Friday, January 6, 2006

Gresham, Fiat Money and Credibility

The Cleveland Fed's October 1, 2005 issue of Economic Commentary had an interesting article on Gresham's Law. Teachers of economics, history, or economic history will likely find it interesting. But, as is demonstrated in the conclusion, it's mostly in a historical context that Gresham's Law has application.

The authors point out that Gresham's Law generally applies only to commodity-based money -- fiat money generally does not suffer from the effects of Gresham's Law. The exception to this is government interference in the circulation of currency. As the article points out, in high-inflation countries, it is the bad money that is driven out and replaced by good money (currency that holds its value). If the government raises the cost of using the low-inflation currency high enough (for example through imprisonment or other such punishment), then the high-inflation, or bad money, will drive out the good.

The example might then be used to explain the importance of the central bank's maintaining a low-inflation environment, which will encourage the economic players to prefer the national currency to others.

As always, your comments are welcome.

Posted by TSchilling at January 6, 2006 3:02 PM

Here's an additional useful citation that the Cleveland Fed article didn't include: George Selgin, Gresham's Law.
EH.Net Encyclopedia, edited by Robert Whaples. June 10, 2003.

Posted by: Lawrence H. White at January 6, 2006 4:48 PM

I've managed to save up roughly $53,528 in my bank account, but I'm not sure if I should buy a house or not. Do you think the market is stable or do you think that home prices will decrease by a lot?

Posted by: Courtney Gidts at May 19, 2006 9:27 PM

I don't know, and I personally don't believe soliciting financial advice over the internet from people you don't know is a good idea. This is especially true given the magnitude of the transaction you're about to undertake. There are way too many factors to consider giving you a glib, off-the-cuff answer.

Posted by: Tim Schilling at May 19, 2006 9:49 PM

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