Virtually no crisis has a single cause.
According to Lars (2009) one of the root cause of
Swedish 1991-92 crisis was result of financial liberalization. As Lars argues:
Financial liberalization fundamentally affected the incentives of lenders and borrowers. After decades of non-price credit rationing, when interest rates were set below market rates and credit was allocated according to political preferences, commercial banks and savings banks were suddenly able to expand their lending without being hampered by regulatory restrictions. They entered into a fierce competition for market shares by freely offering loans to
households and firms.
Here it is worth to point out that the political allocation of the capital prior financial liberalization can also be considered one of the root causes, as without it market correction (the financial crisis) might not have been needed. Crises are often results of misallocation of resources in the economy (e.g. people investing too much into housing, or particular sector etc).
However, housing sector, together with bad incentives set up by Swedish tax policy, was also involved. As mentioned in the previous paragraph crises are often result of misallocation of resources for some reason. Again following Lars:
A lending boom started in 1985-86, channeling credit to asset markets - primarily to housing,
as well as to commercial real estate and to the stock market. The process was fuelled by rising
inflation and a tax system that favored borrowing, resulting in negative real after-tax rates. As
a result, there was a rapid increase in asset prices. They formed the basis for rising collateral
values and the increasing net wealth of households, further fuelling the credit expansion.
Within a couple of years, the aggregate credit volume had increased at an unprecedented
These financial developments impacted on the real economy. The macroeconomic outcome
was a strong boom in 1988-89, characterized by overfull employment, rising consumption and
falling private savings ratios, which eventually turned negative. The current account balance
worsened as export performance weakened and imports rose.
Finally, Sweden had a fixed exchange rate and it is well known that fixed exchange rate prevents central bank from managing boom and bust cycle as fixed exchange rate system preoccupies the tools that central bank could otherwise use for managing the economy. Fiscal policy of Sweden was not countercyclical either. Again citing from Lars:
Due to the pegged exchange rate for the krona, monetary policy was prevented from
mitigating the boom through interest rate increases. Fiscal policies were not sufficiently
tightened to arrest the boom, although national budgets posted large surpluses due to rising
tax revenues from higher consumption, wages, property values and capital gains.
Finally, there were also some external causes (Lars 2009).
The boom in the real economy was eventually halted in 1989-90 and turned into a bust as a
result of a combination of events, both international and domestic. Real interest rates rose
internationally as a result of the contractionary German monetary policy following German
reunification. Rising German interest rates exerted strong upward pressure on Swedish
interest rates, as the krona was pegged to the ecu - the virtual European currency unit - in May 1991. An additional real interest rate shock emerged when the Swedish central bank, the Riksbank, raised nominal interest rates to defend the pegged krona rates against recurring
speculative attacks in 1989-92.
Hence the crisis can be seen as being caused by combination of following factors:
- Financial liberalization: financial liberalization is not always bad per se but if there were bad incentives put in the market it will eventually lead to market correction.
- Political credit rationing: if credit and capital is rationed at below market interest rates that will almost inevitably lead to imbalances that will require some sort of correction at some point.
- Bad incentives baked into tax system: favoring borrowing by making mortgage interest deductible from income tax
- Exchange rate peg: a well known price for having fixed exchange rate is giving up monetary sovereignty as central bank must use (most of) its tools to keep the exchange rate fixed instead of using the same tools to manage business cycle.
- Rise in real interest rates due to German monetary policy in wake of reunification. Sweden is small open economy so it is exposed to economic developments abroad.