The Question Nobody Asks About Inflation
Everyone feels inflation. But almost nobody asks who gets the new money first. That is where the real story is.
When the government and the central bank create new money, it does not appear in everybody’s pocket at the same time like some kind of universal basic income dropped from a helicopter. It enters the economy at specific points. Banks get it first. Then their largest customers. Then the financial markets. Then companies. Then workers. Then renters. Then - last of all - people living on fixed incomes or holding cash under the mattress.
By the time the new money reaches the last person in the chain, prices have already risen. The person at the front of the line spent the money when it was still worth full value. The person at the back of the line receives money that has already been diluted.
This is the Cantillon Effect, named after Richard Cantillon, an 18th-century Irish-French economist who described it in 1730, two hundred years before anyone else got around to writing down how money actually works. He noticed something that every monetary policy debate since has tried to ignore: a change in the money supply does not affect everyone equally. It redistributes wealth from the people who get the money last to the people who get it first.
Richard Cantillon died in 1734. His book Essai sur la Nature du Commerce en General was suppressed by the French government, circulated in manuscript for two decades, and is now recognized as the first systematic treatment of monetary economics. He lived through the Mississippi Bubble - one of history’s greatest monetary experiments - and he understood what was happening before almost anyone else.
The insight is simple. The implications are not.
The Carpets and the Courtiers
Cantillon’s own example is still the best way to understand it. Imagine a country’s money supply doubles. The new money does not arrive in a lump sum distributed evenly. Instead, it enters through a specific channel - say, the king’s treasury. The king uses it to pay courtiers, buy carpets from merchants, and commission buildings. The courtiers, now richer, buy more wine and bread from local suppliers. The merchants, with fuller pockets, order more goods from the countryside. The wine growers and bakers and weavers, now earning more, buy better tools and clothes.
Eventually, after a long chain of transactions, the new money has spread throughout the economy. Prices have risen across the board. The laborer at the end of the chain is now paid twice what he was paid before. But the bread he buys also costs twice what it cost before. He is no better off in real terms.
The courtier at the beginning of the chain, however, is much better off. He received the new money before prices rose. He spent it while it was still full value. The carpenter at the end of the chain received the new money after prices had adjusted. His nominal income rose but his real purchasing power did not. Actually it was worse than that. He was at the end of the chain, so prices had already risen - and he had been paying them - before his own income increased.
This is the Cantillon Effect in its pure form: inflation redistributes wealth from the last receivers to the first receivers. The people closest to the source of new money benefit. The people farthest from it bear the cost.
How New Money Actually Enters the Economy
Today, the “king’s treasury” is the central bank and the government. The “courtiers” are the financial institutions that sit at the front of the monetary pipeline.
When the Federal Reserve creates new money - through quantitative easing, lending facilities, or direct monetary financing - it does not send checks to every household. It buys assets from banks. It lends to financial institutions at near-zero rates. The first recipients of the new money are the largest financial players in the economy.
These institutions take the new money and deploy it. They buy government bonds. They buy corporate debt. They buy stocks. They make loans to their largest corporate customers. They invest in real estate. The money flows through the financial system before it ever reaches Main Street.
By the time the new money shows up in the form of higher wages or reduced hours or more expensive groceries, it has already passed through several layers of the financial system. Each layer takes a cut. Each layer benefits from being closer to the source.
This is not a conspiracy. It is a structural feature of how money is created. The central bank cannot put money directly into everyone’s pocket - at least, not without a system that does not yet exist in the United States. It creates the money at the wholesale level, and the wholesale level gets the benefit of receiving it first.
The Seen and the Unseen of Easy Money
Between 2008 and 2020, the Federal Reserve expanded its balance sheet from roughly $900 billion to over $7 trillion. The Bank of England, the European Central Bank, and the Bank of Japan did the same on an even larger scale. The stated goal was to stabilize the financial system and support asset prices during crises. The stated goal was achieved. But that is the seen part.
