Gresham’s law, which says that bad money tends to drive good money out of circulation, may account for many nations’ episodes of money troubles, as far back as ancient Athens. This Commentary discusses the two main explanations for Gresham’s law and suggests some circumstances in which the law does not apply.Gresham's law ; Money

Ed Nosal

Guillaume Rocheteau

Richard Dutu

English

Research Papers in Economics

occur in several Medieval and Renais-
sance writings, from scholars like
Hostiensis (ca.1200–71), Oresme
(1320–82) and Copernicus (1473–1543),
and from mint officials like Henri 
Poullain (1612). As we have just seen,
Aristophanes, in the 5th century B.C.E.,
had already anticipated the mechanism.
And it was the British economist, Stan-
ley Jevons, who originated the expres-
sion “bad money drives out good
money” in his 1875 book, Money and
the Mechanism of Exchange, even
though Henri Poullain’s conclusion in
1612 that “[b]ad specie smothers and
drives out good specie” came very close!
■ Legal Restrictions and 
Gresham’s Law
MacLeod explained the phenomenon that
he called Gresham’s law on the basis of
government intervention in monetary
affairs. In an anonymous pamphlet writ-
ten in 1696, he says that “[w]hen two
sorts of Coins are current in the same
nation, of like Value by denomination, but
not intrinsically, that which has the least
Value will be current, and the other as
much as possible hoarded.” In other
words, if two coins have a one-to-one
exchange rate, the coin with the lower
content of the valuable commodity—the
October 1, 2005
Federal Reserve Bank of Cleveland
The Tale of Gresham’s Law
by Richard Dutu, Ed Nosal, and Guillaume Rocheteau
ISSN 0428-1276
Gresham’s law, which says that bad
money tends to drive good money out
of circulation, may account for many
nations’episodes of money troubles,
as far back as ancient Athens. This
Commentary discusses the two main
explanations for Gresham’s law and
suggests some circumstances in which
the law does not apply.
It is often difficult to explain why a
particular commodity or currency
becomes a medium of exchange. The
common wisdom is that currencies with
good properties—high intrinsic value,
low storage cost, or low inflation—are
more likely to circulate than those with
bad properties. This is illustrated by the
phenomenon of dollarization, in which
the currencies of high-inflation countries
tend to be partially abandoned in favor of
sounder currencies like the U.S. dollar.
But good currencies have not always
been preferred to bad ones. Monetary
history includes plenty of incidents in
which monies with good intrinsic prop-
erties are displaced by monies with 
inferior properties. For example, Aristo-
phanes’(450–385 B.C.E.) play, The
Frogs, refers to an episode in which the
government of Athens, facing a shortage
of silver, decided to supplement its silver
coins with copper. As a result, silver
coins ceased to circulate and were
replaced by copper ones. The Middle
Ages also furnishes many examples. In
1295, Philip the Fair, king of France,
decided to mint new silver pennies that
contained less metal than similar coins
that were circulating in two adjacent 
territories, Burgundy and Flanders. Both
territories soon substituted the light
coins minted in France for their heavier
domestic ones. More recently, the U.S.
Coinage Act of 1965 replaced the old
silver quarters with “sandwich” coins
made of a silver–nickel alloy. The pre-
1965 silver coins were quickly with-
drawn from circulation, leaving only the
inferior new quarters.
The observation that bad money drives
out good money, usually called Gre-
sham’s law, has become one of the more
famous maxims in economics and has
been used to account for many episodes
of monetary disorder. This Economic
Commentary examines the history and
the economic foundations of Gresham’s
law and identifies two explanations for
the law. The first relies on government
intervention in currency exchange rates.
The second relies on the presence of
asymmetries of information—the fact
that two parties in a trade rarely share
the same information. The Commentary
concludes by discussing the relevance of
Gresham’s law for understanding today’s
multiple-currency economies. 
■ The Origin of Gresham’s
Law
The phrase “Gresham’s law” appeared in
Henry D. Macleod’s 1858 book, Elements
of Political Economy. Macleod (1821–
