Sweden “has nearly extinguished business cycle”

A group of countries, including Australia, Canada, Sweden and the UK seems to have nearly "extinguished" the business cycle while enjoying above-average trend growth, OECD officials said in a paper presented to the Reserve Bank of Australia's July 11-12 annual conference.

OECD chief economist Jean-Philippe Cotis and economist Jonathan Coppel, said these countries are characterized by monetary policy frameworks targeting inflation, as well as by having flexible regulatory frameworks in labour, product and financial markets.

They said the four countries also undertook ambitious and comprehensive economic policy reforms over the past couple of decades to break away from a long-standing record of weak growth trends and high price and output instability.

OECD officials said spectacular improvement in short and long-run performance also stands in stark contrast to the more modest changes observed in large continental European countries, both in terms of policy reforms and economic performance.

“It is indeed striking that faced with the same sort of negative outside shocks as continental European countries, in terms of lost exports and investment, the successful group managed to do a much better job at consumption and output smoothing over the 2001-05 period, while the stance of fiscal and monetary policies was not particularly loose compared to the average in the large Euro area,” they said.

In such a context, the officials said, a sense of disappointment experienced in continental Europe may stem as much from the persistence of long-standing difficulties as from the realization that other countries have really succeeded in improving economic performance over the years.

“This combination of short-run resilience and, on average, parsimonious use of stabilization policies strongly suggests that structural flexibility may have been instrumental in offsetting external turbulences,” Cotis and Coppel said in the paper.

They said an important source of resilience seems to lie in highly flexible financial markets, in particular in the areas of consumer and mortgage financing that have endowed monetary policy with very strong transmission channels.

But, the pair wrote, the flip side may be, that the resilient countries’ monetary policies may be prone to under-rating the risks for future price and output stability from out of kilter asset prices.

The OCED officials said recent comparative evidence suggests a very strong prima facie case for viewing stabilization and structural policies as jointly determining long-term growth performance and short-run price/output stability.