The importance of disturbances in financial markets for real economic activity and the positive association between price level and output movements typically are explained by appeal to a combination of nominal aggregate demand shocks (particularly money-supply shock) and rigid prices. We argue that this view is inconsistent with evidence for short-run responsiveness of price and gold flows to nominal disturbances during the pre-World War I fold-standard era. We offer an alternative explanation that connects financial markets and real activity through disturbances to the availability of credit. This approach links co-movements in prices and output through real effects in credit markets associated with price-level shocks. Empirical analysis, using monthly data for the pre-World War I period, supports the assumption of rapid price adjustment, and the credit-supply interpretation of the transmission of financial shocks. Disturbances to credit availability, including price shocks, contribute substantially to our empirical explanation of output fluctuations during this period.
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