-4 -2 0 Oupu gap 2 0.0 4 Source: NIER. Diagram 10 implies ha when he oupu gap decreases, he muliplier increases, hough a a diminishing rae. I should be noed ha he logisic muliplier funcion in Diagram 10 is no presenly used in he NIER s analysis, nor is i in he ficiious and acual examples shown in Secions 5.2.3 and 5.4. In he laer, he muliplier used is 0.75 for he curren year; i hen decreases according o Equaion (8) above. As is apparen from he preceding presenaion, he size of he muliplier is very uncerain and probably depends boh on he sae of he economy and on he fiscal policy ools ha are used. Consequenly, he NIER in pracice assesses he magniude of he muliplier from case o case. I is he NIER s ambiion ha his assessmen be as explici and eviden as possible. 58

5 The Fiscal Policy Reacion Funcion: a Trade-off beween he Surplus Targe and Resource Uilizaion This chaper presens he NIER s model for assessing how fiscal policy should be used in various fiscal and cyclical siuaions. The assessmen is illusraed in a number of ficiious and acual examples. As discussed in Chaper 2, fiscal policy has several differen purposes, bu he NIER s assessmen of an appropriae sance for fiscal policy focuses solely on how fiscal policy measures affec achievemen of he surplus arge, and resource uilizaion. As discussed in he inroducion o Chaper 2, he NIER views boh hese arges as symmerical, primarily because he Governmen has expressed he arges symmerically. This means ha in principle fiscal policy should reac wih equal force when ne lending is above he surplus arge as when i is below i. Similarly, fiscal policy in principle should respond jus as srongly when he oupu gap is posiive as when i is negaive. 57 Since he surplus arge is defined as an average over an economic cycle, i may be inerpreed as an implici arge for indebedness. The NIER acceps he arge as given and does no discuss wheher i is well designed. There is no heoreical guidance concerning eiher an opimal level of indebedness from a welfare sandpoin or how rapidly a argeed level of indebedness (or argeed surplus) should be achieved (Wyplosz, 2005). Moreover, he heoreical and empirical resuls in Secion 4.5 demonsrae ha here is considerable uncerainy abou he effecs of fiscal policy on GDP (i. e. he magniude and he sign of he so-called muliplier). To pu i differenly, here is no posiive model or mehod for arriving a he bes rade-off beween he wo arges based on some crierion of opimaliy. Consequenly, he NIER s rade-off beween he surplus arge and resource 57 A posiive oupu gap is hen regarded as a condiion o be correced. This approach is he sandard one in he lieraure on opimal sabilizaion policy; see, for example, Benigno and Woodford (2005). However, here are new alernaive models in he Keynesian radiion ha quesion his view; see Appendix 6.2. 59

uilizaion is necessarily subjecive. Bu represening NIER s assessmen (or preferences) hrough a so-called fiscal-policy reacion funcion increases he probabiliy ha assessmens will be consisen over ime. The explici rade-off beween he wo arges also enhances ransparency and is a pedagogical advanage. The approach has been inspired by Svensson (2007), who discusses how he preferences of cenral banks in he rade-off beween resource uilizaion and he inflaion arge can be idenified, formalized and applied pracically in decisionmaking. In Secion 5.2.2 addiional commens on Svensson (2007) are provided, for insance concerning why he NIER currenly uses a reacion funcion insead of a loss funcion. I should be emphasized ha he reacion funcion is only an aid in he NIER s analysis of fiscal policy and ha realiy is more complex han any possible represenaion in a model. For his reason, he NIER s assessmens ofen deviae from he resuls of he reacion funcion. Bu by presening he laer ogeher wih he final assessmen, he reasons for he differences can be communicaed o he reader. This chaper consiss of four pars. Secion 5.1 provides a brief review of he fundamenal conflics beween wo objecives: he surplus arge and full resource uilizaion. Secion 5.2 describes he fiscal policy reacion funcion, including he mehod by which i has been developed. Secion 5.3 discusses circumsances where no following he resuls of he reacion funcion is generally warraned. Here i should be noed ha no maximum or minimum amouns have been se for he reacion funcion. This means ha he reacion funcion can generae boh very large and very small amouns. To couner such a siuaion (including so-called fine uning when small amouns are involved), he resul of he reacion funcion is reviewed afer he fac for reasonableness, as he purpose of he reacion funcion is no o encourage fine uning of resource uilizaion. A he same ime, a more acive fiscal policy is probably needed wih a surplus arge in effec han if resource uilizaion alone is considered in fiscal policy decisions. Finally, Secion 5.4 applies he reacion funcion o Sweden s curren fiscal and cyclical siuaion. 5.1 Fundamenal Conflics of Objecives: a Two-by-Two Table The wo objecives (he surplus arge and full resource uilizaion) someimes conflic, bu no always. If each objecive is considered separaely, he following applies: 60

Low ne lending Acion: increase axes/reduce expendiure. High ne lending Acion: reduce axes/increase expendiure. Low resource uilizaion Acion: reduce axes/increase expendiure. High resource uilizaion Acion: increase axes/reduce expendiure. The problem is ha neiher he surplus arge nor resource uilizaion can be changed in isolaion from he oher objecive. As shown in Secion 4.5, fiscal policy (via he muliplier) affecs resource uilizaion. A change in resource uilizaion in urn affecs ne lending hrough he auomaic sabilizers (see Secion 3.2). The conflics of objecives can be shown in he wo-by-wo diagram, which was presened in Chaper 1. Ne lending High Low Resource High Conflicing objecives Raise axes/cu expendiure uilizaion Low Cu axes / raise Conflicing objecives expendiure I is worh noing ha wih he surplus arge defined as an average over an economic cycle, here are fewer poenial conflics of objecives. The reason is ha achieving he surplus arge can be imed o minimize he damage o resource uilizaion. In wo of he four combinaions, objecives conflic, requiring a rade-off. I should be noed, hough, ha even in he wo cases where here is no conflic of objecives, a rade-off is required on he speed a which he differen arges should be achieved. The fiscal policy reacion funcion derived below is inended o show he NIER s opinion on he consideraion ha should be given o he wo objecives in differen cyclical and fiscal siuaions. 61

5.2 Fiscal Policy Reacion Funcion: Mehod and Resuls The fiscal policy reacion funcion derived in his secion is designed o represen how he NIER on average will make he rade-off beween objecives in all four cases above, and how rapidly he respecive arges are o be achieved depending on he iniial fiscal and cyclical siuaion. To deermine fiscal policy preferences, a number of senior personnel a he NIER were presened wih four ficiious combinaions of fiscal and cyclical siuaions. The reacion funcion derived (by ieraion) from hese choices has hen been applied in a number of acual economic siuaions. The four ficiious examples correspond o he four fields in he wo-by-wo diagram shown in he previous secion. 58 5.2.1 Choice of Variables in he Reacion Funcion In he lieraure on moneary policy, use is ofen made (in boh empirical and heoreical models) of a reacion funcion where he policy ineres rae is normally a funcion of he rae in previous periods (so-called smoohing), resource uilizaion and inflaion (a so-called Taylor rule). As far as he NIER is concerned, resource uilizaion and general governmen ne lending in relaion o he ne lending arge are of course wo cenral variables in a fiscal policy reacion funcion. As discussed in Secion 2.7, counercyclical fiscal policy involves he following relaionship beween cyclically adjused ne lending ( KS ) and resource uilizaion ( ln y ln y ): KS = α ( ln y ln y ), Y (9) 58 This approach may be compared o a revealed prefererence approach. In he microeconomic lieraure, i is used, for example, o describe he individual s choice of goods a given prices and wih a given income. In deriving he fiscal policy reacion funcion, he NIER s choice of fiscal policy has been made for a given iniial level of ne lending and resource uilizaion in a number of ficiious examples. As he experimens where ficiious, one could label he mehod as a saed preference approach, bu we use he erm revealed in he repor. 62

where α > 0. 59 This means ha cyclically adjused ne lending should be higher (i. e. have a conracionary effec) in an expansionary economy han in a conracionary economy. Taking he firs difference of Equaion (9) yields: KS Δ = α ( ln y ln y ) ( ln y 1 ln y 1). Y (10) Equaions (9) (10) hus generae a posiive covariaion beween resource uilizaion and cyclically adjused ne lending; see Diagram 9 from Secion 4.4 below, where he basic developmen of he real rae of ineres over an economic cycle is shown. 60 Diagram 9 Counercyclical fiscal and moneary policy: Ficiious example Percen of poenial GDP and percenage poins, respecively 2 2 1 1 0 0-1 -1-2 -2-3 -3 01 03 0507 09 1113 15 1719 21 23 2527 29 3133 35 37 Source: NIER. Oupu gap Cyclically adjused ne lending (% of po. GDP) Real rae of ineres (deviaion from eq.value) 59 Resource uilizaion, ( ln y ln y ), is expressed, as shown in he reacion funcion below, excluding he proposed fiscal policy (see Appendix 6.4 for a deailed descripion). Noe ha upper-case (lowercase) leers denoe nominal (real) variables. 60 The exac design of moneary and fiscal policy over an economic cycle depends on he effec lag for each policy. In Diagram 9, i is assumed for he sake of simpliciy ha moneary and fiscal policy urn a he same poin in ime. In realiy, moneary policy probably urns somewha earlier han fiscal policy, since he effec lag of moneary policy is generally longer. 63

