The Economist has a recent article about an interesting natural experiment:
History however does not meet the “natural” test. In a previous paper, Mr Brzezinski, Mr Palma and two other authors used one source of volatility in modern Spain’s liquidity: disasters at sea. Ships carrying treasure to Spain from the Americas sometimes encountered storms, privateers or the British navy. In 42 incidents from 1531 to 1810, they lost some or all of the precious metals that Spanish merchants expected to find. The loss amounted to 4% of the Spanish currency stock. Using a variety of sources, including tax records and sheep counts, the authors show the damage caused by this loss to the Spanish economy. Credit became scarce, making it difficult for merchants to buy materials for the weavers, and consumer prices were slow to adjust. A loss of 1% of the money stock can reduce real output by about 1% over the next year. The size of the sheep flock decreased by 7%.
While I love this discovery, a word of caution. The statistical significance of the study appears to be very low:
If this study did not agree with my preconceived notions about financial shocks, I would tell you that it was not significant at the 90% level, and that this could easily reflect the tendency of journals to select studies with a positive effect. over those that get no result at all. (I think I told you that. :))
But for now, let’s assume that the findings are true; the loss of gold really hurt the Spanish labor market. After all, we have seen many modern examples of negative financial shocks leading to high unemployment, following the sharp decline in the US monetary base between 1920-21 and 1929-30. Why would this happen?
There is no obvious reason why a relatively poor Spain should make Spanish workers want to work harder. If anything, you would expect extreme poverty to be an incentive to work hard, as long as you avoid starvation. The real problem is that negative financial shocks act as a form of price control, taking the important market price out of balance.
We often think of price inequality as being caused by things like price controls, rent controls and minimum wage laws. Ryan Bourne he recently edited an excellent book on this problem, which contains many examples. But price control is not always a problem. Monetary policy instability can cause a similar problem. So are irrational public attitudes, such as opposition to “price gouging”, or currency manipulation.
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