This study proposes a novel method to assess the overall economic effects of agricultural droughts using a coupled agronomic-economic approach that accounts for the direct and indirect impacts of this hazard in the economy. The proposed methodology is applied to Italy, where years showing different drought severity levels were analysed. Agricultural drought stress was measured using the fraction of Absorbed PhotosyntheticallyActive Radiation (fAPAR). Using a comprehensive, field-level data set on agricultural yields, fAPAR-based statistical models were applied to major Italian crops and direct crop productivity impacts were estimated. Total estimated damages ranged from 0.55 to 1.75 billion euro, depending on the overall drought severity experienced, while regional losses showed large spatial variability. Although most of the losses were concentrated on agriculture, other related sectors, such as food industry manufacturing and wholesale services, were also substantially affected. Moreover, the simulations suggested the presence of a land-use substitution effect from less to more drought-resistant crops following a drought.