Equaion (10) means ha he change in KS / Y and he change in he oupu gap swich sign a he same ime, as in period 4 in Diagram 9 above. All else being equal, an improvemen in resource uilizaion (i. e. an increase in he oupu gap) means ha higher (i. e. less expansionary) cyclically adjused ne lending is needed (for example, via fewer paricipans in labour marke programmes; see Secions 2.7 och 4.4 for furher discussion). To reflec he NIER s preferences as shown in revealed-preference exercises (see Secion 5.2.3 below), i also proved necessary o include he level of he oupu gap in he reacion funcion, i. e: KS Δ = δ ( ln y ln y ) + α ( ln y ln y ) ( ln y 1 ln y 1), Y (11) where δ > 0. This means, among oher hings, ha KS / Y changes sign a a somewha laer urning poin han wih a reacion funcion of he ype shown in Equaion (10). 61 This difference may be inerpreed by he NIER wih some cauion a urning poins, as idenifying hese in real ime is ofen surrounded by considerable uncerainy. In addiion o he variables in Equaion (11), he surplus arge should of course be included as well. Bu leing he reacion funcion depend on he surplus arge is no wihou problems, as he Governmen uses hree indicaors o deermine wheher he arge has been me (see Secion 2.1.1): (i) (ii) a moving seven-year average, cyclically adjused ne lending, level, and (iii) average ne lendng since 2000. The NIER reas (i) and (ii) as equally imporan, whereas indicaor (iii) does no influence he Insiue s assessmen of an appropriae fiscal policy. 62 Thus, Equaion 61 According o Equaion (10), as noed, he change in KS / Y should be posiive beween periods 4 and 5, and would hus have a cerain conracionary effec on he economy in Diagram 9. Since he level of he oupu gap is included in Equaion (11), he change in periods 4 and 5, or even zero/negaive depending on he parameers. 62 See foonoe 13. KS / Y is less posiive beween 64

(11) is expanded o include an error-correcion erm ha akes ino accoun wheher (i) and (ii) in he aggregae deviae from he surplus arge. 63 The NIER s reacion funcion is hus expressed as follows: 64 KS Δ = δ ( ln y ln y ) + α ( ln y ln y ) ( ln y 1 ln y 1) Y Targe FS 1 KS 1 FS β χ + ( 1 χ), Y 1 Y 1 Y (12) where β 0, 0 χ 1 > < <. ( / ) FS Y refers o average ne lending, as he surplus arge is expressed as an average over an economic cycle. 63 The error-correcion erm differs from he erm on he lef side of he equaion. The reason is ha he surplus arge is defined in erms of general governmen ne lending, whereas he decision variable is cyclically adjused ne lending. The effecs on auomaic sabilizers are included in he calculaion; see Appendix 6.4. 64 Readers of previous versions of he presen Special Sudy may noe ha he reacion funcion has been changed in wo respecs compared o previous drafs. Firs, ( KS 1/ Y 1) has been incorporaed in he error-correcion erm. The reason for his is ha afer more horough discussion a he NIER on he Governmen s hree indicaors for he surplus arge (see Secion 2.1.1), an explici balance has been sruck beween he seven-year moving average, ( FS 1/ Y 1) ne lending, ( KS 1/ Y 1) adjused ne lending, Δ ( KS 1/ Y 1), and he level of cyclically adjused. Second, he previous smoohing erm (i. e. lagged change in cyclically ) has been removed. If he NIER s assessmen of an appropriae fiscal policy were communicaed for a series of years (for example, 2008 2010), a smoohing erm would probably be included in order o smooh ou fiscal policy. In pracice his is no presenly he case. For he years for which he NIER normally publishes is mos imporan assessmen (for example, for 2009 in he spring of 2008), ( KS 1/ Y 1) Δ (i.e.. 2008) has already been deermined by he Governmen s policy in he cenral governme budge for ha year (see he special analysis in The NIER s Fiscal Policy Forecass in The Swedish Economy, January 2008, for a more horough descripion). The smoohing erm hus loses is relevance, as he NIER in is assessmen does no explicily wish o be influenced by he policy acually followed in he previous year. Because of hese wo changes, he oher parameers of he reacion funcion have been modified somewha from previous versions, he purpose being (as in previous versions) o achieve he NIER s chosen fiscal policy in he ficiious and real-life experimens (see Secion 5.2.3 below for a descripion). Thus, he preferences and he fiscal policy deemed appropriae by he NIER are basically he same as in earlier versions. There have been minor changes afer an addiional review of he examples in connecion wih he publicaion of he Special Sudy. 65

Since Equaion (12) is a reacion funcion, is lef side (i. e. he decision variable) should preferably be under he full conrol of he decision-maker (i. e. he Governmen and Parliamen). As discussed in Secion 2.4, he lef side can be affeced by facors which (a leas in he shor run) are no dependen on poliical decisions (i. e. a so-called passive fiscal policy). An alernaive variable on he lef side would hen be he change in he cyclically adjused ne lending of he cenral governmen, which is under greaer governmen and parliamenary conrol. However, in he NIER s assessmens of an appropriae sance for fiscal policy, an imbalance in general governmen ne lending ha in he NIER s opinion warrans acion by he Governmen and Parliamen should be correced specifically via he cenral governmen budge. In oher words, he NIER assumes ha he Governmen and Parliamen bear he overall responsibiliy for he sance of fiscal policy in Sweden. 5.2.2 Reacion Funcion or Loss Funcion? Svensson (2007) argues ha cenral banks should explicily show how hey arrive a he rade-off beween resource uilizaion and he deviaion of inflaion from is arge value. Svensson (2007) exemplifies how he preferences of members of a moneary policy commiee (in Sweden, he Execuive Board of he Riksbank [direkionen]) can be exraced from heir expressed choice of pahs for ineres raes (and hus pahs for oupu and inflaion) in differen cyclical siuaions. In Secion 5.2.3 he parameers for he fiscal policy reacion funcion are derived in Equaion (12) based on he NIER s choices beween resource uilizaion and he surplus arge in various (ficiious and acual) cyclical and fiscal siuaions. Whereas Svensson (2007) employs an ineremporal loss funcion, a reacion funcion is used in he presen sudy. The principal reason for his choice is ha in he NIER s opinion i is currenly more pedagogical o use he reacion funcion. The approach of paramerizing an ineremporal loss funcion, where consideraion should be given o he hree variables in Equaion 12, is also unclear. Tha does no rule ou he possibiliy ha he NIER may swich o an explici loss funcion in he fuure, especially if research can indicae a pracical way o solve he problems of paramerizaion and applicaion. One difference beween a loss funcion and a reacion funcion is ha he former is forward-looking. The quaniy of informaion in he reacion funcion as shown in Equaion (12) includes only hisorical daa and real-ime daa. Bu i is imporan o poin ou ha as described in deail in Appendix 6.4, he resource uilizaion and he ne lending (excluding fiscal policy) used in period and hereafer consiue he 66

NIER s forecass. For example, if he economy is expansionary in period and a conracionary economy is forecas for +i, he reacion funcion, all else being equal, will mean a more expansionary fiscal policy in +i han in. The NIER s preferences were idenified wih his quaniy of forward-looking informaion, resuling in he paramerizaion in Secion 5.2.3 below. As discussed in Secion 5.3, he NIER can also conduc a comprehensive assessmen of he resuls of he reacion funcion over several years, making i possible o ake period +i ino accoun in he final decision on a suiable policy in period ec. Finally, i should be emphasized ha he reacion funcion has been developed chiefly for pracical use wihin he forecasing horizon of 1 2 years (in addiion o he curren year) ha is relevan for he NIER). 5.2.3 Choice of Parameers in he Reacion Funcion The reacion funcion is inended for use in numerous combinaions of fiscal and cyclical siuaions. I is herefore crucial o apply he same paramerizaion hroughou o ensure consisency over ime. The process of guiding he progression of such a paramerizaion based on he NIER s model consised essenially of hree seps: 1. Senior NIER personnel were asked o decide freely wha fiscal policy hey preferred in four ficiious siuaions based on he wo-by-wo diagram in 5.1. A heir disposal was a small fiscal policy model (see Appendix 6.4) ha calculaed he dynamic effecs of he proposed policy on resource uilizaion and ne lending. 2. Based on sep 1, an iniial proposal was developed for paramerizaion of he reacion funcion (i. e. Equaion (12) for he four ficiious siuaions). The resuls of his firs ieraion, which are shown in Appendix 6.3, provided a basis for a discussion on desirable changes in view of he NIER s preferences. 3. The reacion funcion was paramerized again in order o accommodae hese suggesions for change, and new resuls were shown. The process of ieraion beween seps 2 and 3 was concluded when he developmen in all four ficiious siuaions was acceped for he same paramerizaion. This paramerizaion was hen used on wo real-life siuaions in order o illusrae is 67

