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The Sustainability of Portuguese Fiscal Policy in Democracy, 1974–2020

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Abstract

In the current year of 2024, Portugal celebrates half a century of Democracy. In this paper we test the sustainability of Portuguese fiscal policy during this most recent period of Portuguese history – a time when the principle of sound finance is no longer proclaimed as a dogma. Using data taken from different sources, we conclude that, although Portugal has experienced very troubled periods throughout its Democracy, fiscal policy was sustainable during 1974–2020. This sustainability was, however, weak. Our conclusion is based on a difference stationary public debt ratio, on a stationary budget deficit as a percentage of GDP, and, also on the existence of a long-term relation between public revenues and expenditures ratios with a reduced cointegration coefficients. The findings of this paper reinforce the need for Portuguese policymakers to ensure the sustainability of public finances and public debt which is crucial to sustain the Portuguese welfare state itself.

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Data Availability

The data used in this paper are freely available in various different sources, all of which are well identified, under “Sources” of figures and tables.

Notes

  1. During the period 1933-1974, the so-called Estado Novo [New State] – a nationalist, corporatist, anti-liberal, authoritarian, and anti-democratic regime, which uncompromisingly defended the so-called principle of sound finances – ruled Portugal (Ferraz 2017). On April 25, 1974 this dictatorship was overthrown by the Movimento das Forças Armadas (armed Forces Movement) that opened the doors to Democracy.

  2. Total taxes and social contributions received by general government as a percentage of GDP. The general government sector corresponds to the consolidation of the accounts of central, state, and local governments, plus social security.

  3. We thank an anonymous reviewer whose comment enabled us to increase the level of international comparison of our paper.

  4. On this topic see, also, Nunes (2011) and Amaral et al. (2020).

  5. The World Bank (1983) presents an interesting report regarding the difficult situation that the Portuguese economy was experiencing.

  6. In April 2011, the former Portuguese Minister of Finance, Fernando Teixeira dos Santos, declared to Reuters that the Portuguese State could only meet its financing needs until May of that year, and that in June, Portugal would need to activate an assistance programme (see Reuters 2011). The words of the former President of Portugal, Aníbal Cavaco Silva (2006–2016) are very elucidative on the Portuguese situation: "At the beginning of 2011, the country had effectively reached a situation of economic, social and financial emergency. The impossibility to guarantee the normal financing of the state and the economy was evident" (Cavaco Silva 2017, p. 472). Aníbal Cavaco Silva also describes a meeting with the Portuguese Association of Banks which took place at the end of 2010, during which that entity noted that the banking sector "was also very fragile, as it was unable to obtain the financing in the markets that it needed at acceptable interest rates, with the doors [of the markets] only reopening should Portugal report concrete and visible budgetary results. If this failed to occur, then there would be a considerable restriction in the granting of credit to the private sector, which would tend to cause a large contraction in the economy” (Cavaco Silva, pp. 407–408).

  7. In terms of fiscal consolidation, the results obtained from following this path since 2011 become even more clear when we analyse the fiscal balance adjusted for one-off measures (definition: ‘fiscal balance exclusive of measures that has a transitory budgetary effect that does not lead to a sustained change in the intertemporal budgetary position’; on this topic, see European Commission 2013). In 2010, this indicator was of – 8.7% of GDP and subsequently was – 7.6%, – 6.1%, – 5.4%, – 3.6%, – 3.2%, – 2.3%, – 1.0%, + 0.4% and + 0.7% of GDP in 2011, 2012, 2013, 2014, 2015, 2016, 2017, 2018 and 2019, respectively (own calculation, using AMECO 2023).

  8. According to Hakkio and Rush, presenting the algebraic procedure using ratios is more “pertinent”, for example as a percentage of GDP. This permits us not to neglect the effect of price changes which, according to the literature, can be relevant with regards debt dynamics (see Hall and Sargent 1997, 2011; for a detailed explanation of the dynamic effects, see also Conselho das Finanças Públicas, 2024). On the other hand, the literature points out that in a context of an “active” fiscal policy and “passive” monetary policy, an unexpected inflation shock can lead to debt reduction (Leeper 1991; Woodford 1998, Sims 2013). In this regard, recently evidence shows that inflation can lead to a persistent reduction in debt to GDP ratios, both due to primary balance improvements and nominal GDP denominator increases (Garcia-Macia 2023; see also Fukanaga et al. 2020 for a quantification of the impact of inflation in debt ratio in the specific case of the advanced economies). We are grateful to an anonymous reviewer for this point.

  9. With \({r}_{t}\) = (\(\frac{1+ {i}_{t}}{1+ {y}_{t}}\)—1), being \({y}_{t}\) the nominal GDP growth rate and \({i}_{t}\) the nominal interest rate (Marinheiro 2006).

  10. More perspectives and tests can also be found, for example, in Bohn (1998, 2007).

  11. According to the ECB (2012), “solvency is a medium to long-term concept and requires that the government’s net present value budget constraint is fulfilled, stipulating that the net present value of the government’s future primary balances must be at least as high as the net present value of outstanding government debt (“flow concept”)”. On the other hand, “liquidity is a short-term concept and refers to a government’s ability to maintain access to financial markets, ensuring its ability to service all upcoming obligations in the short term”.

  12. As argued by Gros and Alcidi (2019), for a high level of debt, the interest rate cost of that debt will be higher, not only because there will be more debt to service, but also because the cost of each unit of debt will increase, which in turn creates the potential for self-reinforcing loops of high debt and high risk premia (a situation that can become explosive).

  13. The literature has precisely highlighted the importance of the interaction between fiscal policy and monetary policy (Leeper and Li, 2016; ECB 2021; Chang et al. 2021). In this regard, it is important to mention that Portugal is currently part of the so-called eurozone, which means that it does not control monetary policy – a function that falls to the European Central Bank (ECB).

  14. We thank an anonymous reviewer for this point.

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Acknowledgements

We are grateful to the Editor, Professor Kajal Lahiri, and two anonymous reviewers for their important comments and suggestions which enabled us to significantly improve this paper.

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  1. GHES/CSG/Lisbon School of Economics & Management (ISEG), Universidade de Lisboa, RCM2+/Universidade Lusófona, Lisbon, Portugal

    Ricardo Ferraz

  2. ADVANCE/CSG/Lisbon School of Economics & Management (ISEG), Universidade de Lisboa, Lisbon, Portugal

    Joaquim Miranda Sarmento

  3. CeBER/Faculty of Economics, Universidade de Coimbra, Coimbra, Portugal

    António Portugal Duarte

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Appendix

Appendix

See Tables 6, 7, 8, 9

Table 6 ADF tests, 1974–2020
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Table 7 ADF-GLS tests 1974–2020
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Table 8 KPSS tests, 1974–2020
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Table 9 ADF, ADF-GLS and KPSS tests for \(\widehat{\text{u}}\), 1974–2020
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Ferraz, R., Sarmento, J.M. & Duarte, A.P. The Sustainability of Portuguese Fiscal Policy in Democracy, 1974–2020. J. Quant. Econ. (2024). https://doi.org/10.1007/s40953-024-00402-0

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