Portugal is experiencing a negative inflation rate for 2020. This means that the prices of basket-of-goods are decreasing this year.

My first question is: is it a good sign for Portugal's economy?

Secondly, If Portugal's economy is not so strong, why are they experiencing a negative inflation rate?

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    $\begingroup$ Deflation could reflect price/wage stagnation due to weak demand. Moderate and stable inflation (or, more precisely, well-anchored expectation of such) is the usual goal of monetary policy. $\endgroup$ – Michael Jun 4 '20 at 19:48

Regarding whether negative inflation is a good sign: Deflation is generally speaking not a good sign for an economy. Most economist argue that it is good for an economy to have on average about $2\%$ inflation per year. There are many reason for this one example is that wages are sticky and hard to adjust but inflation can help to bring them down in real terms even if they dont change in nominal terms. This is especially crucial during the times of economic crisis when it can help prevent unnecessarily high unemployment.

Regarding the potential causes: Inflation depends on many factors. Generally speaking the price level (changes of which are called inflation) is given by:


So the price level $P$ is increasing in money supply $M$ and velocity of money $V$ and decreasing in real output $Y$ (also note its driven not just by the variables itself but also by expectations of how they evolve). Moreover, Portugal is member of the euro-zone so its inflation rate depends on only situation in Portugal but across whole euro-zone.

Currently Portugal is experiencing recession, due to covid so one would expect that this would ceteris paribus lead to inflation as $Y$ drops. However, an important caveat is that during the recession velocity of money also drops as people are more reluctant to spend and prefer just saving their money 'under their mattresses' and that is what creates a lot of deflationary pressure. However, thats just an back of an envelope analysis of the situation.


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