effecs; see examples in Secion 5.4. The final paramerizaion of he reacion funcion was as follows: 65,66 KS Δ = 0.3( ln y ln y ) + 0.2 ( ln y ln y ) ( ln y 1 ln y 1) Y Targe FS 1 KS 1 FS 0.4 0.5 + ( 1 0.5 ). Y 1 Y 1 Y (13) The following four ficiious siuaions were used in paramerizing he reacion funcion; hey reflec he four fields in he wo-by-wo diagram in Secion 5.1: Example 1: Posiive oupu gap and low ne lending Example 2: Negaive oupu gap and high ne lending Example 3: Negaive economy and low ne lending Example 4: Posiive oupu gap and high ne lending. A fiscal policy muliplier model, including he reacion funcion in Equaion (13), is used o develop he fiscal policy for 2007 2010 ha he NIER considers mos appropriae. 67 Average general governmen ne lending is calculaed from 2004 on. 68 65 The paramerizaion of he reacion funcion has been changed somewha from previous versions. The reason was no ha he NIER s preferences had changed, bu ha wo changes in variables were made afer he previous draf; see foonoe 64 for an explanaion. The slighly modified paramerizaion resuls in basically he same fiscal policy assessmens as he previous paramerizaion (see Diagrams 11 14 in he ex). 66 I should be noed ha his is no some unique represenaion of he NIER s preferences. Anoher combinaion of parameer values or anoher arrangemen of variables/parameers could probably be found. The chosen reacion funcion, however, is considered o provide a saisfacory approximaion of he NIER s preferences in regard o he curren level of general governmen indebedness, for example. I should be noed ha his paramerizaion may be changed laer in ligh of new knowledge and new assessmens a he NIER. 67 See Appendix 6.4 for a deailed descripion. The model is very simple and provides only ha he fiscal policy of he reacion funcion has diminishing effecs on resource uilizaion (see Equaion (8)) and effecs on general governmen ne lending (including auomaic sabilizers). 68

The resuls are shown in Diagrams 11 14. These diagrams also include ficiious pahs for he developmen of resource uilizaion and average ne lending in he absence of he fiscal policy generaed by he reacion funcion. The oupu gap is assumed o diminish by ¼ per year, as a resul, for example, of he design of moneary policy and/or he equilibrium-seeking mechanisms of he economy iself. General governmen ne lending is assumed o be consan in 2004 2006. General governmen ne lending in 2007 2010, absen he fiscal policy generaed by he reacion funcion, consiss of he developmen of he auomaic sabilizers and unchanged cyclically adjused ne lending. The ne lending due o auomaic sabilizers has been se a 0.55(ln y ln y ). The elasiciy of 0.55 is a reasonable average value, bu in pracice he amoun of elasiciy is dependen on he cause (or disurbance) ha explains he change in GDP. The unchanged cyclically adjused ne lending in 2007 2010 is se a he ne lending of 2006 less he ne lending resuling from he auomaic sabilizers. The ficiious pahs are used o compare how fiscal policy generaed by he reacion funcion would affec he developmen of hese variables. The ficiious fiscal policy is assumed in he example o affec resource uilizaion only hrough acual GDP, no poenial GDP. Example 1: Posiive oupu gap and Low Ne Lending In his ficiious example, here is no conflic beween he surplus arge and he objecive of full resource uilizaion. Ne lending is iniially low, averaging 0.5 percen in 2004 2006; see he hin solid line in Diagram 11a and he broad solid line in Diagram 11b. Moreover, cyclically adjused ne lending is negaive (see he dashed line in Diagram 11b). Resource uilizaion is iniially high, 3 percenage poins above equilibrium; see he broad solid line in Diagram 11a. Boh arges hus call for a conracionary fiscal policy. In he absence of fiscal policy, he oupu gap decreases by ¼ each year (see he broad solid line in Diagram 11a), and average ne lending weakens furher, as he auomaic sabilizers conribue less and less as he oupu gap decreases. 68 This means ha he ficiious examples cover he same period for he surplus arge as one of he indicaors presened by he Governmen in he spring budge bill of 2007 (Prop. 2006/07:100, Appendix 1), i. e. he period 2004 2010 (see Secion 2.1.1). 69

Diagram 11a Fiscal policy according o he reacion funcion. Ficiious example 1: Expansionary economy, low ne lending Percen of GDP and poenial GDP, respecively 3.0 2.5 2.0 1.5 1.0 0.5 0.0-0.5 1.2 1.0 0.8 0.6 0.4 0.2 0.0-0.2 04 05 06 07 08 09 10 Oupu gap excluding fiscal policy Oupu gap including fiscal policy Gen.gov. ne lend. excl. fiscal pol. (average 2004-) Gen.gov. ne lend. incl. fiscal pol. (average 2004-) Fiscal policy: Change in CAB (a righ) Diagram 11b Ne lending. Ficiious example 1: Expansionary economy, low ne lending Percen of GDP and poenial GDP, respecively 2.0 1.5 1.0 0.5 0.0-0.5-1.0-1.5 04 06 08 10 Gen.gov. ne lending incl. fiscal policy CAB incl. fiscal policy Auomaic sabilizers incl. fiscal policy Source: NIER. 2.0 1.5 1.0 0.5 0.0-0.5-1.0-1.5 The fiscal policy reacion funcion resuls in gradual srenghening of cyclically adjused ne lending; see he grey bars in Diagram 11a and he dashed line in Diagram 11b. Thus, average general governmen ne lending srenghens unil 2010 (see he hin dashed line in Diagram 11a). The improvemen is curbed o some exen, however, for as cyclically adjused ne lending increases, he oupu gap approaches zero more quickly (see he broad dashed line in Diagram 11a), hus weakening he conribuion of auomaic sabilizers compared o an unchanged policy. The fiscal policy of he reacion funcion means, hough, ha boh resource uilizaion and average general governmen ne lending are brough closer o heir arges han if policy is unchanged. 69,70 69 A relevan quesion is why fiscal policy is no used direcly o achieve full resource uilizaion and he ne lending arge. Bu even if his is heoreically possible, i is no realisic in pracice. One reason is ha he effecs of fiscal policy are uncerain; anoher is ha rapidly meeing he arges would involve abrup shifs in fiscal policy, paricularly when hey conflic. The NIER prefers insead o achieve he wo objecives a an average rae considered reasonable in pracice. 70 I may be noed ha in he example 2010 is no a year of equilibrium in general governmen ne lending. One reason is ha average ne lending is slighly below 1 percen (see Diagram 11a); anoher is ha he level of cyclically adjused ne lending exceeds 1 percen ha year (see Diagram 11b). Consequenly, a minor adjusmen in ne lending will probably be needed afer he ficiious period. The focus, however, is on he forecasing horizon mos relevan for he NIER, usually 1-2 years (in addiion o he curren year). 70

Example 2: Negaive oupu gap and High Ne Lending This cyclical siuaion, which is he converse of he one above, yields he same resul bu wih he opposie sign, as he reacion funcion is linear and symmerical. 71 Resource uilizaion is low, and ne lending is high; boh facors hus call for an expansionary policy. As shown in Diagrams 12a-b, fiscal policy follows exacly he same principle as in Diagrams 11a-b, bu wih he opposie sign. Diagram 12a Fiscal policy according o he reacion funcion. Ficiious example 2: Conracionary economy, high ne lending Percen of GDP and poenial GDP, respecively 2 1 0.0-0.2 Diagram 12b Ne lending. Ficiious example 2: Conracionary economy, high ne lending Percen of GDP and poenial GDP, respecively 4 3 4 3 0-0.4 2 2-1 -0.6 1 1-2 -0.8 0 0-3 -1.0-1 -1-4 -1.2 04 05 06 07 08 09 10 Oupu gap excluding fiscal policy Oupu gap including fiscal policy Gen.gov. ne lend. excl. fiscal pol. (average 2004-) Gen.gov. ne lend. incl. fiscal pol. (average 2004-) Fiscal policy: Change in CAB (a righ) Source: NIER. -2 04 Source: NIER. 06 08 Gen.gov. ne lending incl. fiscal policy CAB incl. fiscal policy Auomaic sabilizers incl. fiscal policy 10-2 Example 3: Negaive oupu gap and Low Ne Lending In Diagrams 11a-b and 12a-b, he sance of fiscal policy was relaively uncomplicaed since here was no conflic in hose wo examples beween he objecives of full resource uilizaion and meeing he surplus arge. In realiy, however, such conflics are likely o arise. In Diagrams 13a-b, he economy is iniially conracionary while average ne lending is iniially low, averaging only 0.5 percen in 2004 2006, i. e. he same ne lending as in Example 1 above. By conras, cyclically adjused ne lending is high, over 2 percen; see he dashed line in Diagram 13b. If no fiscal policy measures are aken, resource uilizaion will gradually rise (solid black line in 71 Alhough Example 2 is only he converse of Example 1, i has been imporan o use i in he paramerizaion of he reacion funcion. As a consequence, NIER personnel paricipaing in his process have had o hink (hough wihou being obliged o ac) symmeically, a precondiion for achieving he arges, on average, over a longer period. 71

