Gresham's Law - Definition
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Gresham's Law Definition
Gresham's law is a monetary principle based on observation in economics that in currency evaluation, when two coins are equal in face value but unequal in intrinsic value (cost of material), the one having less intrinsic value tends to remain in the market circulation, whereas the other disappears to be hoarded or exported as bullion. The law is named after Sir Thomas Gresham (1519-79), a leading English financial adviser to Queen Elizabeth I.
A Little More on Gresham's Law
It states that "bad money drives out good." Where bad refers to the coin with lesser intrinsic value and good refers to the coin with more intrinsic value. In older times, coins were made of gold, silver and other precious metals, which gave them their value. Over time, there was a decrease in the number of precious metals used in making coins because the metals were worth more than the face value mentioned in the coin. The new coins were given the same face value as the existing coins to facilitate the transactions conducted by the people. Because the intrinsic value of the old coins was higher than the coin's face value, people started melting down the coins and sell the metal itself, or hoarding them as a store of value. The new coins with less intrinsic value were considered as overvalued and hence its expenditure increased more than coins with more intrinsic value as they were considered as undervalued, leading to hoarding effect, driving them out of circulation as currency.
Name Origin of Gresham's Law
In the administration of Queen Elizabeth, different metals were in circulation as currency. Some coins were of more intrinsic value than others of the same monitory value. The coins made of the inferior metal tended to drive the better out of circulation as currency. This is because the better coins were either hoarded or melted down and sold as bullion or in foreign exchanges, or used in the fine arts. This was observed by Gresham and also stated at least 40 years before Gresham by Nicolaus Copernicus. The theory was not formalized until the middle of the 19th century by Scottish economist Henry Dunning Macleod in name of Sir Gresham. In some parts of Europe (mostly Central and Eastern Europe) this law is also known as Copernicus Law.
References for Gresham's Law
Academic Research for Gresham's Law
- Gresham's law or Gresham's fallacy?, Rolnick, A. J., & Weber, W. E. (1986). Journal of political economy, 94(1), 185-199. Note that Gresham's Law can be of two forms namely: The law that says bad money pushes the good money out of circulation and a more implicit version of the rule that keeps a constant exchange rate between the two monies. But, history opposes these two forms. Interestingly, the exchange rate has never been constant, and there's the tendency of it being that way. As a result of this, a new, consistent and feasible version of the law has been proposed which requires a constant cost of the transaction. Note that the denomination predicts the fate of the "good money" and vice versa.
- Dollarization in Latin America: Gresham's law in reverse?, Guidotti, P. E., & Rodriguez, C. A. (1992). Staff Papers, 39(3), 518-544. IMF Working Paper Series is in such a way that it allows the availability to large audience research works to IMF staffs. According to statistics, at least 300 Working Papers are published per annum which spreads through a wide range of analytical and theoretical topics such as global liquidity, monetary and fiscal issues, national and international economic developments and balance of payment.
