This chapter examines the response of five prominent Swedish economists, David Davidson, Gustav Cassel, Eli Heckscher, Knut Wicksell and Bertil Ohlin, to John Maynard Keynes’s The Economic Consequences of the Peace and to the German reparations in the 1920s. When Keynes’s book appeared, Davidson and Cassel strongly endorsed it. Heckscher also agreed with Keynes in a long review entitled “Too Bad to Be True”. Inspired by his Malthusian view, Wicksell found the reparations feasible if only German population growth was arrested. The contacts between the Swedes and Keynes became close after Keynes’s book, in particular between Cassel and Keynes. The exchange of views took a new turn when Bertil Ohlin responded to an article by Keynes in The Economic Journal in 1929 on the transfer problem. The famous Keynes–Ohlin discussion laid the foundation for the analysis of the transfer problem, bringing Ohlin international recognition. We also trace how Davidson, Cassel and Heckscher changed their appreciation of Keynes in the 1930s with the publication of the General Theory while Ohlin viewed the message of Keynes in the 1930s as consistent with the policy views of the Stockholm school of economics.

INTRODUCTION

Big deflations are more like singular events than realizations of some stable stochastic process. Thus, the historical particulars, including the perceptions and expectations of central decision-makers should be assessed to understand deflations. This approach is adopted in this study of the two major twentieth-century deflations in Sweden, a big one in 1921–1923 and a small one in 1931–1933. We examine three groups of actors: (1) economists that took part in public debate, (2) policy makers, and (3) wage-setters, as well as interactions between these three groups.

The evolution of the policy recommendations of the economists, actions of the policy makers, and behavior of the labor market participants before, during, and after the two deflations is traced. We focus on how their perceptions and expectations were influenced by the experience of the past. The major reason for considering both episodes of deflations is that the two deflations were close in time. This gives an opportunity to explore how the experience during the first deflation episode in the early 1920s influenced beliefs and behavior ten years later during the second deflation.

Our general framework can be represented as follows. Prevailing perceptions and expectations held by decision-makers concerning the choice and effects of economic policies are determined by the lessons from past macroeconomic episodes. These perceptions and expectations are revised when new information is obtained from new macroeconomic episodes. The economics profession, policy makers and wage setters are involved in a neverending process of adjusting their beliefs, in short in a learning process, where the interpretation of past events, that is, the lesson of the past, serves as the major source of information for revising perceptions and expectations.

Introduction

In the middle of the nineteenth century, Sweden was among the poorest countries in Europe. Approximately 80 per cent of the population was engaged in the agricultural sector. Signs of a take-off in economic growth emerged in the 1850s. In the early 1870s, industrialization based on raw materials, notably iron ore and lumber, provided a base for sustained economic growth, which continued largely uninterrupted for one hundred years. The Swedish economic growth rate was the highest of all industrialized countries during the period 1870–1970 (Maddison, 1990). This exceptional and remarkably smooth growth made Sweden one of the most affluent countries in the world by the late 1960s. Since then economic performance has been weak compared to other industrialized countries, and in terms of GDP per capita Sweden is now no more than average among the OECD countries.

This long-run development makes Sweden an interesting case. How can we explain this pattern of rapid economic growth, sustained for an extraordinarily long period of time, which was interrupted fairly abruptly and followed by the current period of slow growth and relative decline? Much of the industrialized world has experienced a slowdown since the early 1970s, but in Sweden this development has been particularly pronounced.

The purpose of this study is to identify the ‘ultimate’ causes of Swedish growth performance relative to other OECD countries in the postwar period. We aim to explain the slow economic growth since the early 1970s. The analysis is largely exploratory. We can only roughly, if at all, quantify the relative importance of the various explanations we shall put forward.

Introduction

Why do economic policies change? Why do policy makers replace one policy regime with another? An answer to this question is provided here by using Swedish central bank policy over the past 50 years as a case study. Swedish authorities moved in the 1940s and 1950s from a traditional monetary policy based on open market operations, discount changes and unregulated international flows of money and capital to a policy based on foreign exchange and capital controls, central allocation of credit flows of all financial institutions and regulation of interest rates. Then in the 1980s these controls were gradually dismantled and Sweden returned to a monetary policy regime similar in several ways to that which had prevailed before the outbreak of the Second World War.

In short, Swedish monetary policy from 1939 to 1989 can be summarized as a process of financial regulation which prevented financial markets from functioning “freely,” replacing them with centrally-given orders, followed eventually by a process of financial deregulation re-establishing previously fossilized markets or establishing markets for new financial instruments; hence the title for this chapter: the rise and fall of credit controls. This change in policy regime encompasses not only the choice of monetary instruments in a narrow sense, it involves two different sets of rules of behavior for all decision making units in the Swedish economy: the central bank (the Riksbank), the government, the commercial banks, and other financial institutions, as well as private firms and households.

This chapter examines first the transition from a monetary regime based on market incentives to a monetary regime based on bureaucratic controls, and then back again to a regime based on market incentives.

“1937 was a great year for Swedish economics. Erik Lundberg defended his dissertation and Bertil Ohlin made the Stockholm School or Swedish School of economics of the 1930s known internationally through two articles in Economic Journal.” This view was put to me by Kumara Velupillai in the fall of 1986. He continued along the following lines: “The anniversary is coming up next year. Why don't you Swedes celebrate the Stockholm School?” That question was the beginning of this volume.

Actually, Swedes had not celebrated the Swedish School before. There had been no “20, 25, 30, or 40 years after.” The Swedish economics profession has paid surprisingly little attention to its roots. The Stockholm School was no exception to this neglect, although it marks the heyday of Swedish economics. Neither before nor since did the work of Swedish economists attract such international interest. Moreover, there were still a few survivors and close followers of the School who most likely had interesting stories to tell.

The grand old man of Swedish economics, Erik Lundberg, gave me his moral support to organize a conference on “The Stockholm School After 50 Years.” The Marianne and Marcus Wallenberg Foundation generously provided the financial support for the conference that took place at Grand Hotel Saltsjöbaden outside Stockholm on August 31–September 1, 1987.

The foundations of Swedish economics

Sweden has produced two generations of outstanding economists. The first generation, which included David Davidson, Knut Wicksell, Gustav Cassel, and Eli Heckscher, were the founders of economics as an independent academic discipline in Sweden. These men made economics a well-known and respected subject in the eyes of the public, thus paving the way for the second generation that emerged in the 1920s and 1930s. This second generation attracted worldwide attention and became known as the Stockholm School.

Davidson (1854–1942) was appointed professor at Uppsala in 1889, a chair that he held until 1921. In 1899 he founded Ekonomisk Tidskrift, the first scientific journal in economics in Sweden, and remained its sole editor until 1939 when he retired at the age of eighty-five. Under Davidson's editorship, Ekonomisk Tidskrift became established as an important forum for the emerging economics profession, with Wicksell, Cassel, and Heckscher as early major contributors. Here Davidson himself published a large number of articles and comments on current economic events, particularly dealing with monetary issues and problems of taxation.

In the late 1870s a young man presented a public talk in Uppsala, in which he argued that the major social ills in Swedish society were due to overpopulation. His message immediately became a source of immense public debate and criticism. One of his critics was David Davidson, who suggested that the speaker, Knut Wicksell (1851–1926), lacked a knowledge of economics.