Diagram 13a), leading o improvemen in average general governmen ne lending (hin solid line) via auomaic sabilizers. Diagram 13a Fiscal policy according o he reacion funcion. Ficiious example 3: Conracionary economy, low ne lending Percen of GDP and poenial GDP, respecively 1 0.00 Diagram 13b Ne lending. Ficiious example 3: Conracionary economy, low ne lending Percen of GDP and poenial GDP, respecively 3 3 0-1 -0.10-0.20-0.30 2 1 2 1-2 -0.40 0 0-3 -0.50-0.60-1 -1-4 -0.70 04 05 06 07 08 09 10 Oupu gap excluding fiscal policy Oupu gap including fiscal policy Gen.gov. ne lend. excl. fiscal pol. (average 2004-) Gen.gov. ne lend. incl. fiscal pol. (average 2004-) Fiscal policy: Change in CAB (a righ) Source: NIER. -2 04 Source: NIER 06 08 Gen.gov. ne lending incl. fiscal policy CAB incl. fiscal policy Auomaic sabilizers incl. fiscal policy 10-2 In his cyclical siuaion wih relaively srong negaive oupu gap, he quesion naurally arises wheher fiscal policy should be used acively o speed he reurn of he economy o full resource uilizaion even if doing so would mean ha average ne lending deviaed furher from he arge of 1 percen. A way ou of his sabilizaionpolicy dilemma would of course be available if an expansionary economy had been forecas some ime afer he presen conracionary economy. Then an expansionary fiscal policy during he period of negaive oupu gap, causing average ne lending o deeriorae, would have shifed sance o a conracionary policy in he expansionary period. Thus, average ne lending over he full economic cycle would no have o be affeced, and he GDP gap wih fiscal policy included would have averaged close o zero. One problem wih his sraegy is ha economic analysiss generally do no forecas ha he curren conracionary period will be followed by a an expansionary period of equal magniude; i. e. he forecas cyclical paern does no resemble he one in Diagram 4, Secion 4.4. The explanaion is he assumpion ha economic cycles are caused by disurbances (see he discussion in Secion 2.9.2), which generally means ha he oupu gap is forecas o gradually approach zero. Some overshooing, i. e. a conracionary economy becomes expansionary, may be forecas, bu because of he diminishing effec of disurbances on he economy, he magniude of he expansionary period will be less by definiion han ha of he preceding conracionary period. The 72

NIER has chosen no o wai for he nex economic cycle and in he meanwhile le general governmen ne lending, for example, gradually move farher away from is arge. Insead, here is an explici rade-off beween objecives, based on he economic forecas ha he NIER consideras mos reasonable. The NIER s rade-off in he reacion funcion means ha a cerain degree of expansionary fiscal policy is required in his siuaion, as he bars in 2007 2010 add up o more han one percen of poenial GDP (see he righ axis). This means ha resource uilizaion will improve somewha a he cos of no meeing he ne lending arge by 2010. Bu if ha policy is followed, cyclically adjused ne lending will approach 1 percen in 2010. Wih he reacion funcion designed as i is, i can generae very small changes in fiscal policy, as in he example above. If his case had been real and he NIER had chosen o follow he fiscal policy of he reacion funcion, probably no fiscal policy recommendaion would have been made for 2009 2010; see Secion 5.3 for reasons no o follow he fiscal policy of he reacion funcion o he leer. In order o demonsrae he sensiiviy of ne lending and resource uilizaion, Diagrams 13c-d below show he fiscal policy ha he reacion funcion would generae in Example 3 above if (c) ne lending were iniially even lower, 0 percen on average, and if (d) resource uilizaion were iniially 1.5 percen lower. In Diagram 13c he now lower level of iniial ne lending compared o Diagram 13a above means ha he expansionary policy in Diagram 13a is curailed by roughly half. This gradually improves average ne lending, whereas he improvemen in he oupu gap is more limied. Diagram 13c Fiscal policy according o he reacion funcion. Ficiious example 3c: Conracionary economy, low ne lending Percen of GDP and poenial GDP, respecively 0.5 0.10 Diagram 13d Fiscal policy according o he reacion funcion. Ficiious example 3d: Conracionary economy, low ne lending Percen of GDP and poenial GDP, respecively 2 0.0 0.0-0.5-1.0-1.5-2.0-2.5-3.0 0.00-0.10-0.20-0.30-0.40 1 0-1 -2-3 -4-0.2-0.4-0.6-0.8-1.0-3.5-0.50 04 05 06 07 08 09 10 Oupu gap excluding fiscal policy Oupu gap including fiscal policy Gen.gov. ne lend. excl. fiscal pol. (average 2004-) Gen.gov. ne lend. incl. fiscal pol. (average 2004-) Fiscal policy: Change in CAB (a righ) -5-1.2 04 05 06 07 08 09 10 Oupu gap excluding fiscal policy Oupu gap including fiscal policy Gen.gov. ne lend. excl. fiscal pol. (average 2004-) Gen.gov. ne lend. incl. fiscal pol. (average 2004-) Fiscal policy: Change in CAB (a righ) Source: NIER. 73 Source: NIER.

In Diagram 13d resource uilizaion is iniially lower han in Diagram 13a; fiscal policy is hus even more expansionary. Bu as a consequence, ne lending will move sill furher away from he surplus arge by 2010 (see he hin dashed line). Example 4: Posiive oupu gap and High Ne Lending This cyclical siuaion is he converse of he one shown in Diagrams 13a-b above. Alhough resource uilizaion is decreasing, he economy is overheaed in he forecas; see Diagrams 14a-b. A 1.5 percen, ne lending iniially exceeds he surplus arge, bu i gradually moves back oward 1 percen as decreasing resource uilizaion reduces he conribuion of auomaic sabilizers. Cyclically adjused ne lending is iniially negaive; see Diagram 14b. Diagram 14a Fiscal policy according o he reacion funcion. Ficiious example 4: Expansionary economy, high ne lending Percen of GDP and poenial GDP, respecively 3.0 0.70 Diagram 14b Fiscal policy according o he reacion funcion. Ficiious example 4: Expansionary economy, high ne lending Percen of GDP and poenial GDP, respecively 2.0 2.0 2.5 2.0 1.5 0.60 0.50 0.40 0.30 1.5 1.0 1.5 1.0 1.0 0.5 0.20 0.10 0.00 0.5 0.0 0.5 0.0 0.0 Source: NIER. -0.10 04 05 06 07 08 09 10 Oupu gap excluding fiscal policy Oupu gap including fiscal policy Gen.gov. ne lend. excl. fiscal pol. (average 2004-) Gen.gov. ne lend. incl. fiscal pol. (average 2004-) Fiscal policy: Change in CAB (a righ) -0.5 04 Source: NIER. 06 08 Gen.gov. ne lending incl. fiscal policy CAB incl. fiscal policy Auomaic sabilizers incl. fiscal policy 10-0.5 Since he reacion funcion guaranees symmery, fiscal policy from he reacion funcion will be he mirror image of ha in Example 3, Diagrams 13a-b; i. e. fiscal policy should be somewha conracionary wih he economy in his sae, according o he reacion funcion and, hence, NIER s preferences. 5.3 Reasons no o Follow he Fiscal Policy of he Reacion Funcion In he inroducion o his chaper, i was emphasized ha he fiscal policy reacion funcion is only an aid in he NIER s assessmen of an appropriae sance for fiscal policy. In realiy, here are always facors and consideraions ha are specific o he economic siuaion a hand and canno be considered in a simple linear model. The 74

very exisence of siuaion-specific consideraions makes i difficul o anicipae wha hese may be. I is possible, however, o provide in advance examples of he consideraions ha will very probably ener ino he NIER s fiscal policy assessmen, in addiion o he reacion funcion. Some of hese examples are presened below. Bu firs and foremos, i is imporan o emphasize ha he NIER s curren rade-off beween he surplus arge and full resource uilizaion implicily akes ino accoun Sweden s currenly favourable deb siuaion, wih cenral governmen deb around 30 percen of GDP and negaive ne indebedness. Since he surplus arge is expressed in erms of general governmen ne lending, cenral governmen deb is no explicily included in he reacion funcion. Probably he imporance of meeing he surplus arge, i. e. parameer β in Equaion (12), will increase (decrease) he higher (lower) cenral governmen deb is a he ouse. 5.3.1 Abnormal Cyclical Siuaions The four cyclical examples used in Secion 5.2.3 above were all relaively normal in characer. Normal means ha resource uilizaion and ne lending were no oo disan from heir arge values. 72 I is herefore uncerain wheher he reacion funcion reflecs he NIER s preferences when he arge variables are far removed from heir policy values. However, paramerizaion of he arge funcion from abnormal cyclical siuaions as well is no considered very appropriae as a sraegy. One advanage of he presen reacion funcion is ha i is linear and hus relaively easy o undersand. Bu realiy is probably nonlinear; moreover, is nonlineariy is likely o become more pronounced he farher he economy deviaes from normal levels. A reacion funcion ha also covers abnormal siuaions would necessarily be nonlinear and hus relaively difficul o undersand. Moreover, abnormal siuaions are hard o capure even in nonlinear models. The NIER has herefore concluded ha i is more useful o apply a linear reacion funcion ha represens he insiue s preferences in a 72 To define a normal siuaion precisely in advance is of course difficul since normaliy depends on facors like he combinaion of resource uilizaion, ne lending and general governmen indebedness. 75

