Who gets the new money first?
An interactive simulation of the Cantillon effect: how new money, as it spreads gradually through the economy, shifts purchasing power from those who receive it last to those who receive it first.
Praxeologos
When new money is created, it does not reach everyone at once. It enters the economy at particular points, today mainly through the credit expansion of the banks and the central bank’s purchases of securities, and from there it passes gradually from hand to hand. Those who receive it first spend it while prices are still low, and their purchases push prices up. Those who receive it later, or never, already pay higher prices out of an income that has risen too little or not at all. This redistribution is called the Cantillon effect, after Richard Cantillon, who described it in his Essay on the Nature of Trade in General (written around 1730, published in 1755).
Imagine a small economy of five groups of people. From each group we follow one typical person. At first, each of them earns €100 a month and spends all of it, while prices stay the same. They start from the same income on purpose, so that any difference at the end comes only from when the new money reached each of them and how much of it they got. At some point, new money enters the economy.
rise in the income of those who receive the new money first; the later it reaches a group, the smaller the rise
1 = fast, 4 = slow (months from group to group)
Each bar shows how many more or fewer goods the typical person in the group buys this month with their income, compared with before the new money (dashed line: no change; green: gain; red: loss).
How the model works
- At first the typical person in each group earns €100 a month and spends all of it, and prices stay put.
- The new money reaches the first four groups in turn, not all at once: first the banks and their first borrowers, then their suppliers, then employees and last the pensioners.
- The later it arrives, the smaller the rise in income it brings: by then it has been spread over more hands, and wages and pensions rise slowly and usually by less than prices. The banks and first borrowers see their income rise by the percentage you choose, their suppliers by three fifths of it, employees by two fifths and pensioners by one fifth. At 20%, the rises are €20, €12, €8 and €4 a month.
- Savers and people living on an income fixed in euros receive none of the new money.
- Prices follow average spending with a lag of one month: the more people spend new money, the more prices rise. At 20% they end up 8.8% higher, that is, by less than the incomes of the banks and their suppliers but by more than the incomes of employees, pensioners and savers. That is why the first receivers gain and everyone else loses.
- Simplifications: all prices rise together, and the shares of the rise are fixed, chosen for the example. In reality prices do not rise evenly, the order and size of the rises vary from case to case, and new money changes relative prices and the very structure of production, which the model ignores. So winners and losers don’t fall into groups as tidy as these, but the redistribution always happens. The numbers are an example, not a measurement or a forecast.
What it shows
New money does not add a single good to the economy; it only changes who gets the goods that exist. Whoever spends it first buys at the old prices, and what they gain is lost by those who already pay the new prices out of their old income. This is why money is never neutral: every increase in its quantity redistributes wealth and income, and the order in which it reaches people decides who gains and who loses.
“And inflation is, in effect, a race—to see who can get the new money earliest.”
— Murray N. Rothbard, What Has Government Done to Our Money?, II.2 “The Economic Effects of Inflation”
“The first receivers of the new money gain most, and at the expense of the latest receivers.”
— Murray N. Rothbard, What Has Government Done to Our Money?, II.2
In the model, the losers are the employees, the pensioners and, most of all, the savers: those whom the new money reaches late, little or not at all. In reality the burden falls mainly on those whose incomes or claims are fixed in money, and Rothbard lists them:
“Life insurance beneficiaries and annuitants, retired persons living off pensions, landlords with long term leases, bondholders and other creditors, those holding cash, all will bear the brunt of the inflation.”
— Murray N. Rothbard, What Has Government Done to Our Money?, II.2
Glossary terms: Cantillon effect · credit expansion · central bank · inflation · neutral money. See also: What has your euro lost? (with official Eurostat data) · The ECB: When a Committee Sets the Price of Time.