1902) unveiled “a great and fundamental
law of the currency” by which “a bad and
debased currency [that is, a currency with
a lower intrinsic value] is the cause of the
disappearance of the good money.” He
named it Gresham’s law after reading a
letter to Queen Elizabeth from Thomas
Gresham (1519–79), an English merchant
working as the Crown’s financial repre-
sentative in Antwerp. Gresham attributed
the disappearance of gold from the king-
dom to the debasement initiated by Henry
VIII, which reduced the metallic content
of coins “from six ounces fine to three
ounces fine [of gold] […] which was the
occasion that all your fine gold went out
of your realm.” As noted by Fetter (1932),
“it requires considerable ingenuity to
draw from Gresham’s modest statement
[...] a universal law that bad money drives
out good money.”
As a matter of fact, Thomas Gresham
did not invent the law bearing his name.
Statements related to the phenomenon
that “bad money drives out good money”bad money—will drive out or replace the
coin with the higher content of the valu-
able commodity—the good money.
Consider an example: An economy is
based on a monometallic silver system,
with a type of silver coin named coin A.
Suppose the government introduces a
new coin, coin B, which contains only
90 percent as much silver as coin A.
There is free and unlimited coinage of
both A and B. According to their intrin-
sic content, the market ratio between the
two is 1/0.90 = 1.11 coins of type B for
each coin of type A. Suppose further
that the government ordains that both
coins will have the same denomination,
$1, for example, such that one A coin
must buy the same amount of goods as
one B coin. In this situation, an individ-
ual would gain by taking type A coins
out of circulation, melting them, and
having the metal recoined as a larger
number of type B coins. 
This is the story behind Gresham’s law:
Underweight or bad money drives out
full-weight or good money whenever
there is a fixed exchange rate between
the two. To trigger the arbitrage mecha-
nism just described—reminting good
coins as a larger number of bad coins—
the legal ratio must be enforced by the
government. This can be illustrated by
the fate of two good coins in two differ-
ent periods: the thirteenth century gold
florin in Italy and the silver écu during
the French Revolution. In 1252, Flo-
rence started to mint a gold coin of high
intrinsic value, the florin, which became
very popular among merchants. The
city’s authorities never tried to impose
an unrealistic value on the gold coin,
and agents were virtually free to price
the florin and other coins. The florin
remained in circulation and Gresham’s
law did not operate. By contrast, during
the French Revolution, the government
introduced paper notes, called assignats,
and threatened to impose a death sen-
tence on anyone who would not trade
them according to their face values.
Consequently, assignats displaced silver
écus (and gold coins as well), as pre-
dicted by Gresham’s law. (In principle,
the assignats were backed by goods
confiscated from the Church. However,
45 billion French pounds of assignats
were issued between 1790 and 1796,
whereas the sale of goods from the
Church is estimated to have been worth
two to three billion French pounds 
at most.)
The government itself could also imple-
ment the fixed exchange rate by directly
trading bad coins for good, that is, by
asking the mint, where coins are struck,
to stand ready to buy and sell coins at
their declared legal value. However, such
a liberal coinage policy is not sustainable
because it would ultimately lead to the
ruin of the mint: Individuals with B
coins—the lighter ones—would buy A
coins directly from the mint, melt them,
and have the metal recoined as B coins.
The mint would lose the difference on
every trade. Accordingly, it is very diffi-
cult to find examples of such a policy in
monetary history. (Even in a bimetallic
system, in which the legal price of gold
and silver at the mint created an implicit
legal ratio between the two metals, mints
did not trade gold for silver themselves
at this legal ratio. For example, from
1792 until 1834, the U.S. dollar was
defined as 24.75 grams of gold and
371.25 grams of pure silver, creating a
fixed relative price of 15 grams of silver
for one gram of gold. U.S. mints
