MBA 101: Babysitting The Economy

Nov. 30, 2008
I was doing some macroeconomics research over the Thanksgiving break and came across this simple, clear explanation about the mechanics of recession (especially relevant now, but written back in the late 1990s when he was a columnist for the online ...

I was doing some macroeconomics research over the Thanksgiving break and came across this simple, clear explanation about the mechanics of recession (especially relevant now, but written back in the late 1990s when he was a columnist for the online magazine

In the story, distilled from the original authors version (Joan and Todd Sweeney) Nobel-winning economist Krugman tells of this couple's adventures in babysitting (insert liberal economist/nanny state joke here).

Here's the relevant passage:

The Sweeneys tell the story ofyou guessed ita baby-sitting co-op, one to which they belonged in the early 1970s. Such co-ops are quite common: 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 scrippieces 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 reliableand these young professionals certainly werewhat 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 reservethen 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.

Eventually, Krugman says, the co-op consisted of couples sitting glumly at home, unwilling to go out until they had more coupons and unable to earn more coupons because nobody else in the co-op was going out either.

"In short, the co-op had managed itself into a recession," he says.

Since this was D.C. after all (and since many of the group's members were lawyers), the co-op first attempted a regulatory fix -- requiring each member to go out twice a month. This "fix" predictably made the couples even less happy for some obvious reasons. However, the few economists in the group (probably the Sweeneys) eventually convinced the group that the problem was essentially monetary, and to solve the crisis the group issued more babysitting coupons into circulation. With larger reserves, couples became more willing to go out, which led to more opportunities to baby sit, which made more couples willing to go out, and so on. Voila -- a virtuous cycle.

Then, predictably, the co-op issued too many coupons, which leads to an entirely different economic dysfunction -- and a story for another day.

a prescription from Dr. Krugman to fix what ails us.>>

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