- A model of commodity money, with applications to Gresham's law and the debasement puzzle, Velde, F. R., Weber, W. E., & Wright, R. (1999). Review of Economic Dynamics, 2(1), 291-323. What are those properties that must be implemented before the success of Gresham's Law? What are the keynotes of debasement? In order to provide answers to the aforementioned questions, a model of commodity money having both the heavy and light coin was developed and the price and imperfect days were assumed to be provided by bilateral haggling. There are cases where both, neither, or only a type of coin (heavy or light) was in circulation. When these coins circulate, they may be traded by either tale or weight. Irrespective of the incentives given, after a debasement, chances exist with positive government claims and a mixture of both the new and old coins in the market. Journal of Economic Literature Classification Numbers E42, N10
- Some Neglected Aspects of Gresham's Law, Fetter, F. W. (1932). Some Neglected Aspects of Gresham's Law. The Quarterly Journal of Economics, 46(3), 480-495. According to Gresham's public services, 480.--In His letter written to Queen Elizabeth in the year 1558, 482. -- The Recoinage and Gresham's application to it 1560, 483.-- History of the term "Gresham's law", 486.-- Macleod's discussion, 000.Jevons discussion, 490.-- Adoption of terms in America, 491.-- The interpretation given to the quote Bad Money Drives Out Good Money," 492.-- Currency depreciation as regards Gresham's Law, 494
- Salvaging Gresham's Law: The good, the bad, and the illegal, Selgin, G. (1996). Journal of Money, Credit and Banking, 28(4), 637-649. In opposition to the arguments of Warren Weber and Arthur Rolnick, Gresham's Law is not "gibberish." Nor does it means it operates on an impractical assumption of the dis-equilibrium exchange rate between two different monies. However, Gresham's Law as an outcome of rigid law of legal tender is concerned with convincing individuals from being bias in choosing alternative monies. These kinds of law can practically push the urge for "good" money out of circulation by engaging sellers with buyers in a state of Prisoner's confusion where the acceptance of "bad" money depicts a different noncooperative state. Some historical examples of Gresham's Law which are not in synchrony with what Weber and Rolling proposed were given although, they are not readily explainable.
- Currency competition, inflation, Gresham's law and exchange rate, Bernholz, P. (1989). Journal of Institutional and Theoretical Economics (JITE)/Zeitschrift fr die gesamte Staatswissenschaft, 465-488. Advanced inflations bring about the reverse of Gresham's law via historical evidence. An equation consisting of the Monterey approach and currency substitution predicts a fixed real budget deficit. New money is tendered to secure a better portfolio. After the first period, the next period brings the new flow of money with a constant exchange rate to principal authorities that have no influence on the international reserves. The bad money drives out the good in the third period while the reverse is the case for the fourth period. Inflation and a flexible exchange rate gradually move toward infinity.
- Gresham's law in nineteenth-century America, Greenfield, R. L., & Rockoff, H. (1995). Journal of Money, Credit and Banking, 27(4), 1086-1098. This article basically explains the nineteenth century of the American definition of Gresham's Law. These tests explain the disagreement between the silver and foreign dollar as well as the disagreement between the gold dollar and greenback dollar during and after the Civil war. Gresham's law has been found relevant by the authors that the natural outcome of the conflict is based on the pocket-friendly money at face value and a varying premium of good money does not.
- Gresham's Law, Asset Preferences, and the Demand for International Reserves, Aliber, R. Z. (1967). The Quarterly Journal of Economics, 81(4), 628-638. Introduction, 628. -- I.The demand for international reserves in line with the gold exchange system, 630; adjustment to asset preferences, 630; Crisis in the gold exchange standards, 631. -- II. The demand for reserves in the IMF system, 631; properties of reserve assets, 632; ranking of reserve assets, 633; adjustment to asset preferences, 634; changes in asset attributes, 636. -- III. Conclusion, 638.
- Gresham's law in a lemons market for assets, Aiyagari, S. R. (1989). Canadian Journal of Economics, 686-697. An environment where assets of varying qualities can be used for consumption and transaction is termed a simple environment. Note that the quality of the purchased asset is only known to the seller and not the buyer. This assumed characteristic results in a negative relationship between the rate if the return and speed of transaction. Several version of Gresham's law in this niche is also well explained.
- Government transaction policy and Gresham's law, Li, Y. (2002). Journal of Monetary Economics, 49(2), 435-453. As argued by Professor Hayek, citizens should have the liberty of using foreign currencies as s means of payment of debt and exchange in order to check on National budget which relies solely on coining bullion for fiscal purposes. This scheme rests on the reasoning that the ability to make use of foreign currencies allow an elasticity in the demand of domestic currencies, there's causing a reduction in the monopolistic power of government as regards the issuing of currencies. This argument also attests that this will be possible if the foreign currency were the exact replica of the domestic currency. Hence, for Gresham's law to be valid, the aforementioned conditions must be met.