accepted gold and silver in bars to be
coined at these official prices but did not
change gold into silver.) 
Still, governments may not always have
had enough power to impose unrealistic
exchange rates, especially for extended
periods. For instance, in 1577, France’s
Cour des Monnaies, which was in charge
of supervising mint policy, admitted that:
“[y]our Majesty has been forced to
increase the rate of the coins, to accom-
modate the price that your people gave
to them of its own authority.” (Sargent
and Velde, p. 200.) Thus, legal con-
straints provide only a partial explana-
tion for the activation of Gresham’s law.
We now consider an alternative explana-
tion based on imperfect information.
■ Asymmetric Information and
Gresham’s Law
According to the previous explanation,
bad money drives out good when the two
monies are traded at a fixed (and “incor-
rect”) exchange rate. This can happen
when the government introduces legal
tender laws to constrain people to trade
different coins at par. There is, however,
another circumstance under which dif-
ferent coins can circulate at the same
price: when it is difficult to tell one coin
from another.
Going back to our example of the A and
B coins, suppose that the two differ only
in their metallic contents: Coin B still
contains only 90 percent of the silver in
coin A, but now both of them have the
same imprint and the same shape. An
individual who is offered a coin may not
know whether it is a type A or a type B,
unless he is a coin expert. Situations in
which agents face difficulties in recog-
nizing coins could arise for many rea-
sons: Imperfect coinage techniques,
wear and tear, clipping (shaving small
pieces of metal from the rim), hidden
debasement, and counterfeiting. When it
is difficult to verify a coin’s intrinsic
quality, A and B tend to be traded at the
same price. In this case, coin A will be
undervalued and coin B will be overval-
ued. Such situations can be illustrated
by a historical example: In the early
1390s, the Duchess of Brabant in Bel-
gium decided to have a new mint set up
near the mint of her rival, the Count of
Flanders. This new mint was charged
with producing coins identical to the
Count’s, but with slightly less metal.
Simon La Faucille, the Count’s mone-
tary officer, declared that “the difference
[between the Count’s coin and the
Duchess’s] is so subtle that simple peo-
ple will take and already take your
penny for as much as the previous one
which is worth two esterlins more.” (An
esterlin corresponded to 1/160 of a marc
weight. The marc was a standardized
quantity of silver.)
Imperfect information about the quality
of coins can affect the behavior of indi-
viduals in a number of different ways.
An individual who holds a good coin,
and knows that he does, has an incentive
to hold on to it until he meets a mer-
chant who can recognize its true quality.
Imperfect recognizability can also affect
the behavior of coin producers. In the
Middle Ages, mint masters were in
charge of producing the quantity and
quality of coins specified by the sover-
eign. Though controlled, mint masters
might have been tempted to produce
low-quality coins and pocket the differ-
ence between the required and actual
quality of a coin. Indeed, bad coins were
cheaper to produce but they could be
passed off to uninformed individuals as
good coins. Money experts, such as
moneychangers, also had an incentive to
engage in opportunistic trading in this
system. Experts could sort out the heav-
ier coins, use the lighter ones for pay-
ments, then melt the heavy coins and
recoin them as light coins, keeping the
difference as a profit. This kind of oper-
ation, called billonnage, was widespreadwith no imperfection. When the govern-
ment raises the cost of using the low-
inflation currency, however, agents will
be reluctant to use it in transactions and
will keep it as a store of value. For
instance, legal restrictions on the use of
U.S. dollars in countries like Cuba and
the former republics of the U.S.S.R
have generated an outcome that resem-
bles Gresham’s law. In all these coun-
tries, people could be punished for using
dollars: Dollars could be confiscated
and individuals could be fined. In accor-
dance with Gresham’s law, legal restric-
tions raise the cost of using dollars and
keep bad (domestic) currency circulat-
ing widely in these countries.
■ Conclusion
