Here's a commentary up on edweek.org that once again tackles the question of how grades affect student motivation.
The author, Paul Barnwell, makes the point that grades don't always reflect how much students learn. For example, a student who comes into a class with a broad base of knowledge and ends up with an A may actually have learned less than a student who comes in knowing less and actually studies more, but ultimately earns a lower grade. The emphasis should be on how much a student learns, rather than what grade he or she earns at the end of the year, says Barnwell.
He also contends that such a system has negative effects on student motivation.
Another problem with a heavy reliance on grading is the underlying assumption that grades are a necessary motivator for students. There are several problems with this contention. Psychological research has shown that students, and people in general, are more likely to lose interest in what they’re doing if they are promised carrots or threatened with sticks. Using grades as a threat or reward for completing or not completing schoolwork is extrinsic, or external, motivation. This type of motivation often results in a decreased focus on the learning objective.
While I see Barnwell's point, I do think that it's important to have a way to measure student achievement. Determining whether students actually understand the material is essential in order to figure out where they may need more help or where instruction could be improved.
Perhaps what should be shifted here is how grades are perceived. Maybe parents and school officials should keep in mind that one letter cannot tell the whole story of an entire year's worth of learning. Getting a C in a class that challenges and teaches a student a great deal may be worth more than an A in a class that requires no effort.