The Cantillion Effect

The conventional history of economics usually starts with Adam Smith, David Ricardo and J. S. Mill. But there is one who came before, who might deserve to be just as much of a famous name: Richard Cantillion. The Irish economist of French descent (see, there are redeeming features of French economics!) is crucial to the history of economics.

In 1734, as if from a film noir classic, Richard Cantillon was murdered by a disgruntled former employee and his home was set ablaze. His seminal work, Essai sur la Nature du Commerce en General survived the fire and was published in 1755. His work ignited not just Adam Smith’s writings, but intellectual giants of the following centuries from Jean-Baptiste Say to Friedrich Hayek.

Cantillion’s contribution to monetary policy is just as important today. In Essai, Cantillon provided an advanced version of John Locke's quantity theory of money, focusing on relative inflation and the velocity of money. Namely, when you print money, it causes more pounds to chase fewer goods, pushing up the average cost resulting in inflation. His theory has been dubbed ‘The Cantillion effect’, and is a lesson to us all on the effects of inflation ‘financing the financiers’.

Printing press enthusiasts often speak of the virtues of spending as a way to help those at the very bottom of society. From lavish government programmes for the purposes of ‘job creation’ to recklessly inefficient welfare spending, well-intentioned policy in theory often leads to not so well policy in practice. These outcomes can even be contrary to the intended effects of alleviating the status of the poor. Examples are plentiful: rent control, tariffs, planning restrictions, minimum wage laws and zero hour contracts that all hurt the poor under the pretence of helping them.

Monetarists such as Noble Prize-winning economist Milton Friedman have long argued about the importance of curbing inflation but more generally, government inflation has greater ‘unseen’ effects which are ignored.

While Friedman argued that money is ‘neutral’ (meaning an increase in money supply won’t actually change the amount of resources in the economy in the long run), in the short run, inflation as a policy tool has far-reaching socioeconomic effects. It favours time-responsive actors such as investors rather than wage earners who will feel the effects of the increased money supply in the end. It would impose "forced savings" and lower real incomes on those whose income was not changed due to monetary inflation, possibly leading to unemployment.

Cantillion wrote:

“The river, which runs and winds about in its bed, will not flow with double the speed when the amount of water is doubled.”

Inflation is not simply an average rise in prices. Prices do not rise proportionally or simultaneously. This results in arbitrary benefit to some who have not created any economic value and detriment to others who have not destroyed anything of economic value by destroying savings for example. This is the Cantillion effect.

In response to the change in relative prices, more resources are allocated to long-term capital goods such as shares since they are spent by the most time-sensitive actors such as investors e.g. by buying stocks and profiting when prices are low. The sudden increased demand for stocks in the financial market bids up asset prices, this may even happen before the rise in the money supply is taken into account.

This results in deadweight loss (due to market distortions, rather than say, real price signals) due to new investments that may not be as well suited to the economy. This may result in large losses and possible bankruptcies by the owners of these capital goods. To the extent that these adjustments are widespread, they pose a threat to capital markets and the banking system.

The result of the adjustment to the increase in supply may quickly result in this river turning swiftly to one of mud. Why does this effect matter? This regressive tax is often attempted to be overcome with further progressive taxation and this phenomenon has been largely ignored by groups and political parties on the Left.  


Cantillion’s work has very real implications, the Cantillion effect of inflation is one of many of his myriad of theoretical contributions. Ranging from basic methodology to complex macroeconomic models that include the circular-flow model and the price-specie flow mechanism. Cantillion is, unfortunately, one of the more underrated economists of our time. He deserves to be put in classroom economic history textbooks, just like Smith, Ricardo and Mill.

It is not just students who are naive, politicians are often blind to the true consequences of their magic money tree promises. Ironically it is those that aim to help the common man who advocate for disastrous spending policies that hurt us all. Politically this may seem like a monetary sleight of hand, ensuring the flexibility of the labour market and gaining voters, but in practice, inflation is a regressive tax, often under the pretence of egalitarian stability which exacerbates the inequalities it attempts to mitigate.