Richard Cantillon

Richard Cantillon (1680s – May 1734) was dubbed by many as the founder of political economy. The key episode in Cantillon's life was his involvement with John Law and his monetary schemes. Cantillon was opposed to the inflationist theories of Law, but he understood how the schemes worked and what their fatal flaws were. Thus, he was able to create a large fortune from the Mississippi System and South Sea Bubble.

In the aftermath of these financial debacles, Cantillon wrote his famous Essai, his only surviving work. Shortly afterwards, Cantillon was murdered under mysterious conditions. The Essay on Nature of Commerce (Essai sur la Nature du Commerce en General) remained unpublished for more than twenty years. Part one is an analysis of the real economy of the isolated state loosely based on the pre-capitalist economy of his family's heritage, but also entrepreneurship. In part two, Cantillon laid out his pathbreaking analysis of the monetary economy, exposing the great error of mercantilism, that money is wealth. In part three of the Essai, Cantillon addresses the issues of foreign trade, exchange rates, and the role of banks.

Cantillon's contributions were later largely forgotten until a rediscovery by William Stanley Jevons.

Cantillon effects
Cantillon is widely credited as the first to show that changes in the money supply and credit have important impacts on the economy by changing relative prices. He showed that an increase in the supply of money would cause economic expansion, but that ultimately the process would be self-reversing as prices would rise and imports would increase, sending money back out of the economy. Cantillon further showed that monetary inflation does not affect all prices equally or at the same time, but in sequences that depend on the spending behavior of money holders all along the channels of monetary flows. These ideas have been adopted and extended by Knut Wicksell, Ludwig von Mises, and F.A. Hayek and others.

Cantillon effects are the real fundamental changes in resource allocation that result from changing relative prices between the time of the creation of new money and the full adjustment to the increase in supply. For Cantillon, an increase in commodity money, such as silver, would increase employment and prices. It would impose "forced savings" and lower real incomes on those whose income was not changed due to monetary inflation, possibly leading to unemployment or emigration. If the money supply increased due to a balance-of-payments surplus, then the additional money could cause an increase in manufacturing or expansion in whatever the new money holders chose to spend their money on.

In response to the change in relative prices, more resources are allocated to long-term capital goods. Unlike other aspects of the self-adjusting market process, such as money, land, labor, and short-term or intermediate capital goods, these resources become suspended or fixed in long-term fixed capital goods. These resources become formulated in a highly specific capital good that may not be well suited to the alternative production processes of the postadjustment economy. As a result, all of the adjustment in these long-term fixed capital goods must come from a change in price and this will entail large losses and possible bankruptcies by the owners of these capital goods. To the extent that these types of adjustments are widespread, they pose a threat to capital markets and the banking system.