Monetary Policy and the Price of Privilege

An original article based on the monetary theory of Ludwig von Mises and Murray N. Rothbard, set against contemporary analyses of money creation and of the distributional effects of monetary policy.

The salary is paid as usual, but it no longer goes as far as it did. The savings are still in the account, but they buy less. The mortgage gets cheaper, but the house gets more expensive; later, the monthly payment rises too. For the middle class and for working people, monetary policy is not an abstract debate about interest rates. It is part of the distance between the effort they put in and the life they are able to secure.

Who gets the new money first?

A. More money does not automatically mean more wealth

The starting point of Austrian analysis is simple, yet easily forgotten: creating more money is not the same as creating more real resources.

An economy grows richer when it has better tools, more productive knowledge, more effective organization, more of the goods and services that people want. An increase in money balances does not, by itself, create more houses, electricity, medicines, or hours of skilled labor.

In The Theory of Money and Credit, Ludwig von Mises places money within the general theory of value: its purchasing power depends on its supply and on people’s demand to hold it. In Human Action he develops further the thesis that monetary changes are not a mere change in the scale in which prices are expressed. They alter the conditions under which particular people buy, sell, save, and invest.¹

A note on terminology is needed here. Murray N. Rothbard often uses “inflation” for an increase in the money supply beyond any increase in the stock of specie. In today’s public debate, the same word usually denotes a rise in a consumer price index. To avoid confusion, this article distinguishes monetary expansion from price inflation.

The distinction matters. Prices can rise because supply is restricted, because of an energy crisis, or because transport is disrupted. Conversely, monetary expansion can for a time coexist with restrained consumer prices, if productivity or the demand to hold money is rising. The crucial question is not only what happened to the average price index, but what would have happened without the particular monetary change — and who was affected first.

B. The Cantillon effect: the uneven path of new money

The Cantillon effect, named after Richard Cantillon, describes a fundamental asymmetry: new money does not reach everyone at the same time, nor does it raise all prices by the same percentage.

It enters at particular points and spreads through particular transactions.

If, for example, new credit is first directed into the housing market, the first borrowers can outbid others for houses and land. The sellers receive the new money and spend it elsewhere. The additional demand is passed on to builders, suppliers, and the workers of the industries concerned. Prices and incomes change successively, not in step.

The wage earner who receives neither a raise nor new credit may face higher housing costs before his pay changes. The person who already owns property is in a different position from the person trying to put together a down payment.

This is the central point of the analysis of Ludwig von Mises and Murray N. Rothbard: a monetary change is also a change in the distribution of purchasing power. In Man, Economy, and State, Murray N. Rothbard explains that early recipients can spend before all prices have adjusted, while later recipients may face higher prices before their own receipts rise.²

This does not mean that every rich person gains and every poor person loses. Nor does it mean that whoever takes out a loan acquires free wealth: he acquires, at the same time, an obligation to repay. A worker in an expanding industry may benefit early; a well-off holder of long-term bonds may be seriously harmed.

The Cantillon effect is not a class automatism. It is a mechanism that requires us to examine where the money enters, the sequence of spending, and the changes in relative prices.

C. How money is created today

In The Mystery of Banking, Murray N. Rothbard explains that money is not limited to banknotes. Bank deposits used for payments are crucial to understanding monetary and credit expansion.³

Modern banking, however, needs to be described without mechanical oversimplification. As the Bank of England explains, when a commercial bank makes a loan, it usually creates at the same time a deposit in the borrower’s account. It does not simply transfer some pre-existing sum from a saver’s account to the borrower’s (the bank creates a new deposit by a book entry, without first having to deduct the same amount from another depositor’s account). This does not mean an unlimited capacity to lend: banks are constrained by their capital, liquidity, funding costs, credit risk, loan demand, and the regulatory framework.⁴

Likewise, quantitative easing is not simply “free money for the banks.” The central bank buys securities by creating reserves; the seller hands over one asset and acquires another. The significance of the operation lies in the change it brings to liquidity, yields, valuations, and the incentives to rebalance portfolios.⁵

Nor is an increase in reserves converted automatically, through a fixed multiplier, into a corresponding increase in loans.

These clarifications do not weaken Rothbard’s question. They make it more precise: who obtains more favorable financing terms, which assets appreciate, and who is left outside this process?