saisfacory manner in normal siuaions and hen make siuaion-specific assessmens when abnormal siuaions arise. 5.3.2 Sligh Deviaions from Targes Wih he presen design of he reacion funcion, even minimal deviaions from full resource uilizaion and/or he surplus arge resul in a fiscal policy recommendaion, limied hough i may be. This is reasonable on several grounds. As shown in Secion 4.1.5, he uncerainy surrounding resource uilizaion is relaively grea in real ime, as revisions are made afer he fac, boh in acual GDP by Saisics Sweden and in poenial GDP by he NIER. Taken alone, herefore, small deviaions from full resource uilizaion should no be sufficien jusificaion for a fiscal policy measure. There is also uncerainy abou disances from he surplus arge (see Secion 4.1.5). Consequenly, a minor deviaion, by iself, should no elici a fiscal policy recommendaion. For he approximae limis of a minor deviaion, i is he NIER s opinion ha: an oupu gap beween 1.0 and 1.0 is no sufficien reason by iself o recommend a fiscal policy; average general governmen ne lending beween 0.75 and 1.25 percen is no sufficien reason by iself o recommend a fiscal policy, and cyclically adjused ne lending beween 0.75 and 1.25 percen is no sufficien reason by iself o recommend a fiscal policy. By conras, if he oupu gap is beween 1.0 and 0 (1.0 and 0) and a he same ime ne lending is above (below) he surplus arge, a fiscal policy recommendaion may be called for, as here is no conflic beween he wo arge variables. I should also be noed ha wih he adopion of he surplus arge, i is reasonable o use fiscal policy more ofen han if only resource uilizaion were in focus. Because of he surplus arge, i is preferable, all else being equal, o guide ne lending oward he arge raher han in he wrong direcion. Consequenly, given he surplus arge, he NIER will recommend he use of fiscal policy more ofen han if only resource uilizaion were aken ino accoun (i. e. in a siuaion where no surplus arge exised). 76

5.3.3 Avoid Fiscal Policy of Minimal or Grea Magniude Wih he reacion funcion specified as i is, here is no lower or upper limi o he magniude of he fiscal policy ha may be deemed appropriae by he NIER. In pracice, however, i would be neiher reasonable nor desirable o express fiscal policy in excessively small amouns. If for example he reacion funcion implies ha ne lending should be srenghened by 0.3 percen for a wo-year period, i would probably be more reasonable and effecive o srenghen ne lending by 0.6 percen for one year and hen swich o a neural policy. A he oher end of he scale, i may be argued ha when a fiscal policy recommendaion of grea magniude is generaed by he reacion funcion, i is beer o apporion ha recommendaion over several years. 5.4 Applicaion of he Reacion Funcion in Acual Economic Siuaions To show specifically how he concepual framework is inended o funcion in pracice, and o demonsrae is quaniaive implicaions, he fiscal policy sance generaed by he reacion funcion is presened below for he economic siuaion on wo acual occasions: in June 2003 and in March 2008. I should be noed ha he socalled labour marke gap is currenly he NIER s principal measure of resource uilizaion and is used in he real-life examples below, unlike he oupu gap in he ficiious examples above. 73 June 2003: Ne lending in 2000 2003 averaged 2.4 percen, exceeding he surplus arge of 2 percen in effec a ha ime (see he hin solid line in Diagram 15a below). 74 Cyclically adjused ne lending, on he oher hand, was only abou 1 percen 73 The labour marke gap is he percenage difference beween acual and poenial hours worked. A he NIER, an effor is currenly under way o devise and apply a mehod for calculaing a oupu gap. This gap is inended for subsequen use in he reacion funcion insead of he labour marke gap, which is he measure currenly used. 74 The daa used here are hose available in real ime for he forecas in June 2003. Noe ha he former surplus arge of 2 percen was in effec in 2003, when he ne lending of he PPM sysem was included; see Secion 2.1.1. In Diagrams 15a-b, herefore, he arge is 2 percen insead of 1 percen as in Diagrams 11 14. 77

in 2003, i. e. below 2 percen (see he dashed line in Diagram 15b). The labour marke gap was negaive in 2003 ( 0.7) and was expeced o remain so during he forecas years of 2004 2005. This expecaion, however, was based in par on he fiscal policy forecas for 2004 2005, which was conracionary (see he black bars in Diagram 15a, scale a righ). Wihou his conracionary policy, he labour marke gap would have been slighly posiive in 2004 2005 (no shown in he diagrams), given he muliplier approach described in Secion 4.5.4. When he reacion funcion from Equaion (13) is applied o he period 2004 2005, he resuls are as shown in Diagrams 15a-b. Diagram 15a Fiscal policy according o he reacion funcion, 2004 2005. Acual example: The Swedish Economy (SE), June 2003 Percen of GDP and poenial GDP, respecively 5 1.0 Diagram 15b Fiscal policy according o he reacion funcion, 2004 2005. Acual example: The Swedish Economy (SE), June 2003 Percen of GDP and poenial GDP, respecively 5 5 4 3 2 1 0-1 Source: NIER. 0.5 0.0-0.5-1.0-1.5-2.0-2.5 00 01 02 03 04 05 Labour marke gap, SE, June 2003 Labour marke gap incl. recommended fiscal poli Gen.gov. ne lend., SE, June 2003 (av. 2000-) Gen.gov. ne lend. incl. rec. fiscal pol. (av. 2000-) Recommenderad fiscal policy 04-05 (a righ) Fiscal policy, SE, June 2003, (a righ) 4 3 2 1 0-1 00 Source: NIER. 01 02 03 04 05 Gen.gov. ne lending excl. fiscal policy CAB excl. fiscal policy Auomaic sabilizers including fiscal policy 4 3 2 1 0-1 The reacion funcion implies a slighly conracionary fiscal policy (see he grey bars in Diagram 15a [scale a righ]) ha causes cyclically adjused ne lending o approach 2 percen (see he dashed line in Diagram 15b). This also means ha he labour marke gap recovers faser (see he broad dashed line in Diagram 15a) han wih he forecas policy (see he broad solid line in Diagram 15a). March 2008: Jus prior o he forecas in The Swedish Economy, March 2008, average ne lending in 2004-2007 was roughly 1.8 percen of GDP, i. e. clearly above he surplus arge, and i was also expeced o increase during he forecas period (see he hin dashed line in Diagram 16). Cyclically adjused ne lending was abou 3 percen, and he labour marke gap was expeced o be posiive in 2008 2009. 78

Firs, i may be noed ha fiscal policy in 2004 2007 (i. e. during he period considered when he moving average for 2004 2010 is applied in he above-menioned forecas) was clearly conracionary. This is apparen from comparing he broad and hin solid lines in Diagram 16a, where he laer line shows he developmen of he labour marke gap excluding fiscal policy. 75 Wihou he conracionary policy, he labour marke gap would have been more posiive (or less negaive) during he period. Diagram 16a Fiscal policy according o he reacion funcion, 2008 2009. Acual example: The Swedish Economy (SE), March 2008 Percen of GDP and poenial GDP, respecively 2 1.5 Diagram 16b Fiscal policy according o he reacion funcion, 2008 2009. Acual example: The Swedish Economy (SE), March 2003 Percen of GDP and poenial GDP, respecively 4 4 1 1.0 3 3 0 0.5 2 2-1 0.0 1 1 0 0-2 -0.5-1 -1-3 04 Source: NIER. 05 06 07 08 09-1.0 Labour marke gap, excl. fiscal policy 2009 Labour marke gap, incl. fiscal policy 2009 Labour marke gap, incl. fiscal policy 2004-2009 Gen.gov. ne lend. incl. rec. fiscal pol. (av. 2000-) Recommenderad fiscal policy 2009 (a righ) -2 04 Source: NIER. 05 06 07 08 Gen.gov. ne lending incl. fiscal policy CAB incl. fiscal policy Auomaic sabilizers incl. fiscal policy 09-2 If he reacion funcion in Equaion (13) is applied o 2008 2009, i generaes a fiscal policy ha is neural in 2008 and expansionary in 2009: approximaely 0.8 percen of poenial GDP (see grey bars, scale a righ). The cyclically adjused budge balance (CAB) hen sar o move owards he 1 percen arge (see diagram 16b, dashed line). Fiscal policy in 2009 will have an expansionary effec on he labour marke gap in 2009 compared o a siuaion where no policy is applied ha year; he gap including fiscal policy is slighly posiive compared o a negaive gap in he case wihou fiscal policy. As is shown by he hin solid line, however, aggregae fiscal policy for 2004 2009 sill has some conracionary effec on he labour marke gap in 75 This is calculaed wih he same muliplier model as in he ficiious experimens in Secion 5.2.3. See also Appendix, Secion 6.4. 79

