The Mythology of Cantillon Effects

When the great historian of economic ideas Mark Blaug referred to monetary redistribution of purchasing power as “Cantillon effects,” he had no idea what a popular following his designation would unleash.

Economists and intellectuals of many different tribes have long tried to claim Cantillon’s monetary insights for their own: Douglas Vickers emphasized the connection between money growth and output; Arthur Monroe and Marius Wilhelm Holtrop shoved Cantillon into pre-Keynesian formulations of the quantity theory of money; Hayek, both in Prices and Production and in an obscure French review article from 1936, was attracted by the monetary redistribution effects in Cantillon and applied them directly to his business cycle theory. 

In more recent years, the most passionate proponents of Cantillon effects have been some modern followers of Hayek’s and Mises’s business cycle theories (for instance, Bob Murphy, Mark Thornton, and Carmen Dorobat). In a recent podcast on the topic, Jeff Deist even referred to Cantillon effects as “the great untold story of our times.”

I don’t wish to make the case that these writers are mistaken, but rather that the weight they attach to Cantillon’s monetary redistribution is greatly exaggerated. Ironically, Cantillon’s reasoning makes for a much more mundane and universally applicable point than it is made out to be. 

What Are “Cantillon Effects”?

In Richard Cantillon’s famous Essai, written sometime in the 1720s but published posthumously in 1755, he objects to early versions of the quantity theory of money — for instance John Locke’s. The prevailing wisdom among political economists was that increases in the money supply increased prices proportionately; money, in modern parlor, was “neutral” and did not greatly impact real economic transactions. 

Cantillon objected to this and showed persuasively that changes in the money supply have different and uneven consequences depending on where the new money is injected — and who the early receivers are. As the first receivers can spend the money at not-yet-adjusted prices for goods and services, they get an (unfair) advantage over later recipients whose incomes lag the increase in prices. In effect, by introducing new money into the system, early receivers are benefited at the expense of late receivers. 

So far so good. Austrians frequently use this process to scold modern central banks and moralize over the genuine injustice created by their redistributions. By injecting new money into the system, ostensibly to achieve monetary policy goals, central banks exacerbate wealth and income inequality. Critics invoke the power of Cantillon to object to such redistribution of purchasing power. 

There’s only one problem. Cantillon himself was talking about a gold standard — not central bank fiat money. 

What Cantillon Really Said

Cantillon is a strange bedfellow for Austrians to grab on to, which scholars like Thornton openly admit. He calls him a proto-Austrian precisely because there are many areas where Cantillon’s economics is underdeveloped: he’s a mercantilist; he has no concept of economic growth and views the world as a zero-sum game; his view of banking is, at best, confused; and — perhaps in light of his experiences with John Law’s scheme in 1719–20 — he places no useful value on paper money. 

For Austrians, usually strong proponents of hard money, commodity-money regimes, and monetary policy rules, it is ironic that the monetary-redistribution analysis that so endeared him to Austrians is based entirely on a gold standard: 

If the increase in actual money comes from a state’s gold and silver mines, the mines’ owner, the entrepreneurs, the smelters, the refiners, and generally all those who work in them will increase their expenditure in line with their gains. At home they will consume more meat and wine or beer than they used to, and they will become accustomed to having better clothes, finer linen, and more ornate houses and other sought-after commodities. (Cantillon 2015, 215)

In contrast to those beneficiaries of new gold, he explicitly identifies the losers:

Those who suffer first from this dearness and the increase in consumption will be the landlords during the term of their leases, then their servants and all the workers or people on fixed wages on which their families depend. All of them will have to reduce their expenditure in proportion to the new consumption. (Cantillon 2015: 216–17)

The point here is not that Austrians misuse the prescient insights of Cantillon, but that they simultaneously overstate their case and don’t go far enough. They don’t go far enough in that every monetary system includes Cantillon effects; as labor economist George Borjas is fond of saying, every change in economic behavior, policy, or circumstances redistributes income. In this sense, Cantillon effects are universally valid occurrences of any monetary economy. They are not, contrary to how many Austrians view them, a fundamental evil unique to fiat central bank systems. Monetary growth, be it through physically mined gold, virtually mined bitcoins, or digitally increased fiat money, always produces the redistributive effects of purchasing power that Cantillon concerned himself with.

Austrians also overstate their case, at least as far as Cantillon’s writing is concerned; to our “man of mystery,” monetary redistribution does not inevitably set the economy on a path of unsustainable boom and bust — relative prices, wealth, and consumption desires adjust. In contrast to modern Austrians, Cantillon makes no distinction between new money entering the credit market and that entering the goods market. To him, the effects are equivalent. 

Interestingly, Cantillon also ascribes the same monetary redistribution effect to specie imported from abroad — and even immigrants or ambassadors bringing specie to the domestic economy. Indeed, he puts a greater emphasis on the redistributive consequences of regular trade surplus than on gold from mining operations.

Austrians often carve out a distinction here: new money — even from gold mines — that is consumed in the real economy initially alters relative prices but has no business cycle effect since the spending patterns of recipients of new money somehow quickly revert back to their previous consumption–investment patterns. Cantillon explicitly opposed that: 

If gold or silver mines are discovered in a state and if considerable quantities of minerals are mined from them, the owner of these mines, the entrepreneurs, and all those who work in them will increase their expenditures proportionately to the wealth and profits that they make. They will also lend sums of money at interest over and above what they need to spend. All of this money, whether lent or spent, will enter into circulation and will not fail to increase the prices of commodities and merchandise in all the channels of circulation that it enters. (Cantillon 2015, 211, emphasis added)

Rather than inevitably cause an unsustainable boom ending in a bust, Cantillon seems to believe that new money, both in the short run and the long run, prompts people to adjust their behavior. At one point he even states that the goods whose prices increased because of the new money will cause a number of people to cut back on their consumption, thereby nudging prices back to their long-term (“intrinsic”) value. In other words, monetary injections redistribute real resources among society’s individuals, but, according to Cantillon, this does not seem to have the negative business cycle effects that Austrians normally advance. 

Besides, if gold mining operations go on for long enough, even sticky prices (such as landlord leases or other fixed-income contracts) will adjust, bringing the economy back to its previous state.  

In at least one interpretation of Cantillon’s writing — that of his biographer Antoine Murphy — his monetary economics seems more in line with monetary–disequilibrium theory than with hard-money interpretations. First, he equates the economic effects of an increase in velocity with an increase in the money supply, in line with more modern monetary writing. Second, Cantillon objected to a monetary system where increases of the money supply were “out of line with the demand for money,” rather than opposing a growing money supply per se. 

Austrians invoking Cantillon effects are right to focus on Cantillon as a precursor of modern economics; 60 years before Adam Smith, he had the right big-picture insights on many important monetary topics. Their mistake lies in attributing particular injustice to monetary redistribution under central banking, since Cantillon effects occur under every monetary regime. 

Cantillon’s own analysis was made explicitly using money production from gold mines. It also does not seem to include the inevitable boom-and-bust features Austrians associate with money production entering the credit market; to Cantillon all new money had the same redistributive and uneven effects, regardless of whether it was first spent in the real economy or entered the credit markets, reducing interest rates. 

Michael Bordo’s assessment of Cantillon is spot-on: reading this 18th-century writer “would be more than worthwhile to any serious student of money.” 

Related Articles – Central Banking, Monetary Policy