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. |
For example, suppose that the U.S. stock market was to
crash, threatening to undermine consumer confidence. Would this inevitably
mean a disastrous recession? Think of it this way: When consumer confidence
declines, it is as if, for some reason, the typical member of the co-op
had become less willing to go out, more anxious to accumulate coupons for
a rainy day. This could indeed lead to a slump--but need not if the management
were alert and responded by simply issuing more coupons. That is exactly
what our head coupon issuer Alan Greenspan did in 1987--and what I believe
he would do again. So as I said at the beginning, the story of the baby-sitting
co-op helps me to remain calm in the face of crisis. |
Or suppose Greenspan did not respond quickly enough and
that the economy did indeed fall into a slump. Don't panic. Even if the
head coupon issuer has fallen temporarily behind the curve, he can still
ordinarily turn the situation around by issuing more coupons--that is,
with a vigorous monetary expansion like the ones that ended the recessions
of 1981-82 and 1990-91. So as I said, the story of the baby-sitting co-op
helps me remain hopeful in times of depression. |
Above all, the story of the co-op tells you that economic
slumps are not punishments for our sins, pains that we are fated to suffer.
The Capitol Hill co-op did not get into trouble because its members were
bad, inefficient baby sitters; its troubles did not reveal the fundamental
flaws of "Capitol Hill values" or "crony baby-sittingism." It had a technical
problem--too many people chasing too little scrip--which could be, and
was, solved with a little clear thinking. And so, as I said, the co-op's
story helps me to resist the pull of fatalism and pessimism. |
But if it's all so easy, how can a large part of the
world be in the mess it's in? How, for example, can Japan be stuck in a
seemingly intractable slump--one that it does not seem able to get out
of simply by printing coupons? Well, if we extend the co-op's story a little
bit, it is not hard to generate something that looks a lot like Japan's
problems--and to see the outline of a solution. |
First, we have to imagine a co-op the members of which
realized there was an unnecessary inconvenience in their system. There
would be occasions when a couple found itself needing to go out several
times in a row, which would cause it to run out of coupons--and therefore
be unable to get its babies sat--even though it was entirely willing to
do lots of compensatory baby-sitting at a later date. To resolve this problem,
the co-op allowed members to
borrow extra coupons from the management
in times of need--repaying with the coupons received from subsequent baby-sitting
(see note 1) To prevent members from abusing this
privilege, however, the management would probably need to impose some penalty--requiring
borrowers to repay more coupons than they borrowed. |
Under this new system, couples would hold smaller reserves
of coupons than before, knowing they could borrow more if necessary. The
co-op's officers would, however, have acquired a new tool of management.
If members of the co-op reported it was easy to find baby sitters and hard
to find opportunities to baby-sit, the terms under which members could
borrow coupons could be made more favorable, encouraging more people to
go out. If baby sitters were scarce, those terms could be worsened, encouraging
people to go out less. In other words, this more sophisticated co-op
would have a central bank that could stimulate a depressed economy by reducing
the interest rate and cool off an overheated one by raising it. |
But what about Japan--where the economy slumps despite
interest rates having fallen almost to zero? Has the baby-sitting metaphor
finally found a situation it cannot handle? Well, imagine there is a seasonality
in the demand and supply for baby-sitting. During the winter, when it's
cold and dark, couples don't want to go out much but are quite willing
to stay home and look after other people's children--thereby accumulating
points they can use on balmy summer evenings. If this seasonality isn't
too pronounced, the co-op could still keep the supply and demand for baby-sitting
in balance by charging low interest rates in the winter months, higher
rates in the summer. But suppose that the seasonality is very strong indeed.
Then in the winter, even at a zero interest rate, there will be more couples
seeking opportunities to baby-sit than there are couples going out, which
will mean that baby-sitting opportunities will be hard to find, which means
that couples seeking to build up reserves for summer fun will be even less
willing to use those points in the winter, meaning even fewer opportunities
to baby-sit ... and the co-op will slide into a recession even at a zero
interest rate. |
And now is the winter of Japan's discontent. Perhaps
because of its aging population, perhaps also because of a general nervousness
about the future, the Japanese public does not appear willing to spend
enough to use the economy's capacity, even at a zero interest rate. Japan,
say the economists, has fallen into the dread "liquidity trap." Well, what
you have just read is an infantile explanation of what a liquidity trap
is and how it can happen. And once you understand that this is what has
gone wrong, the answer to Japan's problems is, of course, quite obvious
(see note 2). So the story of the baby-sitting co-op
is not a mere amusement. If people would only take it seriously--if they
could only understand that when great economic issues are at stake, whimsical
parables are not a waste of time but the key to enlightenment--it is a
story that could save the world. |