The ‘Buying and Selling of Money for Time’: Foreign Exchange and Interest Rates in Medieval Europe
By Adrian R Bell, Chris Brooks and Tony K Moore
Henley Business School Discussion Paper, 2015
Introduction: Interest rates are one of the most (if not the most) important economic variables. Today, ready access to credit at low rates has encouraged business investment and economic growth, property ownership, a high standard of living and large governmental expenditure, while the manipulation of base interest rates by governments or central banks is used as a macroeconomic tool. The medieval world, by contrast, has been seen as a period of restricted access to credit and high interest rates. In part, this has been explained in terms of the religious prohibition of usury. As a result, loans would be expensive to repay, with a negative knock on effect on the viability of business activity and thus economic growth. Recent work on the middle ages has qualified this negative depiction, presenting evidence of financial innovation and widespread use of credit even in rural areas. Further, interest rates are a vital input into most economic theories and models. A better understanding of the interest rates prevailing during the Middle Ages therefore has the potential to contribute greatly to our knowledge of medieval financial and economic development by facilitating the application of modern ideas and models.
Unfortunately, direct evidence about the interest rates actually charged in the middle ages is hard to find, as can been seen from the very short sections on the medieval period in the standard history of interest rates. This too may be a result of the usury prohibition, which encouraged ‘financial engineering’ to construct products that hid or disguised interest charges. The problem is that, by design, such charges are either invisible in the surviving records or, where the relevant data can be found, it is difficult to convert into standardised interest rates. Even where it is possible to calculate interest rates for particular transactions ex post, these can vary dramatically based on idiosyncratic factors, such as the type of transaction, the ‘credit rating’ of the borrower or the condition of the money market at the time of the loan. As a result, it is very difficult to generalise about medieval interest rates.
Although some economic models rely on the risk-free interest rate, or the real interest rate after inflation, in practice there is no one interest rate today and the same was true in the Middle Ages. The best evidence for medieval interest rates comes from government borrowing, and especially the long-term annuities sold by the Italian city-states. Less is known about the interest rates charged on short-term advances and those to monarchs. There is also some information about consumer loans from pawnshops or Jewish lenders, whose maximum rates were often fixed by law at 1d, 2d or 4d in the pound per week (annualized at 21.7%, 43.3% and 86.7% respectively). While clearly government debt and consumer credit played an important role, perhaps a more significant question for the medieval economy concerned the interest rates charged for commercial credit, particularly for merchants looking to fund trade.