World War I left the country with a larhe imbalance in public finances, caused by the increase in war expenditure and the decrease in fiscal revenue. The Banco de Portugal monetised these deficits during the War and after it ended. The central bank policy of issuing currency generated inflation. In turn, in the aftermath of the conflict in Europe and given the shortage of supplies of essential products, pressure on the cost of living increased. With the end of the fixed price system that was in effect during the War, inflation accelerated, generating widespread discontent. The government was obliged to bring in measures to mitigate the problem. In 1919, bread production was subsidised – creating what was called “political bread” – and this remained in effect until 1923.

In 1922, supply shortages led to subsidies on imported wheat, which had a larhge impact on the public deficit, as well as significant transfers in order to try to rebuild the merchant navy.

This difficult context fuelled uncertainty about the country’s capacity to honour its onerous war debt to the United Kingdom (20 million pounds in 1921). There was also uncertainty around Germany’s ability to pay war reparations to Portugal, which stood at 50 million pounds.

In a climate of volatility, the two main business cycles ended up being associated with the agricultural cycle, with poor crop yields and years of bad olive harvests coinciding to cause two recessions: the first between 1923 and 1924 and the second between 1927 and 1928.

Aggregate real GDP according to two series

Prices had tripled in Portugal during the War, but the inflationary phenomenon continued and even intensified in the years after the conflict. Between 1919 and 1924, prices increased 900%.

Apart from contributing to the tensions inherent to a war economy, the proximate cause of this phenomenon was the monetisation of public deficits by the central bank, which made the money supply increase from 114 million in 1914 (around EUR 570,000) to 536 million (EUR 2.7 million) in 1920 and then to 1,586 billion (EUR 7.93 million) in 1924.

These policies arose from the need to finance public deficits, which had been increasing due to the decline in state revenue and the increase in expenditure.

Real tax revenue, which represented 12% of the GDP in 1914, had fallen to only 4% in 1920. Unlike what happens nowadays, when most taxes fall on the monetary value of goods and services, at that time, most taxes were set in amounts of escudos per asset. Inflation reduced the number of products sold and real tax revenue fell. Expenditure remained high, due to the cost of the subsidies aimed at combating the increase of inflation and the scarcity of wheat.

Public finance control measures were needed. In the 1922-23 financial year, a tax reform gave rise to a huge tax increase, as taxes were now being set proportionally, keeping up with inflation. Efforts were also made to curtail public expenditure in the following years.

With these measures on the ground, the government of Álvaro de Castro undertook a monetary stabilisation programme between 1923 and 1924. The main policy was the immediate end to monetary financing of public deficits, with the government’s commitment not to finance its deficits through the central bank. Together with the tax reform, this programme led to a decline in inflation from the summer of 1924 onwards.

This favourable development brought with it exchange rate stability, which attenuated one of the main difficulties faced by the country: paying for wheat imports with a weak currency.

The first impact of this fiscal and monetary stabilisation was reflected in a slowdown in private consumption expenditure, which then shot up between 1927 and 1930. Private investment made a moderate positive contribution to the GDP from 1926 onwards.

Politically, the coup d'état led by Gomes da Costa in May 1926 began a military dictatorship, but it did not immediately lead to a decrease in social conflict. It was only between 1930 and 1931, with the stabilisation of the armed forces by General Óscar Carmona and the rise to power of Oliveira Salazar, that social and political instability lessened.

Prices were stopped with budgetary control

Inflation and Exchange Rate

Changes in Public Spending

State expenditures increased in 1922, reflecting the high cost of different subsidies that tried to combat rising inflation and wheat shortages.

The country that was in a process of fiscal and monetary adjustment was still very dependent on agricultural production and it was from there that the two recessions identified in the second decade of the 20th century arose.

The main agricultural products at the time were wine, olive oil and some grain crops. In 1924, there was a slight contraction in olive production and a larger fall in wine production. Both only recovered in 1927. There was also a significant fall in the production of wheat, barley and oats, but these crops recovered the following year.

In 1924, a poor year in farming led to a worsening of living conditions in the countryside, leading to social upheaval.

Another drop in agricultural production came in 1928 due to weather conditions. In addition, the 1927-28 farming year was bad for olives, coinciding with a bad year for wine and for most grain crops.

These declines were reflected in the balance of trade the following year, making it necessary to increase imports and leading to the downturns identified in economic activity during this period.

The weight of the farming sector was so important at the time that not even the expansion of most industrial sectors was able to mitigate the impact of the poor harvests.

Internationally, this period was marked by the ascension of the American economy and economic instability in Europe, including the failure of the pound sterling’s return to the gold standard and hyperinflation in Germany. Since Portugal's economy was still quite closed, these external crises had limited influence on the economy. The main international influence during this 11-year period was instead the aftermath of the crises triggered by World War I.

Emigration, which had decreased during the War, did not recover as quickly during this decade. Both the USA and Brazil were making it difficult for immigrants to enter the countries, while the Portuguese were competing with migrants from Ireland and Italy for jobs on the American continent.

Wine and Olive Oil Cycles

In 1924, there was a contraction in olive production. Olive oil production would recover in 1927, contributing to a boom in the economy.