Economist JP Koning wrote a fascinating article last week, What Makes Medieval Money Different From Modern Money? The quick answer: medieval money didn’t have its value printed on it. So, for example, a testoon wasn’t worth any set amount. So if you wanted to buy something that cost a pound, you wouldn’t automatically know how many testoons would be required to pay off that debt. The value of the testoon would be set by royal decree. So if the testoon was decreed to be worth one-twentieth of a pound, you would need 20 of the little buggers to buy the product. Now what has this got to do with monetary policy.
Think back on the 2008 financial crisis. That was just the most obvious sign of the bursting of an $8 trillion housing bubble. And it was that burst bubble that caused the recession. People all over the country woke up one day to find that they actually had a lot less money than they thought they had. Or more often, they learned that they were in a lot more debt than they had thought. That would have been a great time for some inflation. Instead, we got a short period of deflation and then very low inflation for the next 7 years.
The Federal Reserve has had a hard time keeping inflation even at its low 2% target. But what if the Fed could have just dictated inflation? Think of our example above. If the kingdom found itself in recession, the king could proclaim that there were now only 19 testoons in a pound. People aren’t idiots, of course. They would realize that a pound was only worth 95% of what it used to be. So they would raise their prices (products and labor) by roughly 5%. Ta da! It’s like a magic trick: instant inflation.
But now, without doing anything at all, you have helped out the debtors. They would owe fewer testoons than they had before the new decree. This would allow them to deleverage more quickly and get the economy going that much faster. Given that lenders are generally rich, we aren’t worried that modest inflation would reduce their consumption. The king could also use this system to fight inflation by increasing the number of testoons in a pound to 20 or even 21.
Obviously, this is a gross generalization. Koning’s point is that the medieval monetary system was more flexible than one might have thought. But I take away something more sobering. If the Fed had the ability to do this, it might have used it in very minor ways to help out after the 2008 crash. But it wouldn’t have done so aggressively. The Fed chair at that time, Ben Bernanke, has been very clear that he think he and the Fed did a great job.
The problem with the Federal Reserve hasn’t really been a lack of tools, but rather a philosophy that hurting the rich even the smallest amount (a 5% inflation rate would be considered outrageous by those now in power) is unacceptable. I don’t know how much the kings of old used such monetary tools to make life better for the people. I doubt it was used much and for the same reason that our monetary policy is to have a 2% level of inflation: because those in power don’t actually care about the vast majority of the people.