Following on yesterday's revelation that ten accounts at Silicon Valley Bank had an aggregate $13.3 billion on deposit.*
This article is going on five years old but rings truer today than when it was written.
From the Foundation for Economic Education, October 28, 2018:
Not to mention actively harming the living standards of low-income earners.
It may come as a surprise to you that the United States has been financing a welfare program that takes money from the poor and gives it to the rich.
Inflation as a Policy Tool
If you read a lot of modern macroeconomic literature or major in economics in college, you’ll hear economists talk of the “multiplier effect” of monetary and fiscal stimulus. In times of economic slump, money injection (for monetary policy) or government spending (fiscal policy) greases the wheels of our complex economic machine, bringing unemployment down and output up.
In response to these policy proposals to change the level of unemployment or production, “real” metrics of the economy, Milton Friedman argued that money is “neutral.” In other words, changing the supply of money in the economy to manipulate relative price levels doesn’t actually change anything in the long run. When people realize their money is worth less than before, they adjust their mindset, demanding higher wages for higher prices. After these changes are made, unemployment and production end up in the same place as before.
While Friedman’s argument sheds light on many failed economic policies from the latter half of the 20th century, it doesn’t explain the mechanics behind rising price levels (from inflationary policy) once the newly created money travels through the economy, sector by sector.
Contextualizing the Cantillon Effect
Richard Cantillon first suggested in 1755 that money is not as neutral as we think. He argued that money injection—what we could consider inflationary policies—may not change an economy’s output over the long-term. However, the process of readjustment affects different sectors of the economy differently. This analysis, known as the Cantillon Effect, serves as the foundation for the non-neutrality of money theories.
Cantillon’s original thesis outlines how rising prices affect different sectors at different times and suggests that time difference effectively acts as a taxing mechanism. In other words, the first sectors to receive the newly created money enjoy higher profits as their pay increases, but general costs are still low. On the other hand, the last sectors in which prices rise (where there is more economic friction) face higher costs while still producing at lower prices. Because, as Friedman taught us, the real economic variables are still the same in the long run, the price of inflation is paid for by a “tax” on the sectors with more friction, which subsidizes more time-responsive sectors. In our modern economy, the Cantillon Effect is at play with a stratified socioeconomic impact, favoring investors over wage-earners.
For Example
Let’s say the Fed decides to lower interest rates (by expanding the supply of money in the economy). Soon after the Fed makes its announcement, investors anticipate new earnings from increased investment. In fact, once even a few people get wind of the Fed’s intentions, investors expect prices to rise, whether they rely on algorithms or rumors for their information. Investors flock to the financial markets, hoping to get there first; if they can buy stocks while the prices are still low, they can reap enormous profits once prices rise.
However, the sudden increased demand for stocks in the financial market bids up asset prices, and this happens rapidly. Within minutes—seconds, even—the expected increase in the price level has been factored into the financial markets. The first place where “inflation” is felt is in the financial marketplace.
This means that people who are most invested in the market are the first to benefit from inflation. They see their asset prices increasing, yet the prices in the rest of the economy are still low because this happens seconds after it’s clear the Fed is inflating the money supply....
As noted earlier today in the outro from "The Cantillon Effect and Populism":
There are currently no pure-play pitchfork manufacturers and it has been a long-cherished dream (since 2008!) to fill the void and/or live up to my junior high school personal file description: the instigator was....