D. The real wage and the ability to protect oneself against monetary instability

For the worker, what matters is not only the figure on the payslip. What matters is what it can buy.

If the wage rises by 4%, but the cost of the basket a household actually buys rises by 8%, the real purchasing power of the wage falls by about 3.7%. The nominal increase coexists with a real loss.

The pressure becomes sharper when a large part of income goes on food, energy, and housing. These expenses cannot be cut as easily as a trip or a purchase that can be postponed. Moreover, a person with a small financial cushion does not have the same means of diversifying his assets, of obtaining advice, or of waiting for better conditions.

The ECB, in its analysis of the recent inflation surge, recognizes that poorer households usually hold a larger part of their wealth in cash and deposits, and are affected differently because of the composition of their consumption and of their balance sheets.⁶

Here lies an often neglected dimension of social inequality: it is not only incomes that differ; so does the ability to defend oneself against monetary instability.

The well-off can change the composition of their assets. The low-paid often need to keep liquidity for the next bill. They are not less prudent; they have narrower margins of choice.

E. Housing: when cheap credit meets limited supply

Lower interest rates can reduce the payment on a loan and make some investments viable. They do not, however, automatically increase the number of homes.

When the supply of housing responds slowly — because of limited land, permits, infrastructure, or construction time — easier financing can translate into higher purchase prices. The prospective buyer has access to a larger loan, but competes with other buyers who have acquired the same capacity.

The rise in price benefits the existing owner as a holder of property. It is not, however, automatically an improvement for the young worker who wants to buy a first home. He may need a larger down payment and higher total debt for the same house. Yet property owners, too, can be harmed when credit expansion inflates purchase prices and a fall in values or a rise in borrowing costs follows, especially if they carry high variable-rate debt.

So if interest rates later rise, a second pressure appears: more expensive servicing of variable-rate loans, and more expensive refinancing when a fixed-rate period expires.

Monetary policy is not, of course, to blame for every increase in rents or house prices. Supply, taxation, demographics, and local demand matter in their own right. The careful position is that credit can amplify these pressures, especially where the real production of housing cannot keep up.

F. Why saving matters

For the middle class, savings are stored-up working time: the down payment on a house, the capital of a small business, security against unemployment, independence in old age.

If a deposit yields 2% while the price level rises by 6%, its real return is about minus 3.8%, before tax on the interest. The account balance grows, but the ability to buy goods in the future shrinks.

For Ludwig von Mises and Murray N. Rothbard, saving also has a broader function: it makes possible investment in processes of production that pay off later. Real saving is not merely a book entry; it is bound up with releasing real resources from present consumption for other uses.

This does not mean that inflation harms all people of small and middle means equally. A debtor with a long-term fixed-rate loan may benefit from unexpected inflation, since the real value of his nominal obligation falls. But his everyday position also depends on whether his income keeps pace. The fall in the real value of the debt does not, by itself, pay the higher grocery bill.

A related ECB study of 2021–2022 found exactly this heterogeneity: large losses for many retirees holding nominal assets, but gains for some younger, heavily indebted households.⁷

G. From cheap credit to costly correction

Austrian business cycle theory adds a second layer to the analysis: what changes is not only who can spend, but also what appears profitable to produce.

In Ludwig von Mises’ Human Action and Murray N. Rothbard’s Man, Economy, and State, the rate of interest links decisions about present consumption with decisions about future production. When a fall in the interest rate reflects increased voluntary saving, the lengthening of processes of production rests on a real change in the availability of resources.

When, on the contrary, credit expansion pushes interest rates below the level that would have formed without it, entrepreneurs may take easy financing as a sign that more real savings are available. They start projects that look profitable on the new terms, but not all of them can be completed, or run at a profit, once costs, demand, or financing change.⁸

The damage is then not confined to investors’ balance sheets. A worker may have moved house for a job that disappears. A small business may have bought equipment for orders that never come. A family may have taken on long-term obligations on the strength of temporary incomes.

The apparent (false) prosperity becomes socially painful when people organize real lives around unsustainable expectations.

Precision is required, however: low interest rates do not, by themselves, prove an artificial boom. They can reflect high saving, weak investment demand, or changes in expectations. An Austrian interpretation of a particular historical cycle needs documentation of credit flows and of distortions in production; a glance at the policy rate is not enough.

It is also a theoretical approach disputed by other schools, not a universally accepted explanation of every recession.

