Do Cantillon effects matter?

A couple of years ago there was a big blogosphere debate about Cantillon effects. It was prompted by Sheldon Richman's claim that:

Since Fed-created money reaches particular privileged interests before it filters through the economy, early recipients—banks, securities dealers, government contractors—have the benefit of increased purchasing power before prices rise.

Scott Sumner argued that "it makes very little difference how new money is injected" (see Sumner's follow up post here, see Robert Murphy's attempted resolution, and see Sumner's response.)

This debate struck me as a classic argument between comparative statics and market process theory. The process by which monetary expansion occurs will cause some prices to change. Whilst prices adjust, some groups will benefit and some will lose out. It seems uncontroversial to me.

Perhap's the problem is with immediately turning this into a debate as to whether "Cantillon effects" exist. We can think of them in two ways. The first is whether there's a wealth effect on the part of the early recipients of freshly created money. The second is the consequences of the relative price effect. Note that Sumner is challenging Sheldon's account of the former, whilst it is the latter is the really important contribution of Austrian monetary theory (i.e. the interplay between non-neutrality of money, relative price changes, and the capital structure).

Having read through the debate, I believe that the following statements are correct:

  • There is a perceived wealth effect for the specific first receivers (in other words the first receivers gain a consumer surplus from their mutually beneficial voluntary transaction. Mario Rizzo made this point here).
  • There is a wealth effect to some people across the economy as a whole

It is not necessarily the case that:

  • There is a wealth effect for the specific first receivers - because as Sumner points out, they are receiving the market rate for their asset.

I was prompted to look at that debate having read through a couple of old papers by Richard Wagner. One of them, (co-authored with Steve Daley), emphasises the relatiohip between the preferences of the recipients and the impact on relative prices:

"if money is injected at points where the recipients have particularly high demands for goods with relatively inelastic supply, those particular prices will rise further than they would under some alternative locus of monetary injection"

The other article is about Georg Simmel’s Philosophy of Money. Wagner argues that the essence of a Cantillon effect is that "the process of monetary injection will influence the concrete pattern of activities within a society". Whilst a comparative statics approach may dismiss the result as "mere distributional effects", Wagner argues that:

This dismissal arises out of a frame of reference where all that matters is the state of some aggregate economic variables. Yet the dynamic forces that are at work at shaping societies precisely work their way through those micro channels; the aggregate resultants are objects neither of choice nor of desire

In my "Choose your own financial crisis" I grappled with implied counterfactuals. I think a similar issue needs to be made explicit when discussing Cantillon effects. The question is: What is the implied counterfactual?

Bob Murphy was almost right to treat it as a semantic debate about what constitutes fiscal policy. The key point is that Austrian monetary economics rests on the far broader calculation debate. Cantillon effects are important not so much because of non-neutrality (i.e. a monetary reason), but because they disrupt the price mechanism. Incidently, I also think this is how to resolve Jeff Hummel's neglected criticism of ABC. He argues that Austrians have failed to clarify why they assume that monetary expansion should escalate. Whilst an ever increasing growth rate in the money supply will indeed lead to a necessary crash, why assume that a constant growth rate would inevitably escalate? I think the solution requires us to consider how new money is being spent, and the implication for economic calculation. Consider the government subsidies that went to Solyndra. There is no arithmetic reason to say that they should need to rise over time, but our understanding of the economic calculation debate tells us that it is unsustainable. The boom is unsustainable because it is an example of government intervention. Whether that should be considered monetary policy, or fiscal policy, is a separate issue. It's political economy.