Background
The phrase “bad money drives out good” is a longstanding principle in economics specifically referencing Gresham’s Law. The principle deals with the duality in the quality of currencies within a market and refers to the tendency of inferior money to circulate freely while superior forms of the same asset disappear from public hands.
Historical Context
The concept traces its origins to Sir Thomas Gresham, a financial agent of Queen Elizabeth I in the 16th century. Gresham observed that when a government overvalued one type of money and undervalued another, the devalued or “bad” money would remain in circulation while the overvalued or “good” money would be hoarded or melted down for its material value. Although Gresham’s Law became widely recognized in the modern era, it reflects principles dating back to even more ancient economies such as those observed in the Roman Empire.
Definitions and Concepts
“Bad money”: Refers to currency with a lower intrinsic value, often due to its material composition or fiduciary backing being inferior.
“Good money”: Refers to currency with a higher intrinsic value and often of preferred material quality such as precious metals or well-trusted paper currencies fully backed by reserves.
Major Analytical Frameworks
Classical Economics
Classical economists took note of Gresham’s Law primarily through observations of currency debasement. The principle influenced monetary policies that either restricted or managed the issuance of lower-quality currencies.
Neoclassical Economics
Neoclassical approaches incorporate Gresham’s Law into broader theories of resource allocation, emphasizing the importance of uniform standards in currency to prevent economic inefficiencies.
Keynesian Economics
While generally more focused on macroeconomic policy and fiscal intervention, Keynesian perspectives recognize the implications for aggregate demand disruptions if hoarded currencies shift consumer behavior substantially.
Marxian Economics
Marxian critique uses examples like Gresham’s Law to argue against capitalist systems that inherently support class discrepancies through diverse forms of money without equitable value.
Institutional Economics
Institutional economists discuss Gresham’s Law to illustrate the roles established norms and governmental regulations play in shaping monetary systems and financial transactions.
Behavioral Economics
Behavioral economics critiques might incorporate Gresham’s Law in exploring currency preference theories that terrorists or psychological motivations lead to the retention or circulation of different types of money.
Post-Keynesian Economics
Post-Keynesian thinkers might stress the systemic inadequacies suggested under Gresham’s Law as part of critique against advancements in unregulated or loosely regulated financial systems.
Austrian Economics
Austrian economics often sees Gresham’s Law as an argument for solid money backed by tangible assets like gold, advocating for free-market monetary systems where bad money cannot expel good money uncontested.
Development Economics
In the context of development economies, Gresham’s Law might illustrate the transitional challenges for currency stability and the importance of robust monetary institutions to outperform competing low-value currencies.
Monetarism
Monetarist doctrine incorporates Gresham’s Law within broader analyses regarding inflation control and the importance of managing the money supply efficiently to uphold currency values and maintain public trust.
Comparative Analysis
Comparing institutional responses to the observations underlying Gresham’s Law features prominently across historical and contemporary economics, tracking the diverging paths and implemented solutions limitations witnessed among economies.
Case Studies
Roman Empire: Early forms of currency debasement leading to the persistence of inferior monies.
20th-Century United States: Shifts between gold standards and paper currencies prompted examinations echoing Gresham’s thoughts.
Suggested Books for Further Studies
- “Money and the Mechanism of Exchange” by W. Stanley Jevons.
- “The Big Problem of Small Change” by Thomas J. Sargent and François R. Velde.
- “Princes, Popes, and Money” by Peter Spufford.
Related Terms with Definitions
Gresham’s Law: An economic principle stating that when a government fixes the value of one currency above the market value while allowing another to circulate at market value, the overvalued ‘bad’ currency will drive the ‘good’ currency out of circulation.
Inflation: A general increase in prices and fall in the purchasing value of money.
Debasement: The deliberate lowering of the value of currency, especially historically by reducing the precious metal content.
Fiat Money: Inconvertible paper money made legal tender by a government decree, coined as having limited intrinsic value compared to its face value.
