One of the superb features of [Richard] Cantillon's Essaiis that he was the first, in a pre-Austrian analysis, to understand that money enters the economy as a step-by-step process and hence does not simply increase or raise prices in a homogeneous aggregate.Hence he criticized John Locke's naive quantity theory of money — a theory still basically followed by monetarist and neoclassical economists alike — that holds that a change in the total supply of money causes only a uniform proportionate change in all prices. In short, an increased money supply is not supposed to cause changes in the relative prices of the various goods.
Thus Cantillon asks "in what way and in what proportion the increase of money raises prices?" and answers in an excellent process analysis,
in general an increase of actual money causes in a State a corresponding increase of consumption which gradually brings about increased prices. If the increase of actual money comes from Mines of gold and silver in the State the Owner of these Mines, the Adventurers, the Smelters, the Refiners, and all the other workers will increase their expenses in proportion to their gains. They will consume … more … commodities. They will consequently give employment to several Mechanicks who had not so much to do before and who for the same reason will increase their expenses. All this increase of expense in Meat, Wine, Wool, etc. diminishes the share of the other inhabitants of the State who do not participate at first in the wealth of the Mines in question. The alteration of the Market, or the demand for Meat, Wine, Wool, etc., being more intense than usual, will not fail to raise their prices. These high prices will determine the Farmers to employ more land to produce them in another year; these same Farmers will profit by this rise of prices and will increase the expenditure of their Families like the others. Those then who will suffer from this dearness and increased consumption will be first of all the Landowners, during the term of their Leases, then their Domestic Servants and all the Workmen or fixed Wage-earners who support the families on their wages. All these must diminish their expenditure in proportion to the new consumption … it is thus, approximately, that a considerable increase of Money from the Mines increases consumption.
In short, the early receivers of the new money will increase spending according to their preferences, raising prices in these goods at the expense of a lower standard of living among the late receivers of the new money or among those on fixed incomes who don't receive the new money at all. Furthermore, relative prices will be changed in the course of the general price rise, because the increased spending is "directed more or less to certain kinds of products or merchandise according to the idea of those who acquire the money, [and] market prices will rise more for certain things than for others." Moreover, the overall price rise will not necessarily be proportionate to the increase in the supply of money. Specifically, because those who receive new money will scarcely do so in the same proportion as their previous cash balances, their demands, and hence prices, will not all rise to the same degree. Thus, "in England the price of Meat might be tripled while the price of Corn rises no more than a fourth." Cantillon summed up his insight splendidly, while hinting at the important truth that economic laws are qualitative but not quantitative:
An increase of money circulating in a State always causes there an increase of consumption and a higher standard of expenses. But the dearness caused by this money does not affect equally all the kinds of products and merchandise proportionably to the quantity of money, unless what is added continues in the same circulation as the money before, that is to say unless those who offered in the Market one ounce of silver be the same and only ones who now offer two ounces when the amount of money in circulation is doubled in quantity, and that is hardly ever the case. I conceive that when a large surplus of money is brought into a State the new money gives a new turn to consumption and even a new speed to circulation. But it is not possible to say exactly to what extent.
Not only that, but, as Professor Hebert has pointed out, Cantillon also provided a remarkable proto-Austrian analysis of the different effects of the money going into consumption or investment. If the new funds are spent on consumer goods, then goods will be purchased "according to the inclination of those who acquire the money," so that the prices of those goods will be driven up and relative prices necessarily changed. If, by contrast, the increased money comes first into the hands of lenders, they will increase the supply of credit and temporarily lower the rate of interest, thereby increasing investment.
Repudiating the common superficial view, brought back to economics in the 20th century by John Maynard Keynes, that interest is purely a monetary phenomenon, Cantillon held that the rate of interest is determined by the number and interactions of lenders and borrowers, just as the prices of particular goods are determined by the interaction of buyers and sellers. Thus, Cantillon pointed out that
If the abundance of money in a State comes into the hands of money-lenders it will doubtless bring down the current rate of interest by increasing the number of money-lenders: but if it comes into the hands of those who spend it will have quite the opposite effect and will raise the rate of interest by increasing the number of entrepreneurs who will find activity by this increased spending and who will need to borrow in order to extend their enterprise to every class of customers.
An increased supply of money, therefore, can either lower or raise interest rates temporarily, depending on who receives the new money — lenders or people who will be inspired by their newfound wealth to borrow for new enterprises. In his analysis of expanding credit lowering the rate of interest, furthermore, Cantillon provides the first hints of the later Austrian theory of the business cycle.