Gresham’s law says bad money tends to
drive good money out of circulation. We
have shown that this proposition may
account for a number of historical
episodes. We have also presented the
two main explanations for Gresham’s
law: One is based on government inter-
vention in exchange rate determination,
and a second is based on imperfect
information about the quality of coins.
These two explanations suggest the fol-
lowing qualifications of the law: Bad
money drives out good money when
there is a fixed exchange rate between
the two or when it is difficult to distin-
guish between them. In the absence of
such market imperfections, good and
bad monies will both circulate and be
priced according to their quality. 
The evolution of monetary systems
toward the use of fiat currencies has
decreased the relevance of Gresham’s
law considerably. Still, legal restrictions
can reduce the velocity of the low-infla-
tion currency, as indicated by Gre-
sham’s law.
■ Recommended Reading
Richard Dutu. 2004. “Moneychangers,
Private Information, and Gresham’s
Law in Late Medieval Europe,” Revista
de Historia Economica 3, vol. 22.
Frank W. Fetter. 1932. “Some Neglected
Aspects of Gresham’s Law.” Quarterly
Journal of Economics, vol. 46, no. 3, pp.
480–95.
Robert L. Greenfield, and Hugh Rock-
off. 1995. “Gresham’s Law in Nine-
teenth-Century America,” Journal of
Money, Credit, and Banking, pp.
1086–98.
Arthur J. Rolnick, and Warren E.
Weber. 1986. “Gresham’s Law or Gre-
sham’s Fallacy?” Journal of Political
Economy, vol. 94, no. 1, pp.185–99.
Thomas J. Sargent, and François R.
Velde. 2002. The Big Problem of Small
Change, Princeton and Oxford: Prince-
ton University Press.
in Europe at times when differences
between coins were hard to detect.
Some moneychangers were also caught
clipping coins.
There are various accounts of money-
changers’role in the activation of Gre-
sham’s law based on asymmetries of
information. Hostiensis, a prominent
medieval jurist, wrote that: “Money is
defrauded by changers who weigh coins
one by one and keep the heavier ones
have them melted, and allow the other
ones to pass.” Another example of
experts’role in activating Gresham’s
law comes from Copernicus
(1473–1543) who, commenting in 1526
on the monetary reform carried out by
the king of Poland, wrote that “[g]old-
smiths and those specialized in precious
metals take advantage of our misfor-
tune. They sort out ancient coins, melt
them, and then sell the silver, always
receiving from inexperienced persons
more silver with the same amount of
money. When older coins have almost
disappeared, they choose the best from
the rest and just leave the worst curren-
cies.” Moneychangers were often
blamed for activities that ultimately
contributed to bad coins’crowding out
good ones. 
■ Gresham’s Law Today
When it comes to modern fiat money
systems, Gresham’s law has lost most of
its grip, because the two explanations
underlying the law hinge on features
specific to the commodity money sys-
tem. It is actually the imperfect recog-
nizability of metal coins that explains
why agents with good coins preferred to
wait for sellers able to recognize them,
and why money experts sorted out the
better coins. It is also because money
was made of precious fungible metals
like gold and silver that good, underval-
ued coins could be melted and recoined
as lighter ones. But modern fiat systems
do away with these two important ingre-
dients: The intrinsic value of coins,
bills, and deposits is zero, and good cur-
rencies cannot be melted. 
Still, there remains one factor that can
put Gresham’s law into play today: gov-
ernment interference in the circulation
of currencies. In high-inflation coun-
tries, when agents are free to choose
their medium of exchange, the high-
inflation currency tends to be displaced
by the low-inflation currency. This phe-
nomenon, known as dollarization, is the
natural outcome in a currency marketFederal Reserve Bank of Cleveland
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Richard Dutu is a senior lecturer at the 
University of Waikato’s Management
School. Ed Nosal is an economic advisor at
the Federal Reserve Bank of Cleveland, and
Guillaume Rocheteau is an economist at 
the Bank.
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The tale of Gresham's law

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