[gust post by JVW]

Pertinent questions:

Can Notre Dame beat Kentucky (can anyone)?
Is Tom Izzo the best tournament coach of his time?
Will Gonzaga’s size give Duke fits?
What are the chances that Rick Pitino wears his white first communion suit tomorrow?
Isn’t Wisconsin a fun team to root for?

Discuss.

– JVW

Krugman brings up this babysitting co-op example all the time and referred to it again on March 25:

And by the way: if you want a simple, homely example of how demand shocks can happen and cause unemployment, there is the baby-sitting coop.

The link goes to a famous, and ridiculously flawed, Krugman article in Slate from 1998. Since Krugman constantly brings up this babysitting co-op example, I think it’s about time a modern, conservative/libertarian blog not narrowly specializing in economic theory took on this canard. I am at your service!

I’ll let Krugman describe the problem at length, and then I will reveal what he didn’t tell you. Finally, I will ask you if you can figure out the solution — which seems to me to be perfectly obvious.

Here’s 1998 Krugman:

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. At this gloomy moment, when Asia’s woes seem to threaten the world economy as a whole, the lessons of that inspirational tale are more important than ever.

The story is told in an article titled “Monetary Theory and the Great Capitol Hill Baby-Sitting Co-op Crisis.” Joan and Richard Sweeney published it in the Journal of Money, Credit, and Banking in 1978. I’ve used their story in two of my books, Peddling Prosperity and The Accidental Theorist, but it bears retelling, this time with an Asian twist.

The Sweeneys tell the story of—you guessed it—a 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 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. Eventually, of course, the co-op issued too much scrip, leading to different problems …

If you think this is a silly story, a waste of your time, shame on you. What the Capitol Hill Baby-Sitting Co-op experienced was a real recession. Its story tells you more about what economic slumps are and why they happen than you will get from reading 500 pages of William Greider and a year’s worth of Wall Street Journal editorials. And if you are willing to really wrap your mind around the co-op’s story, to play with it and draw out its implications, it will change the way you think about the world.

Oh, Good Lord. Krugman’s solution: print more money and everything is fine!!!!!

Except, not so much. That last sentence of Krugman’s penultimate paragraph (the ellipsis is in the original) should cause you to raise an eyebrow. So printing more scrip worked, but then there was too much . . . leading to “different problems” . . .

. . . which we won’t discuss, but will simply allude to with an ellipsis . . . and then we’ll move on to elaborate about how great printing money is. Woo-hoo! Printing money!

If you’re thinking: “maybe someone should Google the original article to find out what these mysterious ‘problems’ were that were caused by too much scrip” . . . then I’m one step ahead of you. Here is the article (.pdf), and here is what happened:

Whatever the cause, the golden age lasted only a couple of years. (Golden ages are like that.) Maybe morals deteriorated-or perhaps the scrip was again out of whack. Now the problem was that more people wanted to go out than to sit.

In fact, the ten-scrip reform has moved the co-op from a position where there was too little scrip and the amount was shrinking, to a position where there was just about the right amount of scrip but the amount was growing. After a while, it naturally followed there was too much scrip and more people wanted to go out than to sit.

What a shock.

So: it turns out that Krugman’s little money-printing solution was not the ideal solution after all. It ended up leading to inflation and excessive demand (for babysitting services). Who could have guessed?!

Krugman’s description of the co-op’s initial reaction is hilarious, and says so much about how government responds to economic problems.

Let’s remind ourselves what the problem was; too much supply (of babysitting services) and not enough demand. And look at what the co-op did to try to address this problem: “They tried to legislate recovery—passing a rule requiring each couple to go out at least twice a month.”

In other words, faced with low demand . . . they tried to pass a rule ordering demand to increase! You vill go out and consume der babysitting services!

I’m wiping tears from my eyes at how much this reminds me of government.

After listening to an episode of the Tom Woods podcast that briefly alluded to this, I spent a little time Googling some discussion, and (especially because this seems like a very simple problem to solve) I was very amused at some of the bizarre reactions. Here’s an Austrian economist who says we’re not talking about money at all, but barter. (Brian Doherty at Reason.com seems to agree.) And this fellow thinks the problem was “consumer confidence” — and that the members of the co-op simply needed to be rational, put their heads together, and agree to stop hoarding scrip! And here’s a guy (at Forbes, no less! Forbes!) who says: Krugman is exactly right — and that Krugman’s amazing observational skills prove that Bitcoin is doomed. Doomed!

Oh. My. God. Is this really that difficult, folks? Really?

Again: let me remind you what the problem was: too much supply and not enough demand.

Can you imagine a possible solution to this incredibly difficult conundrum?

Please leave your suggestion below in the comments before reading the extended entry — which you can read from the main page by clicking “more.”

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