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In the modern economy, the central bank decides the cost of borrowing money using interest rates along with other several tools and technic. But I was wondering, in a gold-based economy (not the gold standard) by which tools and technics the "cost of borrowing money" or in simple terms the interest rate was determined?

[NOTE: Answer based on a real historical Gold standard is fully appreciated. By the gold-based economy, I meant where there is no ratio between the gold reserve and the banknotes. where notes are fully backed by 100% of gold.]

My guess is because the bond has still existed at that time so the yield of the bond determined the cost of borrowing money or the interest rate for the government and companies. On the other hand for personal borrowing, local banks and open markets did determine the cost of borrowing money or the interest rate.

Actually I just want to know that, back then by which tools and technics the money supply was controlled. how the cost of borrowing money was controlled for the government, companies, and for the retailer also?

[NOTE: By tools and technics, I meant something like interest rate, fed fund rate, QE, bond yield, and all the other things that can control the money supply. But back then they didn't exist. so back then besides the actual supply and demand of the gold, what other factors possibly could exist that affected or determined the supply of money or the cost of borrowing money?]

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  • $\begingroup$ What exactly do you mean by "the central bank decides the cost of borrowing money"? Interest rates for retail loans are not directly set by central banks (in most countries). $\endgroup$ – Giskard Jun 7 at 9:40
  • $\begingroup$ Even non-nominal yields of government bonds are usually determined in treasury auctions, not directly set by central banks (in most countries). $\endgroup$ – Giskard Jun 7 at 9:47
  • $\begingroup$ @Giskard By this, I meant the overall interest rate that basically affects every aspect of an economy. Basically the interest rate that controls the money supply. $\endgroup$ – noobforever Jun 7 at 9:51
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    $\begingroup$ Since you write "affect" I am guessing you understand that there are other factors in lending and borrowing that affect the "equilibrium" interest rate in a modern economy. In this case however I do not understand your question. These same factors exist in gold-based economies. $\endgroup$ – Giskard Jun 7 at 11:02
  • $\begingroup$ @Giskard Actually I just want to know that, back then by which tools and technics the money supply was controlled. how the cost of borrowing money was controlled for the government, companies, and for the retailer also? $\endgroup$ – noobforever Jun 7 at 11:54
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This question cannot easily be answered.

If we look at historical societies, bond markets appeared in eras where was a central bank, most importantly, the Bank of England. During the Gold Standard, notes were not 100% gold backed. If we look at earlier eras, customs were very specific to a culture. For example, there were eras which were largely non-monetary.

However, as currently written, the question asks how interest rates would be set in a hypothetical 100% gold reserved backed monetary system. The problem is that one would need to explain the mechanisms behind this hypothetical economy. Example issues that would need to be addressed.

  • Why would not credit-based money push the gold-backed money out of the financial markets?
  • Why would the financial system not collapse, and be replaced by a system that approximates ones actually seen in the real world? After all, every historical gold-backed currency failed in the era of industrial capitalism.

It seems unlikely that this website is the proper forum for that discussion of hypothetical monetary systems.

Update: a comment has suggested that we look at historical examples. The problem is that is an extremely large question, and would need the era pinned down. Meanwhile, there do not appear to many economic historians that frequent this website.

  • Although the Bank if England was private, it acted like a central bank. (Discussed in the book “Lombard Street” by Bagehot.) The systems for determining interest rates was not radically different than current systems; technology just made trading more efficient.
  • If we go back further in time, we run into the reality that lending at interest (usury) was forbidden in the Christian countries. Sovereigns worked around that in various ways.
  • If we go back to Roman and even Greek times, modern scholarship suggests that they had what might be viewed as banks. (Discussed in the text “Monetary Systems of the Greeks and Romans”, edited by W.V. Harris.) Interest rates appear to have been set by convention. However, like banks, the lending entities (often a group of rich individuals), ran a credit-based system that was not 100% gold backed.
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  • $\begingroup$ Answer based on a real historical Gold standard is appreciated. $\endgroup$ – noobforever Jun 7 at 16:27
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    $\begingroup$ The question explicitly says “not the historical gold standard.” $\endgroup$ – Brian Romanchuk Jun 7 at 22:05
  • $\begingroup$ I should edit the question then. $\endgroup$ – noobforever Jun 8 at 3:15
  • $\begingroup$ @noobforever You should not retroactively edit a question this way. You can post a new question if you wish. $\endgroup$ – Giskard Jun 8 at 5:41

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