Paul Krugman loves to use the story of the baby-sitting coop told in an article published by Joan and Richard Sweeney in the Journal of Money, Credit, and Banking in 1978 and has repeatedly recycled it, all the while failing to understand that it is a very poor analogy for the American economy and that the lessons he draws from it are false. I have updated and modified it to explain what is actually going on in the U.S. economy as well as to show why Krugman’s proposed solution – print more money – cannot possibly work:
Twenty years ago I read a story that changed my life. I think about that story often; it helps me to stay calm in the face of crisis, to remain hopeful in times of depression, and to resist the pull of fatalism and pessimism….
A group of people (in this case about 150 young couples with congressional connections) agrees to baby-sit for one another, obviating the need for cash payments to adolescents. It’s a mutually beneficial arrangement: A couple that already has children around may find that watching another couple’s kids for an evening is not that much of an additional burden, certainly compared with the benefit of receiving the same service some other evening. But there must be a system for making sure each couple does its fair share.
The Capitol Hill co-op adopted one fairly natural solution. It issued scrip–pieces of paper equivalent to one hour of baby-sitting time. Baby sitters would receive the appropriate number of coupons directly from the baby sittees. This made the system self-enforcing: Over time, each couple would automatically do as much baby-sitting as it received in return. As long as the people were reliable–and these young professionals certainly were–what could go wrong?
Well, it turned out that there was a small technical problem. Think about the coupon holdings of a typical couple. During periods when it had few occasions to go out, a couple would probably try to build up a reserve–then run that reserve down when the occasions arose. There would be an averaging out of these demands. One couple would be going out when another was staying at home. But since many couples would be holding reserves of coupons at any given time, the co-op needed to have a fairly large amount of scrip in circulation.
Now what happened in the Sweeneys’ co-op was that, for complicated reasons involving the collection and use of dues (paid in scrip), the number of coupons in circulation became quite low. As a result, most couples were anxious to add to their reserves by baby-sitting, reluctant to run them down by going out. But one couple’s decision to go out was another’s chance to baby-sit; so it became difficult to earn coupons. Knowing this, couples became even more reluctant to use their reserves except on special occasions, reducing baby-sitting opportunities still further.
In short, the co-op had fallen into a recession.
Since most of the co-op’s members were lawyers, it was difficult to convince them the problem was monetary. They tried to legislate recovery–passing a rule requiring each couple to go out at least twice a month. But eventually the economists prevailed. More coupons were issued, couples became more willing to go out, opportunities to baby-sit multiplied, and everyone was happy.
Later in the article, Krugman goes on to explain how the coop’s “central bank” can manage the coupon supply to prevent couples intent on staying in from accumulating too many coupons and acquire coupons on loan if they found it necessary to go out more often than they’d planned. But what he fails to anticipate is the situation where the coop board has provided lots and lots of coupons to the various couples in anticipation of their future use for an extended period of time. In short, he fails to account for the possibility that the “recession” is not caused by a coupon shortage, but rather by the limits of babysitting demand.
There are three limits to the demand for babysitting coupons, one physical, one practical, and one psychological. The physical limit is that a couple cannot possibly make use of more than seven evenings-worth of coupons per week since that is the maximum number of evenings they can go out and leave the children home. The practical limit is the financial resources the couple has to spend on going out, and the psychological limit is based on the amount of the couple’s desire to actually spend evenings with their children. If, in a given time period, any of these three limits are exceeded by the amount of the coupons distributed or loaned out to the couple, the couple will not make use of them regardless of how many more coupons they are given. Therefore, it should be obvious that any decline in the amount of going out that is based on one of these three limits of demand cannot be solved by simply distributing more coupons for babysitting.
In fact, for the coop, the correct policy prescription is to do exactly the reverse of what Krugman is recommending. Not only should more coupons not be distributed, but all coupon distribution should stop so that people can use up the coupons they have. Coupons given out on loan should be either repaid or simply cancelled; more coupons can be distributed once people have used up their existing supply and actually require more babysitting.
Note: the fact that babysitting coupons are less fungible and important to the coop than money is to a national economy means that one cannot concoct an example of the Austrian business cycle utilizing this analogy. The coupon supplier is not causing the problems here; they are exogenous to the coupon supply. But, this invocation of the material and immaterial limits of demand should demonstrate that Krugman’s analogy is not necessarily relevant to the present economic situation, and to the extent that it can be shown that the American consumer has exceeded the limits of his demand, it shows that his conclusions are demonstrably inapplicable.