Boom Slump Crisis

• Portugal 1995-2013 boom-bust cyclecomments and discussion 195 in anticipation of Portugal’s entry into the euro area, and expectations of sustained growth, again from adoption of the euro. The implications are equally straightforward: strong demand and sustained growth, the lat-ter running at an average of 4 percent per year, leading to a decrease in the unemployment rate from 7.5 percent to 4 percent, together with an increase in the price of nontradables, increased demand for tradables, and a large increase in the current account deficit, from rough balance in 1995 to 10 percent of GDP by 2000. The second chapter—the focus of most of the paper—which starts in 2001 and ends in 2007, is the story of the slump. It is shown in the middle panel of figure 1. As the start of the euro does not lead to the hoped-for growth miracle, Portuguese households and firms revise their expectations, and private demand slows down. The textbook adjustment process suggests that this should lead to a decrease in the price of nontradables, a shift in consumption toward nontradables, a shift in production toward tradables, and a decrease in the current account deficit. This does not take place, however, partly because countercyclical fiscal policy props up demand and output—the budget deficit remains high, at around 5 percent of GDP—and partly because of nominal wage and price rigidities. Indeed, nominal wage growth continues, in excess of productivity growth (which is low), lead-ing to a further real appreciation and a current account deficit that remains around 10 percent of GDP