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American Focus > Blog > Economy > Monetary shocks: A natural experiment
Economy

Monetary shocks: A natural experiment

Last updated: October 18, 2024 1:37 pm
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Monetary shocks: A natural experiment
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The Economist recently published an article discussing a unique natural experiment that sheds light on the impact of monetary shocks on the economy. The study conducted by Mr. Brzezinski, Mr. Palma, and their co-authors focused on the effects of disasters at sea on the money supply of early modern Spain. Ships carrying treasure from the Americas would sometimes encounter hurricanes, privateers, or the British navy, resulting in the loss of precious metals that were expected to boost Spain’s money stock. The study found that these losses, averaging 4% of Spain’s money stock, had significant negative effects on the 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 stock could reduce real output by about 1% in the subsequent year, and sheep-flock sizes fell by 7%.

While this finding is intriguing, it is important to note that the statistical significance of the study appears to be relatively low. If the results had contradicted existing beliefs about monetary shocks, one might argue that the significance level was barely at 90%, possibly influenced by a bias towards studies that find positive effects. However, for the purposes of this discussion, let’s assume the findings are accurate and explore why negative monetary shocks can lead to higher unemployment.

It may seem counterintuitive that a decrease in wealth would cause workers to work less diligently. In reality, negative monetary shocks disrupt market equilibrium by affecting crucial prices. Disequilibrium prices can arise from various factors, including price controls, rent controls, minimum wage laws, and monetary policy instability. In some cases, irrational public attitudes towards pricing, such as opposition to “price gouging” or money illusion, can also contribute to this problem.

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Historical examples, such as the declines in the US monetary base during 1920-21 and 1929-30, highlight the detrimental impact of negative monetary shocks on unemployment. These instances underscore the importance of maintaining stability in monetary policy to prevent disruptions in the labor market. Overall, the study on early modern Spain’s money supply offers valuable insights into the complex relationship between monetary shocks and economic outcomes, prompting further research and analysis in this area.

TAGGED:ExperimentMonetaryNaturalshocks
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