Acting out the babysitter economy

I'm teaching a class in the economics of intervention. Yesterday I was trying to explain Paul Krugman's example of the babysitting co-op, and how a shortage of scrip led the economy into a recession. What I did was actually handout scrip, semi-randomly to different members of the class. Then I told them they each had a desired cash balance. (To keep things simple, I made it the same for everyone in the class.) If their balance was above that, then they would decide to "go out," and would try to hire a babysitter. If their balance was lower, they would "look for work" and accept babysitting jobs, in order to raise it. We went through several "rounds" of this economy, and students saw their cash balance go up and down, and exchanges occurring.

Then I began to withdraw scrip from the economy. After a couple of more rounds, everyone's cash balance was too low, and no further exchanges took place. We had created a Krugmanian recession, right before their eyes. Then I pumped cash back in, and they saw economic activity resume. Now they had witnessed Krugman's solution first hand as well.

This is an exercise I highly recommend. Even if you think Krugman is wrong in his diagnosis of what is troubling an economy in recession, you should want your students to understand his theory.

And next class, I will introduce price flexibility, and show them how reduced wages for babysitting are an alternate solution to pump priming in getting the economy going again.

And then they will understand that the chief dispute between the defenders of Say's Law and the general glut theorists is an empirical one: what predominates in any real economy, quantity adjustments or price adjustments?

7 comments:

  1. I think there is more to it than just this. Today’s money is not just some tokens out there but every single penny was created along with a debt relationship. When Krugman asks for more money in the economy he is not suggesting to just print them up and hand them out evenly. He either wants to have market interest rates reduced by action of the CB so the private market is seduced to increases its debt load or the government should increase its deficit or both, so by increasing debt he increases the money supply.

    What this means is that not only does he argue that the market cannot sufficiently adapt its prices, but also that it doesn’t add any problems if the money supply is increased in tandem with more debt. This is highly questionable and definitely not answered by the babysitting co-op.

    I am sure you are aware that your credibility in a debt relationship very often depends on the credibility of others, which means if only one party defaults this can cause a chain reaction of defaults, and with this a crash in the money supply.

    Now even if we would admit that the market wasn’t sufficiently flexible in pricing, and that his solution to pump up the money supply would be adequate for this particular problem, at no point does this justify an equivalent increase in debt as well, since this might just build up a debt time bomb which at some point in the future will explode only to implode the money supply again only to again have to resort to another increase of the money supply by a bigger debt time bomb this time…. Finally maybe to arrive at the situation at which Krugman and Summers claim to be in a permanent liquidity trap, which means ZIRP and big deficits forever.

    The “recession” in the babysitting co-op serves no purpose, since there is only on good supplied and no debt ot capital to allocate exists.

    Maybe you can at least advance your experiment by trying to add debt to it in some form.

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    1. The second to last sentence should be:
      "The “recession” in the babysitting co-op serves no purpose, since there is only one good supplied and no debt or capital to allocate exists"

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    2. "When Krugman asks for more money in the economy he is not suggesting to just print them up and hand them out evenly."

      In the babysitting example that is exactly what he suggests.

      "The “recession” in the babysitting co-op serves no purpose..."

      Huh?! Ordinary recessions serve some purpose?

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    3. “In the babysitting example that is exactly what he suggests.“

      Didn’t claim otherwise, did I? In reference to you last paragraph I wanted to add that there is more to it than that and that in the real economy, in contrast to his babysitting co-op, there is also debt created when the money supply is expended, or is it not?

      “Huh?! Ordinary recessions serve some purpose?”

      What is a recession other than a cluster of failing businesses that make losses? Or do you think that “losses” generally don’t serve any purpose?

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  2. "And next class, I will introduce price flexibility, and show them how reduced wages for babysitting are an alternate solution to pump priming in getting the economy going again"

    As soon as you introduce a significant amount of fixed nominal debt in the experiment, you will see that flexible wages will not be a viable alternative solution.

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    1. "As soon as you introduce a significant amount of fixed nominal debt in the experiment, you will see that flexible wages will not be a viable alternative solution."

      Yes, I'm just trying to get the students the idea of the dispute, not sell them on a solution.

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    2. LK, funny that we both bring up debt, although of course with a different understanding of it.

      How do you know that by adapting the money supply to have prices on a certain level, but which today also means necessarily changing the amount of debt, you don’t actually build up/induce a new debt structure that is unsustainable again?

      Also conditions of debt contracts depend on the expectations of people, right? If you as CB take away certain risks (like a falling money supply and hence falling prices) then you will naturally have more such debt contracts that are susceptible to these risks therefore further increasing the actual problem you fear. Do you agree?

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