2009. Thus, he fiscal policy acion aken in 2009 can be said o give fiscal policy a less conracionary sance and o swich sign when he change in resource uilizaion also swiches sign. 76 To pu i anoher way, overall fiscal policy is conracionary in 2004 2009 since he changes in cyclically adjused ne lending have had a conracionary impac on resource uilizaion. The deerioraion in cyclically adjused ne lending in 2009 have an expansionary effec on he economy; as a resul, resource uilizaion will be higher in 2009 han i oherwise would have been, and overall fiscal policy in 2004-2009 will be less conracionary. 76 See Secion 2.3 for a discussion of fiscal policy erminology and Secion 2.7 for a discussion of fiscal policy over an economic cycle. 80

6 Appendices 6.1 Fiscal Policy and Resource Allocaion: Examples and Rules of Thumb Secion 2.3 presened he following rule of humb shown below for using Δ ( KS / Y ) o indicae wheher fiscal policy in period is expansionary or conracionary (see secion 2.3.1 for a discussion concerning he imporance of he ime dimension when labelling fiscal policy as expansionary or conracionary): ( KS Y ) ( y y ) ( KS Y ) ( y y ) Δ / > 0 Δ ln ln < 0 Δ / < 0 Δ ln ln > 0. Wih he aid of wo examples, here is hen a more deailed discussion of he condiions under which his rule of humb is valid. The analysis is divided ino wo seps: Sep 1: How does fiscal policy affec he fiscal policy measure KS / Y? Sep 2: How does Δ ( KS / Y ) affec resource uilizaion, ( ln y ln y )? (14) 6.1.1 Example. 1: Fiscal Policy Tha Affecs Acual bu no Poenial GDP Sep 1: Effec on cyclically adjused ne lending as a share of poenial GDP Cyclically adjused ne lending is defined in Equaion (4). By leing ( / ) G = G U U + G + rd, Equaion (4) can be simplified as follows: 77 U N Ti, B i, G = i= 1, i KS. (15) Y B Y Y 77 i, / i, Bi, / Y is he equilibrium value of ax base B i, in U proporion o GDP, G is unemploymen compensaion, U, U are unemploymen and equilibrium unemploymen, respecively, G is general governmen expendiure (in addiion o unemploymen compensaion) and rd is cos of ineres. T B is he implici ax rae for ax i, ( ) 81

Assume a permanen increase in ax i (i. e. he implici ax rae Ti, / B i, rises) ha affecs neiher poenial GDP, equilibrium unemploymen nor he composiion of GDP (i. e. Y, U and ( B ) i, / Y are consan). If Equaion (15) is differeniaed by he implici ax rae Ti, / B i,, i can be seen how KS / Y is affeced by a ax increase of one percenage poin: ( / ) ( Ti, / Bi, ) KS Y Bi, = Y > 0. If ax base i is 30 percen of GDP, KS / Y improves by 0.3 percenage poin as a resul of he ax increase. If he muliplier of 0.75 is used, a ax increase of 0.3 percenage poin of GDP will mean ha GDP decreases by 0.30.75=0.225 percen in he same year (see Secion 4.5.4). Since poenial GDP is unchanged, he oupu gap is affeced o he same degree. (16) If expendiure is increased insead, here will be a negaive effec on ( ) KS Y Y / 1 = = 2 Y G < 0. ( Y ) KS / Y : (17) If Y = 3000 billion and G increases by 30 billion, Equaion (17) means ha KS / Y increases by 0.01, or one percenage poin. If he muliplier is assumed o be 0.75, GDP increases by 0.7530=22.5 billion, or 0.751.0=0.75 percenage poin. The following conclusion can hen be drawn: Conclusion 1: A ax increase/expendiure cuback (ax cu/expendiure increase) ha does no affec poenial GDP improves (worsens) cyclically adjused ne lending in proporion o poenial GDP. Sep 2: Effec on he oupu gap Sep wo is now o analyze how ( KS / Y ) Δ from sep 1 affecs he oupu gap. In his example, since poenial GDP is no affeced, a ax increase or a cuback in expendiure will reduce resource uilizaion, ( y y ) Δ ln ln < 0, i. e. have a conracionary effec on he economy. The reason is he assumpion ha ax 82

increases and expendiure cubacks negaively affec acual GDP (hrough he convenional Keynesian channel 78 ). The aggregae effec will be ha he oupu gap, i. e. he percenage difference beween acual and poenial GDP, ln y ln y, decreases. The converse applies, of course, in he case of a ax cu or an increase in expendiure. Overall, he following conclusion may be drawn: Conclusion 2: In cases where fiscal policy does no affec poenial GDP, he rule of humb in Equaion (14) applies, given he assumpion of a shor-erm Keynesian muliplier. As shown in he example below, he analysis becomes more complicaed when fiscal policy measures are allowed o affec poenial GDP. 6.1.2 Ex.2: Fiscal Policy Tha Affecs Acual and Poenial GDP Sep 1: Effec on cyclically adjused ne lending in proporion o poenial GDP Assume now ha he ax increase in Example 1, Equaion (16) reduces poenial GDP, by decreasing labour supply, for example. If we ignore possible effecs on equilibrium unemploymen and he composiion of GDP, he ax increase has he following effec on implici ax rae Ti, / B i, : KS / Y, shown hrough differeniaing Equaion (15) by he Y G ( KS / Y ) B, ( i, / i T Bi, ) = 2 ( Ti, / Bi, ) Y ( Y ) > 0. (18) 78 See Secion 4.5 for a presenaion of he heory and empirical resuls for he fiscal policy muliplier. 83

This effec is less han he one in Example 1, Equaion (16), since ( Y ( T, i B, i) ) / / < 0. Bu on reasonable assumpions, i is sill posiive. 79 The following conclusion hus applies: Conclusion 3: A ax increase (ax cu) wih negaive (posiive) effecs on poenial GDP means ha he improvemen (deerioraion) in case where poenial GDP does no change. KS / Y will be less han in he An increase in expendiure (hrough increased general governmen invesmen, for example) ha is judged o have a posiive effec on poenial GDP means ha KS / Y is affeced as follows: G Y Y G ( KS / Y ) G G = 2 G ( Y ) < 0. (19) The assumpion ha higher general governmen invesmen will increase poenial / > 0, means ha he negaive effec on KS GDP, ( Y G) / Y will be less han here in Equaion (19) compared o Equaion (17) in Example 1. Under reasonable assumpions, however, he effec will sill be negaive. 80 The following conclusion can hus be drawn: Conclusion 4: An increase (decrease) in expendiure wih posiive (negaive) effecs on poenial GDP means ha he deerioraion (improvemen) in han in he case where here is no change in poenial GDP. KS / Y will be less 79 Theoreically he derivaive in Equaion (18) could be negaive. In ha case he ax base mus be fairly small and he negaive effec on poenial GDP comparaively large. An example migh be an increase in he ne wealh ax or in he ax on high incomes. Since relaively few people are affeced, he ax revenue involved would be raher limied, bu he ax increase in iself migh mean ha financial and human capial move o oher counries, possibly wih a subsanial negaive impac on poenial GDP. In a normal case, however, he NIER esimaes ha he derivaive in Equaion (18) will be posiive. 80 Since G Y Y / G > Y / G if he derivaive in Equaion (19) is o be posiive an unlikely oucome. If i were deermined insead ha he increase in G reduced Y, he change in KS / Y would of course be even more negaive. < i is necessary ha ( ) 84

For he effecs of fiscal policy on KS / Y, he summarizing conclusion below can hus be drawn from Examples 1 and 2: Conclusion 5: Under reasonable assumpions, ax increases/expendiure cubacks (ax cus/increases in expendiure) cause cyclically adjused ne lending o improve (deeriorae) in proporion o poenial GDP. Sep 2: Effec on he oupu gap The quesion now is wheher i suffices o consider Δ( KS / Y ) how ( ln y ln y ) in order o deermine is affeced by fiscal policy when fiscal policy measures also affec poenial GDP. When poenial GDP is affeced, he siuaion is more complicaed, as here will be a supply channel in addiion o he demand channel from Example 1. For example, he ax increase discussed above may reduce labour supply, wih a resulan decrease in poenial GDP. The demand channel, however, is he same as in Example 1; i. e. resource uilizaion decreases (hrough lower growh in demand) as a resul of he ax increase. The wo channels hus lead resource uilizaion in differen direcions, and i is no possible o deermine which channel is generally sronges. The NIER s assessmen, however, is ha he demand channel normally predominaes over he supply channel in he shor run. 81 Bu he analysis may vary depending parly on he sae of he economy and parly on he fiscal policy insrumens used. 82 The following summary conclusion can be drawn concerning he link beween : and ( ln y ln y ) KS / Y 81 In he special analysis Effecs of he New Governmen s Economic Policy in The Swedish Economy,, December 2006, he assessmen was ha fiscal policy (cus in income axes, lower replacemen levels in unemploymen benefis, ec.) reduced resource uilizaion in ha poenial GDP would be affeced more posiively han acual GDP in he shor run, 2007 2010. Thus, in his case he supply channel was considered o predominae over he demand channel. 82 The increase in expendiure in Example 2, which was expeced o increase Y, means ha ( KS / Y ) 0 necessary ha ( y y ) Δ < in Equaion (19). For he rule of humb in Equaion (14) o remain applicable, i is Δ ln ln > 0, i.e. acual GDP mus be affeced more posiively han poenial GDP in he shor run as a resul of he increase in expendiure. However, he economy may be in a sae (see he more deailed discussion in Secion 4.5) where he Keynesian demand channel is small or even negaive. The supply channel would hen predominae; his means ha poenial GDP would generaly be affeced more han acual GDP in he shor run, i. e. ( y y ) Δ ln ln < 0. The rule of humb in Equaion (14) does no apply in his case, which like similar siuaions is regarded by he NIER as a relaively rare excepion o he rule of humb. 85

