Definition
Gresham’s Law
Gresham’s Law is an economic principle stating that “bad money drives out good money.” It posits that if two coins are in circulation, both accepted as having the same nominal value but made of different metals (e.g., gold and silver), the coin made from the more valuable metal will be hoarded and the coin made from the less valuable metal will be used for transactions. This leads to the more valuable coin being driven out of general circulation.
Examples
Historical Coinage: In the 16th century, England experienced a blend of expensive gold coins and cheaper silver coins. People tended to hoard gold coins because they retained intrinsic value, whereas silver coins were used for daily transactions, thus driving gold coins out of circulation.
Modern Currency: Consider a hypothetical country where two types of paper money exist: new, robust currency and old, worn-out currency. If both are accepted at the same face value, high-quality notes might be saved while the old, less-desirable notes are spent more frequently.
Frequently Asked Questions (FAQs)
What does Gresham’s Law explain?
Gresham’s Law explains why more valuable currency often disappears from everyday use, as people prefer to spend money that has lesser intrinsic value and save valuable currency.
Is Gresham’s Law relevant today?
Yes, it applies in scenarios involving different forms of payment with different intrinsic values, like digital versus physical money, or during times of rapid inflation.
Can Gresham’s Law apply to non-monetary assets?
While its application is mostly in currency, a modified version can apply to other assets where legal and market values conflict.
How can Gresham’s Law be prevented?
Ensuring all forms of currency have similar intrinsic and market values can prevent Gresham’s Law from making one type of money hoarded and another one spent.
Related Terms
Commodity Money
Money whose value comes from a commodity of which it is made, such as gold or silver coins.
Fiat Money
Currency that has value because of government regulation or law, not because of its intrinsic value.
Legal Tender
Money that must be accepted if offered in payment of a debt.
Hoarding
Accumulating money or valuables and keeping them in reserve.
Market Value
The amount for which something can be sold in a given market.
Online References
Suggested Books for Further Studies
- “Money Mischief: Episodes in Monetary History” by Milton Friedman.
- “Economics in One Lesson” by Henry Hazlitt.
- “The Wealth of Nations” by Adam Smith.
- “Principles of Economics” by N. Gregory Mankiw.
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