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Challenges to monetary policy: lessons from Medieval Europe

Summary:
Prof Nathan Sussman of Graduate Institute of Geneva in this post on Bank underground blog discusses monetary policy in Medieval France: The monetary system is going through significant changes: the rise of cryptocurrencies, negative interest rates, and the decline in the role of traditional banks as intermediaries. History offers policymakers and academics useful case studies that can serve as distant mirrors beyond the study of crises and policy responses to them. Medieval Europe was a period of monetary experimentation and development. The rulers of this period faced similar challenges to those of modern central banks: competition with private monies, no recourse to interest rates as policy tools, and limited use of inside money created by deposit banks. This post draws on my

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Prof Nathan Sussman of Graduate Institute of Geneva in this post on Bank underground blog discusses monetary policy in Medieval France:

The monetary system is going through significant changes: the rise of cryptocurrencies, negative interest rates, and the decline in the role of traditional banks as intermediaries. History offers policymakers and academics useful case studies that can serve as distant mirrors beyond the study of crises and policy responses to them. Medieval Europe was a period of monetary experimentation and development. The rulers of this period faced similar challenges to those of modern central banks: competition with private monies, no recourse to interest rates as policy tools, and limited use of inside money created by deposit banks. This post draws on my research on monetary policy in late Medieval France to demonstrate the principles that guided policymakers in addressing these challenges.

Lessons:

The historical record shows that state currencies dominate private currencies in general public use for two main reasons. First, states enjoy a comparative advantage in establishing reputation and commitment and therefore are best suited to provide a medium of exchange – a public good – at the lowest cost. The debate about the environmentally unfriendly blockchain verification technology used by cryptocurrencies exemplifies this. Second, the state has a monopoly of the legal system that allows it to provide a legal – contracting – advantage to the state’s unit of account. Then, as now, the legal status of private (crypto) currencies is key to their ability to function as a medium of exchange rather than a financial asset (Rogoff (2017)).

The comparative advantage of the state in circulating a national medium of exchange creates a moral hazard. Historically, private currencies and competition from foreign currencies were a constraint on the state’s opportunistic behavior. However, this did not prevent occasional recourse to inflation tax. Only the independence of monetary policy from fiscal considerations, as Oresme advocated, can prevent this from happening.

Finally, the Medieval experience, which was not unique to France (Cipolla (1982)), shows that monetary policy can be conducted without going through the banking sector. This should be comforting news to central bankers in a world where the role of banks as financial intermediaries will decline (Benes and Kumhof (2012)). It also predates solutions to monetary policy at the effective lower bound based on the distinction between reserve money and the medium of exchange (Agarwal and Kimball (2015)). In the modern version, the government could vary the amount of reserves private institutions are required to hold against the issue of (digital) cash.

Fascinating to read and figure this monetary and banking history.

Amol Agrawal
I am currently pursuing my PhD in economics. I have work-ex of nearly 10 years with most of those years spent figuring economic research in Mumbai’s financial sector.

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