Conclusion 6: In he normal case, he change in KS / Y may be used as an indicaor in deermining wheher fiscal policy in period has an expansionary or conracionary effec on he economy. If ( KS / Y ) 0, i. e. Δ( ln y ln y ) < 0. If ( KS Y ) period, i. e. Δ( ln y ln y ) > 0. Δ >, a conracionary policy is followed in period Δ / < 0, an expansionary policy is followed in 6.2 Cyclical Variaions and Welfare As can be seen from he reacion funcion in Chaper 5, a posiive oupu gap, all else being equal, means ha fiscal policy will bring he economy back o equilibrium. In oher words, a posiive oupu gap is considered bad and requires correcion. In heoreical models for opimal moneary and fiscal policies (see, for example, Benigno and Woodford, 2005), he sandard resul is ha welfare is opimized if moneary policy minimizes variaion in he oupu gap, among oher facors. This means ha a posiive oupu gap are jus as harmful o welfare as a negaive oupu gap, one reason being he effec on inflaion, where variaion also has negaive effecs on welfare. Moreover, since he oupu gap averages zero in hese models, a posiive oupu gap now means ha a negaive oupu gap will arise in he fuure. Tha variaion is negaive for individual welfare. This applies wheher he economy is wih or wihou disorions (such as resricions on compeiion on goods and labour markes). If consideraion is no given o he effecs on inflaion and he possibly higher probabiliy of a conracionary period in he fuure, an expansionary period will normally mean a higher level of welfare in an economy where imperfec compeiion prevails on goods and labour markes. Galí e al. (2007) illusrae his poin in a model where hey derive a so-called efficiency gap, which is he difference beween he welfare ha would resul in an economy where perfec compeiion prevailed and welfare in an economy wih limiaions on compeiion. In he former, he marginal raio of subsiuion beween consumpion and leisure (MRS) would equal he marginal produc (MPL), and Pareo-opimal equilibrium P would arise in Diagram 86

17 below. 83 Bu because of imperfec compeiion on goods and labour markes, equilibrium is achieved only a poin J, hus causing a loss of efficiency/welfare in he economy (shown by he disance beween MRS and MPL). An expansionary period means ha he economy moves oward P, increasing welfare as he difference beween MRS and MPL decreases. I may also be noed ha cyclical flucuaions have asymmeric effecs on welfare; he difference beween MPL and MRS increases more in a conracionary economy han i decreases in an expansionary economy. Benigno and Woodford (2005) show, however, ha even in his siuaion of imperfec compeiion, i is opimal o minimize variaion in he oupu gap, hus maximizing welfare. Bu his applies on he condiion ha equilibrium oupu varies over ime and is deermined by he shocks ha currenly drive he developmen of he economy. In summary, he lieraure on opimal moneary and fiscal policy is relaively recen (see Secion 4.1.4), and he NIER inends o follow is fuure developmen closely. 83 The equaliy MRS=MPL means ha an individual a he margin (for example, by working for an addiional hour) produces goods whose value generaes increased consumpion poenial exacly equivalen o he perceived cos o he individual of he leisure loss required o produce he increased oupu. 87

Diagram 17: Efficiency Gap as a Measure of Welfare Real earnings = efficiciency gap MRS+ markup on labour marke MRS J P P = Pareo J = Equilibrium MPL MPL+ markup on goods marke Negaive oupu gap Posiive oupu gap Employmen 6.3 Fiscal Policy Reacion Funcion. Firs Ieraion To exemplify how he paramerizaion of he reacion funcion was developed a he NIER, he fiscal policy generaed by he reacion funcion is shown; he paramerizaion used is from he firs ieraion. Diagrams 18 21 below should be compared wih he final resul in Diagrams 11 14 in he main ex. Diagram 18 Fiscal policy according o he reacion funcion: Iniial paramerizaion Ficiious example 1: Expansionary economy, low ne lending Percen of GDP and poenial GDP, respecively 3.0 1.2 Diagram 19 Fiscal policy according o he reacion funcion: Iniial paramerizaion Ficiious example 2: Conracionary economy, high ne lending Percen of GDP and poenial GDP, respecively 2 0.0 2.5 1.0 1-0.2 2.0 1.5 1.0 0.5 0.8 0.6 0.4 0.2 0-1 -2-0.4-0.6-0.8 0.0 0.0-3 -1.0-0.5-0.2 04 05 06 07 08 09 10 Oupu gap excluding fiscal policy Oupu gap including fiscal policy Gen.gov. ne lend. excl. fiscal pol. (average 20 Gen.gov. ne lend. incl. fiscal pol. (average 200 Fiscal policy: Change in CAB (a righ) 88-4 -1.2 04 05 06 07 08 09 10 Oupu gap excluding fiscal policy Oupu gap including fiscal policy Gen.gov. ne lend. excl. fiscal pol. (average 2004 Gen.gov. ne lend. incl. fiscal pol. (average 2004- Fiscal policy: Change in CAB (a righ) Source: NIER. Source: NIER.

Diagram 20 Fiscal policy according o he reacion funcion: Iniial paramerizaion Ficiious example 3: Conracionary economy, low ne lending Percen of GDP and poenial GDP, respecively 2 0.10 Diagram 21 Fiscal policy according o he reacion funcion: Iniial paramerizaion Ficiious example 4: Expansionary economy, high ne lending Percen of GDP and poenial GDP, respecively 3.0 0.10 1 0-1 -2-3 0.05 0.00-0.05-0.10 2.5 2.0 1.5 1.0 0.05 0.00-0.05-4 04 05 06 07 08 09 10-0.15 Oupu gap excluding fiscal policy Oupu gap including fiscal policy Gen.gov. ne lend. excl. fiscal pol. (average 2004 Gen.gov. ne lend. incl. fiscal pol. (average 2004- Fiscal policy: Change in CAB (a righ) 0.5 04 05 06 07 08 09 10-0.10 Oupu gap excluding fiscal policy Oupu gap including fiscal policy Gen.gov. ne lend. excl. fiscal pol. (average 200 Gen.gov. ne lend. incl. fiscal pol. (average 2004 Fiscal policy: Change in CAB (a righ) Source: NIER. Source: NIER. The general difference beween he firs and final paramerizaions is ha greaer imporance is aached o meeing he surplus arge in he firs proposal; i. e. parameer β in Equaion (12) was higher. This means, for example, ha he fiscal policy conracion (expansion) is more powerful in Diagram 18 (Diagram 19) above han in Diagram 11 (Diagram 12). In he wo cases where objecives conflic, he reacion funcion means, in principle, ha, policy will be neural in Diagram 20 (Diagram 21) compared o a slighly expansionary or conracionary policy, respecively, in he final paramerizaion; see Diagrams 13 and 14. 6.4 Fiscal Policy Model: Effecs on Ne Lending and he Oupu Gap This secion shows he calculaions underlying he fiscal policy, and is effecs on resource uilizaion, generaed by he reacion funcion in Diagrams 11 14 in Chaper 5. The calculaions are performed in a small fiscal policy model, he principal elemens of which are he following: a fiscal policy reacion funcion based on he NIER s preferences, designed o reflec how he NIER on average reaches he rade-off beween he surplus arge and resource uilizaion in various fiscal and cyclical siuaions (see Chaper 5) a Keynesian muliplier model where he shor-erm muliplier is posiive bu decreasing and he long-erm muliplier is zero. The size of he muliplier is 89

deermined for an implici moneary policy response o he fiscal policy acion; see Secion 4.5 for a discussion on he size of he muliplier depending on ime horizon, fiscal policy insrumen and cyclical siuaion. Moreover, he calculaions rack he effecs of changes in he oupu gap (which resul from he fiscal policy generaed by he reacion funcion) on he auomaic sabilizers. As noed above, he reacion funcion describes he developmen of cyclically adjused ne lending, hus making i possible o calculae he effecs on general governmen ne lending. The fiscal policy generaed by he reacion funcion is calculaed in wo seps: Sep 1: Calculaion of forecas pahs for resource uilizaion and ne lending excluding forecas fiscal policy. Here he on-going forecass published in The Swedish Economy Δ / 0), are used. If hese forecas pahs include forecas fiscal policy (i. e. ( KS Y ) he muliplier model is also used o calculae how he oupu gap and ne lending develop in he forecas if his policy is disregarded. These forecas pahs are referred o below as base pahs. Sep 2: The base pahs are hen fed ino he fiscal policy reacion funcion in order o calculae an appropriae fiscal policy. Wih he aid of he muliplier model, he dynamic effecs on he oupu gap and general governmen ne lending are hen deermined. The procedure in seps 1 and 2 is described in greaer deail below. 6.4.1 The Oupu Gap and Ne Lending wih Fiscal Policy Excluded Oupu Gap wih Fiscal Policy Excluded Fiscal policy (measured as he change in cyclically adjused ne lending in proporion o poenial GDP; see Secion 2.2) is disregarded by removing i from he exising forecas in a reverse muliplier analysis. Alhough his procedure is relaively sraighforward, he following example is used o make i clearer. Assume ha 2007 is he firs year of he forecas and ha he fiscal policy forecas is conracionary and 0.5 percen of GDP, i. e. ( KS Y ) Δ / = 0,5. If he muliplier is esimaed a 0.75, he oupu gap excluding he fiscal policy forecas for 2007 will be 90

