Understanding Gresham’s Law and the Role of the IMF
Gresham’s Law states that “bad money drives out good” and can be applied to the currency markets. This principle originated from the historical use of precious metals in coins and their subsequent value. Since the abandonment of metallic currency standards, the theory often describes the stability and movement of different currencies in global markets.
Understanding Gresham’s Law
Sir Thomas Gresham (1519-1579) wrote about the value and minting of coins while working as a financier and later founded the Royal Exchange of the City of London. When Henry VIII debased the English shilling by replacing a significant portion of the silver with base metals, people hoarded the coins containing more silver, which were worth more than their face value. Both currency types were legal tender and available simultaneously. Gresham observed that bad money was driving good money out of circulation.
* **Bad money:** Currency with equal or less value than its face value.
* **Good money:** Currency with the potential for greater value than its face value.
People tend to use bad money first and hold onto good money. The Scottish economist Henry Dunning Macleod attributed this law to Gresham in the 19th century.
Targets of Monetary Policy
There are several views on the aims of monetary policy:
1. A Stable Price Level
This view advocates for keeping the value of money (price level) stable, as changes can have undesirable effects on the economy. However, complete stabilization is neither possible nor desirable. Mild inflation (2-3% per annum) or a functional rise in prices is often preferred.
2. A Gently Rising Price Level
Some economists, like Keynes, believe a slowly rising price level provides incentives for producers, leading to increased employment and income.
3. A Gently Falling Price Level
Others, like Dennis Robertson, argue that a slowly falling price level benefits fixed-income earners and consumers. However, it can also be inequitable, favoring creditors and wage-earners at the expense of debtors and producers.
4. Neutral Money
This concept suggests that money should only serve as a medium of exchange and unit of account, without influencing the economy. However, it has limited practical application.
5. Exchange Stability
Maintaining stable exchange rates can reduce uncertainty in foreign trade. However, it may lead to instability in the domestic price level.
6. Avoidance of Cyclical Fluctuations
Monetary policy alone cannot eliminate business cycle fluctuations.
7. Full-Employment and Economic Growth
This is the most widely accepted aim of monetary policy. Keynes argued that a cheap monetary policy and deficit spending could promote economic growth, but these should be subordinate to fiscal policy.
The International Monetary Fund (IMF)
The IMF works to achieve sustainable growth and prosperity for its 190 member countries by supporting economic policies that promote financial stability and monetary cooperation.
Achievements of the IMF
- Provides financial assistance to countries with balance of payments deficits.
- Promotes exchange rate stability.
- Created Special Drawing Rights (SDRs) as a reserve asset to supplement existing reserve assets.
- Serves as a forum for discussions on economic, fiscal, and financial policies.
- Provides assistance to developing and ex-communist countries.
- Combats terrorism and money laundering.
Paper Money
Paper money is the most advanced form of money, fulfilling most qualities of good money. It is economical, easily recognizable, portable, and storable. Most paper currency today is fiat money, meaning it has value by government decree.
Merits of Paper Money
- **Cheap and Economical:** Printing costs are relatively low.
- **Convenience:** Easy to transfer and carry.
- **Security:** Difficult to counterfeit due to design and special materials.