The alchemy of gold: interest rates, money stock, and credit in eighteenth‐century Lisbon

This article addresses the partial equilibrium functioning of the short‐term credit market in eighteenth‐century Lisbon and its response to massive gold inflows from Brazil. Gold inflows were a colonial rent, and thus a source of income and a financial asset that increased the liquidity supply in a credit market populated by both (direct) participants and non‐participants in the colonial trade or in mining. As a source of income it would induce a positive upward pressure on interest rates, while as a financial asset it would lead to the opposite. A method is developed to extract interest rates from notarized personal credit, unbundling the aggregate and the idiosyncratic components of risk pricing. The results show that interest rates in Lisbon did not differ critically from those observed in other cities at the core of the premodern European economy, which were spared from devastation by the earthquake that struck Lisbon in 1755. A simple model relating the market interest rate series to gold stock variations finds that the liquidity channel dominated over the endowment channel, which explains the downward trend in interest rates up until 1757 when the interest rates were freely settled. Mild credit rationing may have been introduced by a 5 per cent ceiling on interest rates that was imposed after 1757.