Question

Q1: Explain whether "free banking" causes hyperinflation or not. Note that hyperinflation is run-away inflation in which the general price level continues to rise limitlessly. So, a short-time rise in the price level is not "hyperinflation". Under free banking, anybody with a sufficient amount of money can start a bank and issue bank notes (paper certificates of gold), bank deposits are not protected by the government or the central bank and there are no legal tender laws. Pay special attention to what happens to the money supply when some banks go under.

Q2: Explain under what conditions Gresham's law is valid (can be observed).

(Gresham's law: Bad money drives out good. Gresham's law is not a piece of legislation. You don't need to explain Gresham's law. Focus on the necessary conditions for it.)

Answer 1

Sol: 1) Free banking refers to the time period when banks are allowed to issue their own currency notes(that is not possible in general case), without any intervention of central bank or any other agencis.Notes issued on the behalf of commodities like gold, silver etc.

When banks get no fear , increase the money supply due to whcih things not look so expansive and the worth of the money get reduced even to zero.

Banks in order to enjoy the benefits of free banking grant more loan, enjoy their own interest rates. having their own reserve requirements. Granting more loans lead to increase in money supply that increases the demand of all the goods and services due to which condition of inflation arises. but shouldn't treated as hyperinflation as only exists for a shorter period of time. once the things get normal or the at the end of "Free banking era" , control comes under the central govt. ( The FED), price started getting stabilize.

hence should not be treated as Hyprinflation.

Can see the case of " free banking era" of U.S.A, will find that many banks shut down , only the state-chartered banks exists issue their own currency on behalf of gold,silver etc.

Source : wikipedia

2)Greesham's law is applicable fruitful in the case free banking, when already existed more valueable commodity (which was demanded too), become disappear from gthe market , than we says tha" Bad Money, Drives Out).