On the one hand, higher interest rates may be required to dampen an investment boom. On the other, lower interest rates may be needed to moderate the inflow of short-term speculative funds. In these circumstances, monetary policy needs assistance from fiscal policy: a budget surplus may be needed to curb domestic demand, and to provide the financial resources to sterilise the foreign exchange inflow.
In the period from 1995 to 2007, the budget deficit averaged 4.3% of GDP, and was always above the Maastricht threshold of 3% of GDP. When the international financial crisis broke, the weak potential output growth and rising external indebtedness fuelled investors’ doubts about the capacity of Portuguese economic agents to pay their debts.