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Cantillon Effect: A Brief Look at Common Misconceptions

Fabian Bogg

In the previous article “First. The Rise of Javier Milei (Part 2)”, I elaborated on the workings of the so-called Cantillon effect. For the sake of conciseness, I left some common misconceptions untouched. Due to the significance of the effect in terms of wealth distribution and especially due to its high complexity, it is worthwhile to go over some common fallacies and thus establish a higher amount of clarity. After giving a brief intro into the Cantillon effect again (a more elaborate explanation is found in the above-mentioned article) this outsourced snippet will go over said misbeliefs.

The Cantillon effect describes a distribution pattern occurring when expansionary monetary measures are used. Comparable to the pouring of honey in a cup, the distribution is uneven with a clump appearing in the middle before spreading out. In the context of the Cantillon effect, the clump are institutions and people close to central banks or the state respectively those that commonly and easily get financing – usually institutions and people well off already. In contrast, the rest are people or entities lacking those characteristics – usually middle or lower class. This uneven distribution pattern leads the former to be able to buy goods and services at today’s uninflated prices while the latter must buy products at tomorrow’s inflated price. The logical consequence is increased economic disparities.

Misunderstanding 1) The new money has no more purchasing power than the existing money. At its face value, this statement is correct and a clever objection to the Cantillon effect. However, it misses the point behind the theory. It is certainly not that the earlier supply of money leads to some magical price favoritism on the part of the early receivers and thus simultaneously price discrimination against late receivers.

Instead, it helps to think of the purchasing power those additional monetary units achieve once they reach their receiver. Even assuming an equal nominal distribution of all payments, the early receivers gain more purchasing power than the late ones as they get the money earlier. They can exchange the additional nominal units at a better barter rate than late receivers can. If they are financially savvy, they can even buy profitable assets that are at least inflation-linked and thus profit substantially.

Misunderstanding 2) Central banks do not give the money away for free but instead exchange it for goods. Consequently, no one of the early receivers is wealthier than before

The implication behind the second misunderstanding is that the central bank is just another buyer.

Admittedly, this idea sounds very convincing at first. A thought by Arkadiusz Sieroń, however, helps us eradicate that notion instantaneously. He fittingly describes “The crux of the problem is that when the central bank creates money, it, just like a money counterfeiter, enters the market with some unearned purchasing power. That enables the central bank to possess more assets and to exert greater influence on their prices, affecting not only the price level but also the structure of prices.”. What he realizes is the uniqueness of the central bank that enters the market with a “newly-minted” piece of money. Observing it through the supply-and-demand framework, it becomes clear that this increased demand – often a big part of the overall product demand – lifts the equilibrium price. Hence, the early receiver profits through increased prices on all of his sales.

“People keep looking to government for the answer and government is the problem.” – Ronald Reagan

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