0.50.75=0.375 percenage poin higher han he forecas. 84 More generally, he following formula is used o calculae he forecas GDP gap excluding fiscal policy, ( lny lny ) ExFP : s 1 For m KS ln ln = ln ln +, Δ i+ 1 Y (20) ExFP ( y y ) ( y y ) For i= 0 i ExFP where ( ln y ln y ) For ( ln y ln y ) year, s is he final oucome year, m is he muliplier and ( KS / Y ) is he oupu gap excluding he fiscal policy forecas, is he oupu gap forecas in The Swedish Economy, is he forecas For Δ is he fiscal policy forecas. 85 If, for example, = 2008, s = 2006, m= 0,75 and: ( y y ) ( KS Y ) ( KS Y ) Equaion (20) hen applies as follows: For ln ln = 1, 0 2008 For Δ / = 1,0 2007 For Δ / = 0,5 2008 i (21) ExFP ( ln y ln y ) = 1, 0 + 0, 75( 0,5) + ( 1, 0) 2008 = 0, 25. 0,75 2 (22) Thus, in his example, he oupu gap for 2008 excluding fiscal policy is less han he oupu gap including fiscal policy, which was forecas o be expansionary in boh 2007 and 2008. 84 In he ineres of simpliciy, i is assumed ha fiscal policy does no affec poenial GDP. 85 Of course, ne lending and he oupu gap during he forecas period are also affeced by he fiscal policy followed before he curren year. These decisions, however, have already been aken and canno be reversed. Their impac during he forecas period remains in ha hey are implicily included in he base pahs for ne lending and resource uilizaion. Thus, hey are also included implicily in he forecas pahs, which consis of base pahs plus effecs of he fiscal policy generaed by he reacion funcion. 91

Ne Lending wih Fiscal Policy Excluded In he examples in Chaper 5, a seven-year moving average is used; he laer can presenly be calculaed as an average from and including he year 2004 (see Secion 2.1.1), i. e: s FS 1 FS =, (23) Y s Y ( 2004 + 1) i= 2004 where s is he final oucome year, 2006, for example if he curren year is 2007. Wih he aid of his mehod, which was developed by Braconier and Holden (1999, see also Braconier and Forsfäl, 2004), FS is separaed ino cyclically adjused ne lending, KS, and he conribuion of auomaic sabilizers, AS. The calculaion of ne lending excluding fiscal policy is performed wih he help of is wo elemens, KS and AS. An unchanged policy is defined as a policy where KS / Y is unchanged (see Secion 2.2), i. e: ( KS Y ) = ( KS Y ) ExFP = = ( KS Y ) / /... /, s s+ 1 k wih s being he final oucome year and k he final forecas year. The auomaic sabilizers are affeced by he difference in he appropriae and forecas level of GDP from Equaion (20) as follows: i ExFP ExFP For AS AS ExFP For = + α ( ln y ln y ), Y Y (24) where i is commonly found for Sweden ha α = 0,55. General governmen ne lending can hen be defined as follows: 86 ExFP ExFP ExFP +. FS KS AS Y Y Y (25) Using he ime series for ( / ) ExFP FS Y in Equaion (25), average general governmen ne lending excluding fiscal policy can hen be calculaed for he forecas period. Equaion (23) is used wih he change ha s = 2007, and he average is calculaed for one more year, ec. 86 See Equaion (3) for an exac definiion. 92

6.4.2 Appropriae Fiscal Policy According o he Reacion Funcion Based on he average ne lending beween 2004 and he final oucome year in Equaion (23), and on he oupu gap excluding fiscal policy in Equaion (20), he fiscal policy reacion funcion can now be used o calculae an appropriae fiscal policy and is effecs on he oupu gap and ne lending. In pracice, here is a cerain difference beween he calculaions for he firs year of he forecas and he remaining forecas years; for his reason hey are described separaely. Calculaions for he Firs Year of he Forecas For he firs year of he forecas (2007, for example) he reacion funcion is he following: RecFP KS ExFP ExFP ExFP 0.3 ( ln y ln y) 0.2 ( ln y ln y) ( ln y ln y) 2007 2007 2006 Y 2007 Δ = + For Targe FS KS FS 0.4 0.5 (1 0.5), + Y 2006 Y 2006 Y (26) Δ KS / Y denoes recommended fiscal policy ( RecFP ). A new oupu where ( ) RecFP gap including he recommended fiscal policy can hen be calculaed, wih he lef side of Equaion (26) ransposed o he righ side as below: RecFP RecFP ExFP KS = Δ 2007 2007 Y 2007 ( ) ( ) ln y ln y ln y ln y m, (27) where m is he muliplier. The auomaic sabilizers from Equaion (24) are hen adjused as follows: RecFP ExFP AS AS RecFP ExFP = + α ln ( y ln y ). Y Y 2007 2007 (28) Thereafer, general governmen ne lending can be calculaed using he lef side of Equaions (26) and (28). Calculaions for he Remaining Forecas Years For he remaining forecas years, he principle is similar o he one shown above in Equaions (26) (28). The difference is ha he fiscal policy for 2007 generaed by he reacion funcion mus now be aken ino accoun, as he oupu gap for 2008 is o be used in Equaion (26). More specifically, he oupu gap excluding he fiscal policy forecas for 2008 is adjused in Equaion (20) wih he aid of he fiscal policy for 2007 93

generaed by he reacion funcion; he adjusmen is made via he muliplier ( m /2). This adjused oupu gap provides he basis for he fiscal policy generaed by he reacion funcion for 2008. For 2009, he oupu gap in Equaion (26) mus be adjused for he fiscal policy generaed by he reacion funcion for 2007 and 2008 ec. When 2008 is analyzed, he lagged average general governmen ne lending in Equaion (26) mus be he ne lending ha incorporaes he fiscal policy of he reacion funcion for 2007. This loop of calculaions concludes wih he final year of he forecas. Then diagrams can be prepared for comparing hree pairs of pahs for average general governmen ne lending and he oupu gap: 87 1. forecas pahs including forecas fiscal policy. 2. forecas pahs excluding forecas fiscal policy. 3. pahs including fiscal policy generaed by he reacion funcion. 87 Of course i is also possible o calculae cyclically adjused ne lending and he auomaic sabilizers (level and average). 94

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Tiles in he Occasional Sudies No Auhor Tile Year 1 Konjunkurinsiue Penningpoliiken 2002 2 Konjunkurinsiue Egnahemsposen i konsumenprisindex En granskning av 2002 KPI-uredningens förslag 3 Elofsson, Kaarina och Kosnadseffekivie i svensk miljöpoliik för Ösersjön 2003 Ing-Marie Gren en uvärdering 4 Gren, Ing-Marie and Ecosysems, Susainabiliy and Growh for Sweden during 2004 Lisa Svensson 1991-2001 5 Bergvall, Anders Uvärdering av Konjunkurinsiues prognoser 2005 6 Konjunkurinsiue Produkivie och löner ill 2015 2005 7 Öberg, Ann Samhällsekonomiska effeker av skaelänader för 2005 hushållsnära jänser 8 Söderholm, Parik och Kosnadseffekiva syrmedel i den svenska klima- och 2005 Henrik Hammar energipoliiken 9 Öberg, Ann och Joakim Marginell ubyesgrad e må på drivkraferna för arbee 2006 Hussénius 10 Hammar, Henrik Konsekvenser för skogsindusrin vid e evenuell 2006 införande av en svensk kilomeerska 11 Lundborg, Per, Juhana Den svenska jämviksarbeslösheen: En översik av 2007 Variainen och Göran Zeergren kunskapsläge 12 Samakovlis, Eva and En uvärdering av kosnadseffekivieen i 2007 Maria Vredin Johansson klimainveseringsprogrammen 13 Forslund, Johanna, Per- Samhällsekonomiska värderingar av luf- och 2007 Olov Marklund and Eva Samakovlis bullerrelaerade hälsoproblem 14 Sjösröm, Magnus Moneär värdering av biologisk mångfald. En 2007 sammansällning av meoder och erfarenheer 15 Hammar, Henrik och Kan ekonomiska syrmedel bidra ill en giffri miljö? 2007 Lars Drake 16 Konjunkurinsiue Konjunkurinsiues finanspoliiska ankeram 2008 16 Konjunkurinsiue The NIER s Consepual Framework for Fiscal Policy 2008