H. The necessary objection: can monetary easing help working people?

Yes. Serious criticism must acknowledge it.

In an economy with unemployment, credit dysfunction, and collapsing demand, monetary easing can support employment and lower the cost of servicing debt. For someone who finds a job, that benefit may far exceed the interest lost on a small deposit.

Research by Michele Lenza and Jiri Slacalek on the euro area’s asset purchase program estimated a reduction in income inequality, mainly by boosting the employment of poorer households, and a small effect on net-wealth inequality.⁹

This does not refute the non-neutrality of money. It shows that different channels can work in opposite directions. Rising share prices may favor those who hold shares, while rising employment may benefit most those who previously had no work.

The claim that “every monetary easing always increases inequality” is therefore an exaggeration. The stronger argument is different: no monetary intervention should be judged only by the average growth rate or by an index of inequality, without examining who benefits, who bears the burden, the time horizon, and the risks created.

Likewise, monetary tightening may be necessary to stabilize prices, but it carries a real transitional cost. Protecting purchasing power does not require us to deny the pressure that higher interest rates put on workers and small businesses.

I. Why a system of privilege is not a free market

The Cantillon effect and cronyism are not synonyms. Uneven diffusion of new money can occur without bribery or political favor. Cronyism begins when institutional rules are used to protect particular interests selectively.

In the free market, as Ludwig von Mises and Murray N. Rothbard define it, a business earns revenue by persuading customers who are free not to buy its products or services. Profit is not guaranteed, and loss is not automatically shifted onto third parties.

Under a system of political privilege, or cronyism, access to power can secure financing on privileged terms, state guarantees, the exclusion of competitors, or the rescue of failed investments. Then the very criterion of success changes.

The decisive distinction is not between “big” and “small” business. It is between a business that survives because it creates value and a business that survives because it can pass the cost of its failure on to others.

The expectation of a bailout can encourage excessive risk-taking. An investor who expects to keep the gains but avoid part of the losses works under different incentives from the small entrepreneur who risks his personal savings.

A distinction is needed here too: temporary provision of liquidity against adequate collateral to a solvent institution is not the same as bailing out the shareholders of an insolvent firm. Protecting the payment system does not imply that every owner, management, and creditor must be protected from every loss.

When, however, private loss is turned into a politically secured claim on everyone else, something deeper than economic efficiency is eroded: trust in the rules.

The worker is asked to accept discipline. The small entrepreneur is asked to withstand competition. The politically connected investor asks for an exemption.

This asymmetry is not the principle of the free market. It is its negation.

There is no need, of course, to attribute every social hardship to cronyism, or to regard every private transaction as infallible. The specific argument is stronger: political protection from competition and from losses rewards access rather than productivity, and burdens those who have no comparable access.

The defense of the market, therefore, is not a defense of every existing business. It is a defense of competition — even against the businesses that would like to be rid of it.

J. A policy for the individuals who work and save

The practical value of this analysis does not lie in the promise of an economy without uncertainty. It lies in the demand for institutions that do not turn the uncertainty of the powerful into a compulsory bill for everyone else.

Such a direction presupposes:

A clear distinction between monetary stability and the rescue of investors. The functioning of payments is not the same thing as preserving every bank, shareholder, or management.
Transparency in guarantees and subsidies. Support must not be hidden inside impenetrable balance sheets or privileged terms of access.
Losses borne by those who took the risk, with predictable resolution rules and protection of contractual rights.
Removal of barriers to real production, especially in housing, energy, and the entry of new firms. Cheaper credit is no substitute for unhindered production and supply.
Protection of households’ long-term planning, instead of making it depend on successive surprises in inflation, interest rates, and emergency bailouts.

Murray N. Rothbard goes much further, defending commodity money (gold and silver) and full reserves against demand liabilities (no creation of money out of thin air). Mises gives a central place to sound money and to the limits on credit expansion, without the two men’s positions on banking being identical in every detail. These institutional proposals need separate assessment; recognizing the Cantillon effect does not by itself prove every proposed monetary reform.

The fundamental lesson, however, remains.

Social progress requires that the person who works be able to plan, that the person who saves be able to preserve real purchasing power, and that the person who starts a business be able to compete without needing a political shepherd and protector.

An economy of opportunity rewards the creation of value. An economy of privilege rewards access to power.

