Chapter 6: Currency Competition, Inflation, Gresham’s Law and Exchange Rate
1 6.1 INTRODUCTION In this chapter several characteristics of inflation, among them the working of Gresham’s and Thier’s Laws, which have been analysed before, will be considered together in a model trying to explain a complete cycle of inflation beginning with the introduction and ending with the demise of an inflating money in high or hyperinflation (Table 5.2). We have already studied two complete cycles, namely the events during the American Revolution and of the Ming paper money (Chapter 4). The idea of a complete cycle was first introduced by Subercaseaux (1912). In his highly interesting El Moneda Papel (pp. 279, 281) he calls the substitution of the inflating by stable money at the end of the cycle the ‘abnormal way of re-establishing the metallic money (the demonetisation of paper money)’. This is in contrast to the normal way of returning to a stable currency by changing the monetary regime through a currency reform. Four relevant stylised periods of inflation will be described in our simple model, which is related to the ‘monetary approach’ to the balance of payments and the exchange rate (see for example Frenkel and Johnson, 1976), to the theory of currency substitution (see for example Connolly, 1978 and Girton and Roper, 1981) and of competing monies (Starbatty, 1982). The four periods contain characteristics corresponding to stylised facts which have been observed in many historical cases of inflation, and most of which have been described above. In period one, a new kind of money is introduced...
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