Madrid reached its zenith, but also declined under the Habsburgs. Charles I of Spain, also Holy Roman Emperor, united the kingdoms of Castilla and Aragon with their capitals at Toledo and Saragossa respectively. This formed the territory of modern Spain. Charles rose to the throne in 1516, and with that Spain became even more connected to the dynastic struggles in Europe. Under his rule the Spanish economy was made over by the influx of precious metals from America. Charles divided his inheritance in two parts: Spain and its overseas territories on one hand and the Holy Roman Empire on the other. This proved a difficulty for Philip II, who succeeded Charles I after the latter abdicated.

Unaffected by religious conflict, Spain remained Roman Catholic. Philip championed Catholicism and was firmly opposed to the Turks. He moved the court to Madrid in 1561. The seat of court became the de facto capital. Madrid had nothing in common with other European capitals during the 16th and 17th Centuries – the city’s inhabitants were economically dependent on the court. This period is known as the Golden Century of Madrid. Spain had become a leading political and military power in Europe, and Madrid’s fortunes mirrored those of the country. Spain formed the Iberian Union with Portugal in 1580, which resulted in unification of the peninsula and added Portugal’s resources to the Spanish crown. Sadly, prosperity preceded a fall. Spanish dependency on gold and silver imports, the expulsion of Moors and Jews from Spain, and the rising inflation rate combined to cause a series of financial crashes and bankruptcies in Spain.

Philip III rose to power in 1598. In 1618 Spain entered the Thirty Years' War. Three years later Philip IV was crowned king. During his reign Portugal and Catalonia rebelled. The crown lost Portugal, and Catalonia was suppressed. Spain’s power waned under the rule of Charles II, Philip's son. The Habsburg dynasty became extinct in Spain, and power passed to the Bourbon dynasty.

The geniuses of El Greco and Cervantes flourished during this era. Many works of architecture testify to the grandeur of the age. These include the Town Hall, designed by Gomez de la Mora, the Plaza Mayor, built by Philip III in 1619, and the Casa de la Panaderia. The Plaza Mayor is a monumental square, which was the centre of Habsburg Madrid. Nine vaulted gateways lead into the square. The 16th Century Palacio de los Vargas, located in the Calle del Sacramento, contains a number of interesting relics.