Money serves society when it facilitates cooperation among those who produce. It undermines society when the rules of its creation and distribution allow some to shift onto others, systematically, the cost of their own choices. For the middle class and for working people, this is no secondary institutional detail. It is the difference between the prospect of independence and the constant effort to keep up with prices, debts, and privileges that run faster than their wages.

A society does not become fairer by making it easier for the already powerful to obtain financing and harder for everyone else to acquire real property. Nor does it become richer because book valuations rise faster than its productive capacity.

The economy of freedom allows a person to get ahead by serving others. The economy of privilege teaches him that he gets ahead by securing protection from them.

That is the essence of the distinction between the market and cronyism. And for the middle class and for working people, it is the difference between a life in which work and saving open doors and a life in which wages forever chase prices, while the politically protected keep their head start.

Praxeologos

Sources and documentation

Ludwig von Mises, The Theory of Money and Credit, especially the parts on the value of money and on the relation between money and banking; and Human Action, ch. XVII, “Indirect Exchange,” and ch. XX, “Interest, Credit Expansion, and the Trade Cycle.” References are to chapters and parts, to avoid differences in pagination between editions. Human Action online: https://mises.org/online-book/human-action
Murray N. Rothbard, Man, Economy, and State, ch. 11 and ch. 12, section 11, “Binary Intervention: Inflation and Business Cycles” (https://mises.org/online-book/man-economy-and-state-power-and-market/12-economics-violent-intervention-market/11-binary-intervention-inflation-and-business-cycles), especially the analysis of the successive diffusion of new money and of its temporary and permanent redistributive effects. See also Murray N. Rothbard, “Essentials of Money and Inflation,” in The Rothbard Reader, ch. 18 (https://mises.org/online-book/rothbard-reader/chapter-18-essentials-money-and-inflation).
Murray N. Rothbard, The Mystery of Banking, especially the chapters on deposit banking, free banking, and central banking. See in particular ch. VIII, “Free Banking and the Limits on Bank Credit Inflation” (https://mises.org/online-book/mystery-banking/viii-free-banking-and-limits-bank-credit-inflation).
Michael McLeay, Amar Radia and Ryland Thomas, “Money creation in the modern economy,” Bank of England Quarterly Bulletin, 2014 Q1 (https://www.bankofengland.co.uk/quarterly-bulletin/2014/q1/money-creation-in-the-modern-economy). See also Bank of England, “Quantitative easing” (https://www.bankofengland.co.uk/monetary-policy/quantitative-easing).
Quantitative easing is the purchase of bonds or other securities by the central bank with new money that it creates electronically. Its aim is to lower long-term yields and to ease borrowing and spending. It can also raise asset prices, benefiting their holders, without automatically creating new real wealth.
European Central Bank, “The impact of the recent inflation surge across households,” Economic Bulletin, Issue 3/2023 (https://www.ecb.europa.eu/press/economic-bulletin/articles/2023/html/ecb.ebart202303_02~037515ed7d.en.html). It examines consumption baskets, incomes, assets, liabilities, and households’ differing exposure.
European Central Bank, “The unequal impact of the 2021-22 inflation surge on euro area households,” Research Bulletin No. 116, 20 February 2024 (https://www.ecb.europa.eu/press/research-publications/resbull/2024/html/ecb.rb240220~a77abebe0e.en.html). The findings concern that particular episode and the study’s methodology; they are not a universal rule for every inflation.
Ludwig von Mises, Human Action, chs. XIX–XX; Murray N. Rothbard, Man, Economy, and State, chs. 6, 8 and 12. The distinction between real saving and credit expansion is the core of the Austrian interpretation presented here. It is not the same as the claim that every new credit or every low interest rate necessarily implies unsustainable investment.
Michele Lenza and Jiri Slacalek, “Quantitative easing did not increase inequality in the euro area,” ECB Research Bulletin No. 54, 29 January 2019 (https://www.ecb.europa.eu/press/research-publications/resbull/2019/html/ecb.rb190129.en.html). The analysis combines estimated macroeconomic effects with household microdata. See also ECB, “Monetary policy and inequality,” Economic Bulletin, Issue 2/2021 (https://www.ecb.europa.eu/press/economic-bulletin/articles/2021/html/ecb.ebart202102_01~1773181511.en.html), on the distinction between the interest-rate, asset-price, and employment channels.