The Real Effects of Money Supply Shocks: Evidence from Maritime Disasters in the Spanish Empire

We exploit a recurring natural experiment to identify the effects of money supply shocks on the economy: Maritime disasters in the Spanish Empire (1531-1810), that resulted in the loss of substantial amounts of monetary silver. We find that a permanent 1% reduction in the money supply led to a 1% drop in real output that persists for around four years. The price level fell permanently, but only with a lag. Tighter credit markets temporarily increased lending rates by 200 basis points. Motivated by these findings we build a DSGE model to disentangle the channels through which silver losses affected output: net worth losses, credit frictions, or nominal rigidities. The estimated model attributes half of the initial output response to nominal rigidities, and much of the response's persistence to credit market frictions. The net worth shock entailed by silver losses had only small effects.