The Government Commission on Stabilisation Policy for Full Employment in the Event of Swedish Membership in the Monetary Union (Fi 2000:07) today delivered its final report to the Minister for Finance.

Membership in the monetary union means a change in the stabilisation policy regime because domestic monetary policy disappears as an instrument to stabilise the economy. Instead, Sweden will become a participant in a common European monetary and exchange rate policy. Sweden thereby loses the opportunity to counteract macroeconomic shocks that specifically affect the Swedish economy with the help of changes in the interest rate level. This increases the demands on the labour market to adjust, and on fiscal policy. The primary purpose of this investigation is to analyse the problems which may arise in this new stabilisation policy regime and to propose how fiscal policy is best pursued under these new conditions.

Adjustments of relative wage costs will become essential to stabilise employment in case of large shocks to aggregate demand that hit Sweden differently from other member countries. EMU membership may to some extent strengthen the incentives of the labour market parties to achieve an increased nominal wage flexibility, for example through shorter contract periods, clauses that tie wage growth to macroeconomic developments, more frequent renegotiations of existing agreements and less resistance to low nominal wage increases. However, there is reason to believe that changes in nominal wage flexibility will be rather limited and only to a minor extent will compensate for the loss of national monetary policy as an instrument of stabilisation policy.

In the debate, special interest has been attached to so-called buffer funds as a means to increase wage cost flexibility. The view of the Government Commission is that a system with buffer funds, under the auspices of the labour market parties and constructed properly, could contribute to increasing the economy’s ability to adjust, thereby moderating cyclical fluctuations. An agreement among the labour market parties on such a system should therefore be welcomed, but the advantages are not so significant that they justify government subsidies.

In the case of a Swedish participation in the monetary union, the need for a domestic anchor for the long-term rate of inflation disappears. Fiscal policy should instead have as a primary stabilisation policy target to counteract major fluctuations in the level of activity both in the short and medium term. Such a stabilisation should be pursued under the restriction of the target for general government net lending over the business cycle. Price and wage cost developments relative to other countries are particularly relevant indicators of the possibilities to stabilise the level of activity in the medium term and should therefore be given a prominent role when formulating fiscal policy.

Discretionary fiscal policy, that is, a policy of active decisions to change taxes and public expenditures, should only be used for stabilisation purposes in the event of major macroeconomic shocks. The motives for this are that fiscal policy has a tendency to be too expansionary, that the fiscal policy decision process is slow, and that measures of the cyclical state of the economy (the output gap) are uncertain. In case of small shocks, fiscal policy stabilisation should be achieved through the automatic stabilisers, whereas discretionary fiscal policy should be focused on attaining the target for general government net lending over the business cycle, as laid down by the parliament.

The institutional framework of fiscal policy has in recent years been reformed in a way that decreases the risk of stabilisation policy failures. However, since EMU membership will entail increasing importance of fiscal policy as a stabilising tool, further steps are justified to ensure that fiscal policy is pursued in a way that is desirable from the perspective of stabilisation policy.

The Government Commission presents the following proposals:

· The parliament (the Riksdag) should determine a basic framework for pursuing fiscal policy in the case of Sweden’s participation in the monetary union, with the following guidelines:

- The objective of fiscal policy as regards stabilisation policy shall be to counteract major deviations from the sustainable level of output in the short and medium term. This is equivalent to stabilising employment and unemployment near their equilibrium levels.

- Discretionary fiscal policy shall only be used for stabilisation purposes in the case of major shocks, roughly equivalent to an output gap of at least plus or minus two per cent.

- To create room for automatic stabilisers and discretionary fiscal policy in the event of major shocks, general government net lending should amount to 2.5, or alternatively, 3 per cent of GDP on average over the business cycle.

- To ensure enough room for stabilisation policy, the budget margin below the central government expenditure ceiling should be divided into a margin for cyclical expenditure and a planning margin. The margin for cyclical expenditure must not be utilised for anything besides such increases in expenditure that follow automatically from cyclical developments, including labour market policy measures, or for discretionary fiscal policy decisions to stabilise the economy during major shocks. The margin for cyclical expenditure should amount to approximately three per cent of the expenditures restricted by the ceiling. The planning margin is to cover planned ‘reforms’ and uncertainty in forecasts that are the result of factors other than the business cycle, to the extent that the government does not wish to balance increases in expenditure of this type with changes that decrease other expenditures.

· An advisory body, a fiscal policy council, should be set up with the task of analysing macroeconomic developments and making fiscal-policy recommendations based on the guidelines determined by the Riksdag. The fiscal policy council should be an authority under the auspices of the government, but independent. The recommendations of the council are to be strictly focused on stabilisation policy. The council’s analyses and recommendations should be presented twice a year, once in the beginning of March to serve as a basis of government and Riksdag work on the Spring Budget Bill, and then in early August to serve as a basis for the work on the Budget Bill. The government should take a stand on the recommendations of the council and motivate deviations from them.

· In order to facilitate the decision process the government should select a small number of appropriate fiscal policy measures in advance for use as policy tools during major macroeconomic shocks. These instruments should, as far as possible, have general aggregate-demand effects and have as small effects as possible on income distribution and resource allocation. The measures should be used for a limited time period fixed in advance. The instruments that according to the Government Commission primarily should be considered are:
- a proportional ‘business cycle tax’ or ‘business cycle tax reduction’ in the income tax system
- temporary changes in the value-added tax
- variations in payroll taxes
- variations in public consumption and public investment

· Local government income should be stabilised over the business cycle. This could be achieved by calculating the local government tax base on the basis of an average of taxable incomes over several years. Alternatively, central government grants can be formulated so that they automatically compensate for the effects of the business cycle on the local government tax base.