Cantillon Effect

Cantillon Effect

A Cantillon effect is a change in prices related to one another that was caused due to a change in the money supply, first discovered by Richard Cantillon an 18th-century economist. History shows that some assets are favored over other ones when extra money is available in the economy for spending and investing. These preferences lead to increasing prices in some economic areas and sectors and declining prices in other ones.

A Cantillon effect can happen when an expansionary monetary policy happens during an economic recession leading to high demand for commodities that causes their prices to increase at the same time that the debt-based assets are declining in price and value.

Since the money that is added to the economy through loans and asset purchases by the central bank or removed from the economy through write-offs of debt and bankruptcy liquidations have different timing, prices do not all rise or fall simultaneously. Biflation can happen during  points in the economy instead of a correlation in market prices moving together. Inflation and deflation happen as trends and go through a  process of ups and downs before achieving a new equilibrium from monetary expansion creating new supply and demand cycles. The relation between the price changes across various markets that happen can confuse policy makers and economists from understanding if the economy is experiencing inflation or deflation.[1]

Cantillon’s theory was that who benefits when a country prints a large sum of fiat currency is based on the institutional setup of that country. In the 18th century when he lived, this meant that the closer people were to the king and the wealthy, the more they benefitted, and the further away they were, the more they were harmed. Money is not a neutral agent as it is used by the people and politicians with access to it to benefit their self and their own interests. The observation that money printing has distributional consequences that operate through the price system, is known as the “Cantillon Effect.”

He observed that when “doubling the quantity of money in a state, the prices of products and merchandise are not always doubled. The river, which runs and winds about in its bed, will not flow with double the speed when the amount of water is doubled.”

Cantillon discussed how money would flow, noting that the wealthy near the mine would spend it on luxuries like servants and food delicacies, causing a general rise in prices. Eventually the money would trickle down to the general population farther from the mine, but until then, working people would pay higher prices without access to any of the new money that the mine owners acquired from the source. So there would be inflation, with an uneven distribution of purchasing power and appreciation of assets, goods, wages, and services.[2]

Cantillon Effect

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