The Economist has a recent article discussing a fascinating natural experiment:
Nevertheless, history throws up ‘natural’ experiments. In an earlier article, Mr. Brzezinski, Mr. Palma and two co-authors exploited one source of variation in the money supply of early modern Spain: disasters at sea. Ships carrying treasure from America to Spain sometimes encountered hurricanes, privateers or the British Navy. In 42 incidents between 1531 and 1810, they lost some or all of the precious metals that the Spanish merchants had expected to receive. Losses averaged 4% of Spain’s money supply. Drawing on a variety of sources, including tax data and sheep numbers, the authors showed the damage these losses were doing to the Spanish economy. Credit became scarce, making it difficult for merchants to purchase supplies for weavers, and consumer prices were slow to adjust. A loss of 1% of the money supply could reduce real output by about 1% in the following year. The size of the sheep herd decreased by 7%.
While I like this finding, a word of caution. The statistical significance of the study seems quite low:
If this study did not match my preconceived ideas about monetary shocks, I would tell you that it was barely significant at the 90% level, and that this could easily reflect the tendency of journals to favor studies that find a positive effect. than those who experience no effect at all. (I think I told you that. :))
But for now, let’s assume the finding is true; a loss of gold has really hurt the Spanish labor market. After all, we have seen many modern examples of negative monetary shocks leading to higher unemployment, especially after significant declines in the US monetary base in the years 1920-21 and 1929-30. Why would this effect occur?
There is no clear reason why Spain, being a bit poorer, would make Spanish workers less willing to work. In any case, you would expect that extreme poverty would be an incentive to work harder, if only to prevent famine. The real problem is that negative monetary shocks act as a kind of price control; they push an important market price out of equilibrium.
We normally think of price imbalances as being caused by things like price controls, rent controls, and minimum wage laws. Ryan Bourne has recently published an excellent book on this problem, which contains numerous case studies. But price regulation is not always the problem. Instability of monetary policy can cause a similar problem. This also applies to irrational public attitudes, such as opposition to ‘price gouging’ or money illusion.