Back to Cantillon: On the Relevance of the Monetary Economics of Richard Cantillon

Simon Bilo

Advisor: Lawrence H White, PhD, Department of Economics

Committee Members: Peter J. Boettke, Richard E. Wagner

April 23, 2013, 02:15 PM to 10:45 AM


Richard Cantillon was an eighteenth-century economist who raised the idea of monetary non-neutrality that we today also know as “Cantillon Effects”. Cantillon and his followers emphasize that changes in the quantity of money progress over the economy in a step-by-step fashion and lead to wealth redistributions and to real effects on production processes. Cantillon's idea of monetary non-neutrality is the underlying theme of the three chapters of the dissertation.

In the first chapter, I argue that the idea of “Cantillon Effects” has been lost for the modern macroeconomics. While “Cantillon Effects” can be also expressed in terms of the equilibrium analysis, this option has been dismissed. I illustrate the dismissal by the Nobel Lecture of Robert Lucas and his discussion of David Hume's analysis of monetary change, which is identical to the analysis of Cantillon. I conclude that the idea of “Cantillon Effects” should not have been abandoned because it stands the test of consistency of the equilibrium analysis as well as that of historical relevance.

In the second chapter, I reconsider the business cycle theory of Mises and Hayek, where the idea of “Cantillon Effects” is an important component. Critics often point out that the theory relies on the assumption of people committing systematic errors during monetary expansions. How else could one relate economic recessions to a cluster of errors as Mises and Hayek do in their theory? Contrary to the criticisms the theory holds also in settings where people commit unbiased errors. If heterogenous people form unbiased expectations about the length of monetary expansion, there are both overestimating and underestimating people. The pattern of errors produced by the overestimations is, however, different when compared to the pattern of the underestimations. The overall pattern of errors then conforms to the business cycle theory of Mises and Hayek.

In the third chapter, I expand the business cycle framework of Mises and Hayek into the international context. I argue that domestic monetary policy imposes real effects at home as well as abroad and aligns international co-movement of business cycles across different currency areas. I show that domestic monetary expansion changes through “Cantillon Effects” the relative prices between domestic and foreign goods and also between goods of earlier stages of production and goods of later stages of production. The change in the relative prices leads to coordination failures as people invest into specific factors of production that become unprofitable once the monetary expansion ends. The framework explains the surge of coordination failures that we see during the bust phase of the business cycle. The framework is also consistent with the observed co-movement in economic aggregates across countries.