Nuno Palma
(European University Institute and the University of Groningen)
The existence and persistence of liquidity effects: evidence from a large-scale historical natural experiment
Abstract: The discovery of mines of precious metals in Central and South America led to a massive exogenous monetary injection to Europe's money supply. I argue this episode can be helpful to identifying the causal effects of money in a macroeconomic setting. Using a panel of six European countries for the period 1531-1790, I find strong evidence in favor of non-neutrality of money for changes in real economic activity. The magnitudes are substantial and persist for a long time: an exogenous 10% increase in production of precious metals in America leads to a hump-shaped positive response of real GDP, peaking at an average increase of 1.3% four years later. The evidence suggests this is because prices responded to monetary injections only with considerable lags. Several exogeneity tests and robustness checks confirm the results.