A Model of Commodity Money, with Applications to Gresham's Law And
Federal Reserve Bank of Minneapolis Research Department Staff Report 215 Revised July 1997 A Model of Commodity Money, With Applications to Gresham's Law and the Debasement Puzzle Fran¸cois R. Velde∗ Federal Reserve Bank of Chicago Warren E. Weber∗ Federal Reserve Bank of Minneapolis and University of Minnesota Randall Wright∗ University of Pennsylvania ABSTRACT We develop a model of commodity money and use it to analyze the following two questions motivated by issues in monetary history: What are the conditions under which Gresham’s Law holds? And, what are the mechanics of a debasement (lowering the metallic content of coins)? The model contains light and heavy coins, imperfect information, and prices determined via bilateral bargaining. There are equilibria with neither, both, or only one type of coin in circulation. When both circulate, coins may trade by weight or by tale. We discuss the extent to which Gresham’s Law holds in the various cases. Following a debasement, the quantity of reminting depends on the incentives offered by the sovereign. Equilibria exist with positive seigniorage and a mixture of old and new coins in circulation. ∗ The views expressed here are those of the authors and not necessarily those of the Federal Reserve Banks of Minneapolis or Chicago or the Federal Reserve System. We thank Arthur Fishman, Angela Redish, Thomas Sargent, Theodosios Temzelides, and seminar participants at the Federal Reserve Banks of Minneapolis and Philadelphia, the Penn Macro Lunch Group, the Universities of Chicago, Essex, Cambridge and Haifa, and the 1996 SEDC conference in Mexico City. This paper develops a model where metal coins are used as media of exchange, and uses the model to analyze two closely related questions in monetary economics: What are the conditions under which Gresham’s Law holds? And, what are the mechanics of a debasement, an operation in which the metallic content of coins is lowered? Gresham’s Law, as it is commonly stated, asserts that bad money drives out good money.
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