I'm reading How Will Capitalism End? by Wolfgang Streeck, and in the chapter on fiscal consolidation, he claims Sweden was punished by financial markets in 1991 for its expansive fiscal policy.

I've been taught that the 1991 economic crisis was a caused by a housing bubble akin to 2008, in what way did the creditors cause it?

I should add, Streeck sees this as the definite victory of Friedman style austerity regimes over keynesianism. Why can raised taxes not be used for consolidation and ensuring creditor trust?


1 Answer 1


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 speed.

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.
  • $\begingroup$ Thank you for your thorough answer! What do you think about the last question in my post? Why is raising tax to pay off public debt generally not something OECD countries do, instead preferring austerity politics and further privatization? $\endgroup$
    – 333inar
    Sep 6, 2022 at 11:29
  • $\begingroup$ @333inar you are welcome, you can consider accepting the answer if you think it answered your main question. Regarding the last question, increasing taxes also counts as austerity politics. By definition increasing taxes (ceteris paribus) is also austerity measure. "Austerity measures refer to official actions taken by the government, during a period of adverse economic conditions, to reduce its budget deficit using a combination of spending cuts or tax rises." see financial times lexicon web.archive.org/web/20130322221836/http://lexicon.ft.com/… $\endgroup$
    – 1muflon1
    Sep 6, 2022 at 11:42
  • $\begingroup$ so you are talking about 2 different types of austerity. As to why most OECD countries do the former kind rather than latter, I think it is probably because generally speaking most OECD countries already have very high tax rates. In most western countries tax to GDP ratio is about 40%, taxes create deadweight loss to society so at some point it is impossible to consolidate government finances just by rising taxes further. Sweden in particular has income taxes that are either already at a level that is optimal for even the most redistributive (Rawlsian ideology) or actually even higher $\endgroup$
    – 1muflon1
    Sep 6, 2022 at 11:48
  • $\begingroup$ which would mean that rising taxes further (at least income taxes) would be bad (it would mean less welfare is redistributed, and in Sweden's case it might be that even public finances would not improve too much as Sweden is one of the countries that are mentioned to be close to the top of the gov's revenue curve) In countries such as UK, or Ireland that have relatively low taxes I guess its politics or perhaps they have different goals in mind than having Rawlsian tax system (they could be utilitarian, liberal etc under which lower tax rates are optimal). $\endgroup$
    – 1muflon1
    Sep 6, 2022 at 11:49

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