The unseen part is the distributional effect. The first recipients of all that new money were the banks and financial institutions that sold assets to the Fed. The next recipients were the corporations that borrowed at near-zero rates to buy back their own stock or acquire competitors. The next were the investors whose stock portfolios and real estate holdings rose as the new money bid up asset prices.
The people who did not own stocks or real estate - who held their savings in cash, who rented their homes, who depended on wage income rather than capital gains - received the new money last, if at all. Their purchasing power was diluted by rising prices for housing, education, healthcare, and food. These are not goods whose prices are set by global supply chains. These are goods whose prices are heavily influenced by local demand and local demand is heavily influenced by how much money is sloshing around the economy.
The financial journalist who says “QE did not cause inflation because CPI was low” is missing the point entirely. QE caused asset price inflation. Stock markets hit all-time highs. Real estate in desirable cities became unaffordable for a generation. The newly created money did not cause consumer price inflation in the short run because it went into asset purchases, not grocery purchases. But the person who did not own assets did not benefit from the asset inflation and eventually paid for it through higher rents and higher cost of living.
This is Cantillon’s insight in modern dress. The people closest to the new money get richer. The people farthest from it get poorer. The mechanism is the same whether the king is buying carpets or the Fed is buying bonds.
The First Lesson of Economics, Applied
Thomas Sowell’s first lesson of economics is that scarcity means you cannot have everything. The Cantillon Effect adds a second lesson: the distribution of new money is itself a policy choice, even when it is not an explicit one.
Every time the government or central bank decides to create new money, it makes an implicit decision about who receives it first. If the money enters through the banking system, the banks and their largest customers get the benefit. If it enters through government spending, the contractors and suppliers who win the government contracts get the benefit. If it enters through direct transfers to households - as during the COVID stimulus - the households get the benefit, but only if the transfers arrive before prices adjust.
The distribution of the benefit depends on the pipeline, not the intention. The Federal Reserve did not intend to make renters poorer when it created $3.5 trillion in new money during 2020. But the effect was the same as if it had. The money entered through the financial system. The financial system’s customers got it first. Everyone else caught up later, after prices had already risen.
This is where the policy debate gets uncomfortable. The people who argue that “inflation is a tax on the poor” are half right. Inflation does hurt the poor disproportionately because they hold more cash, borrow at higher rates, and do not own assets that rise with inflation. But the mechanism is not automatic inflation. The mechanism is the Cantillon Effect - the specific pipeline through which new money enters the economy, which determines who benefits and who loses.
A monetary policy that created new money and distributed it evenly - through direct household transfers - would have a very different distributional effect than one that distributed it through the banking system. The total amount of money created could be the same. The inflation rate could be the same. But the winners and losers would be completely different.
This is the question nobody asks. Not “how much money should we create?” but “where should it enter?” The first question dominates every monetary policy debate. The second question is rarely even acknowledged.
What This Means for the Inflation Debate
The Cantillon Effect is not an argument for or against any particular monetary policy. It is a framework for understanding who the policy actually helps.
When you hear a politician or pundit say that a certain policy will cause inflation, ask them: who gets the new money first? Because the answer to that question tells you more about who benefits than any aggregate inflation figure ever could.
When you hear a central banker say that QE is necessary to stabilize the economy, ask: stabilize whose economy? Because the financial system and Main Street are not the same thing, and stabilizing one does not automatically stabilize the other.
And the next time you hear someone blame “greedy corporations” or “price gougers” for rising prices, consider whether the real cause might be simpler: there is more money in the economy, and it is running ahead of the people who would benefit from receiving it at the same time.
The Cantillon Effect is two and a half centuries old. But it explains more about modern inflation - who wins, who loses, and why the debate never seems to ask the right questions - than most of what you will read in the financial press today, let alone the mainstram media..
That is because the most important economic question about any policy is not “what is the intention?” It is “who gets there first?”
Next: Public Choice Theory → Why governments do what they do, and why it is not what they say.