The baby sitting co-op story, examined in light of the original source

by on October 6, 2011 at 12:09 pm in Economics | Permalink

From Matthew Klein, here is a lengthy post about the real story behind the baby-sitting co-op example which has become so popular; think of it as analogous to Coase’s take on the lighthouse in economics.  It is not easy to excerpt, so I recommend that you read the whole thing.  “Money” does still matter, but it shows how many unconsidered aspects of the story there have been, ranging from why the shortage of exchange media developed in the first place (“contractionary fiscal policy”) to why the experts’ inflationary “solution” didn’t work out very well.  For one thing, the system ended up with too much scrip:

The price of baby sitting is constitutionally pegged at one unit of scrip for every one-half hour of baby sitting. Hence, this system of price controls means the inflationary pressure does not drive up the scrip-price of baby sitting, inflation is suppressed, and shortages are found.

[...]

Now there is great difficulty rounding up sitters for all those who want to go out. This is a classic sort of inflationary pressure—too much money (scrip) chasing too few goods (sitters).

Here is a link to the original document on the history of the co-op.

Justin Bassett October 6, 2011 at 12:26 pm

I think a more fundamental problem is treating a half-hour of babysitting at noon as equivalent to a half-hour of babysitting at 7pm. Try hiring a babysitter to care for your child for an hour during the day, and then try hiring one to to watch your kid for an hour on date night. The prices are not the same at all – daytime care is far higher!

During the summer, however, the price difference is much smaller, I think because teenagers aren’t in school and increase the labor supply.

david October 6, 2011 at 12:27 pm

The article recommends expansionary deficit-funded fiscal policy! The horror, the horror.

I wonder how to merge it with its other conclusion of expert incapability.

Silas Barta October 6, 2011 at 12:35 pm

That’s the criticism that laypersons have been leveling at it for some time: why not just let the price of babysitting time adjust? If people are “too willing” to provide babysitting services, that’s a _good_ thing, and should lead to lower prices for that service.

Indeed, if you go up to a typical intelligent person who is untrained in economics, and present them with the supposed “problem”, you will find that they pretty quickly identify the possibility of letting the price of a coupon change.

I think a more fruitful venue of research would be to inquire into the IQ level of the participants, and what might have caused it to be too low to find this solution.

david October 6, 2011 at 12:39 pm

Price stickiness is an empirical phenomenon, though.

Even Keynes himself pointed out that “letting the prices change” is a perfectly fine solution – in a socialized community where wages and prices are set by degree. We don’t live in such a community. The baby-sitting co-op could have done so, perhaps, but we can’t.

Assuming away the constraint is like solving flight by assuming away gravity. Congratulations, your theory now allows flight. Too bad gravity still exists.

Wonks Anonymous October 6, 2011 at 12:50 pm

Prices were less sticky in the 1920-1921 recession. We should empirically investigate the causes of stickiness.

david October 6, 2011 at 1:04 pm

It’s all about the expectations, I daresay.

Will October 7, 2011 at 12:43 am

Indeed we should. Debt overhang may be a factor?

Silas Barta October 6, 2011 at 1:04 pm

You honestly think that prices are *less* sticky in the generally economy than they could have been in the tiny baby-sitting co-op?

Yes, prices are a little sticky, but you need a *lot* more stickiness to invalidate this solution.

david October 6, 2011 at 1:09 pm

You miss the point of invoking the baby-sitting co-op, which is to illuminate interesting concept about the general economy. The baby-sitting co-op has fewer constraints and thus many solutions. But you need to consider only the ones applicable to the general economy, or the point is lost.

Governments can influence the supply of money. Governments cannot order a general deflation or inflation of prices, at least not since the 70s.

Silas Barta October 6, 2011 at 1:17 pm

@david: On what planet does the baby-sitting co-op have fewer constraints? It has two types of goods and <1000 people. The general economy has a lot more goods and people, and does not adhere to price controls. Whatever inflexibility prevented the layman's solution in the co-op is much less of a factor in the general economy.

david October 6, 2011 at 1:27 pm

It has fewer constraints because its ‘policymakers’ – the secretaries and rulemarkers of the co-op – can do more by fiat relative to the size of the economy they are manipulating; because there are so few goods and individuals, adjusting the individual price of goods is easy. There is only one good! And its price was set by fiat in the first place.

But you cannot do that for the wider economy. There are rational individual reasons for price rigidity that are difficult to remove. People talk up minimum wages but these are binding for only a tiny proportion of the labour force; for everyone else, rational decisions by managers and so on over morale concerns are more pressing. Governments cannot make these go away. So the wider economy is more inflexible for the policymaker, not less. Your instruments are still limited to your ‘scrip’, but the economy is so much bigger.

Silas Barta October 6, 2011 at 1:43 pm

We’re talking about price flexibility in the markets here, as that is the supposed impediment to solving the problem through letting prices adjust — remember???

And yes, in the general economy is MUCH easier to bid or ask a higher or lower price for something — including baby-sitting services.

So, the only challenge this experiment poses for anti-Keynesians is, “Could the recession be caused by the inability of people to trade goods at lower dollar prices?” And as far as I can tell, they’re much more capable of doing that in the economy than in the co-op.

david October 6, 2011 at 1:45 pm

Is your response to the problem of price stickiness really “pfft price stickiness isn’t a problem”?

May I suggest you consult the vast New Keynesian literature on reasons for price rigidity? And why people might, for rational and profit-maximizing reasons, not adjust prices downwards during a recession?

Silas Barta October 6, 2011 at 1:48 pm

No, david, my response is, “Damn … these morons could have solved their problem just by *letting* coupon price adjust. The presence of price controls is not a problem in the general economy, so it’s unclear how this proves the need to print more money to solve the non-existent problem of price controls.”

Tell me: why can’t we just get out of the recessing by letting prices fall, as they could have in the co-op experiment? If you say people have a stubborn desire to refuse to trade at different (real) prices, then money injection only works to the extent that you can keep people in a state of ignorance (“asymmetric information”) about the real value of their money … which is supposed to be a bad thing, right?

david October 6, 2011 at 1:54 pm

Nope. Money injection works based on expectations and people must know that it is happening.

I reiterate that price stickiness is a phenomenon that exists despite the absence of prevalent wage or price controls. You could, of course, sit around and wait for nominal deflation to occur. But why wait?

I think you are working off an old Keynesian view of money illusion, but money illusion is not necessary for price rigidity – monopolistic competition plus menu costs is enough, for instance; Greg Mankiw was a prominent author in that.

Silas Barta October 6, 2011 at 2:33 pm

Wait, I thought *you* were going off the “money illusion” assumption. If people *don’t* have money illusion, then how in the heck does increasing prices via printing money get people to accept low enough real wages, when they know how much the inflation has increased prices??? How does it speed anything up, relative to letting nominal prices fall?

Personall, I prefer nominal prices to fall anyway so as to reward those who think ahead and therefore incentivizing good behavior rather than meth-addled bubbly animal spirit behavior, but to each his own, right?

david October 6, 2011 at 2:37 pm

What part of “there are rational individual reasons for price rigidity” did you not understand?

It speeds up the adjustment of real prices and quantities, of course.

Silas Barta October 6, 2011 at 2:41 pm

Okay, and those rational reasons would apply just the same to the prices you try to trick people into accepting via monetary policy. What’s your point?

david October 6, 2011 at 2:44 pm

Nope. There are only two ways by which a general decline in the real price of goods can be achieved: a decline in nominal prices carried out by every individual in the economy, or a devaluation of currency by the central bank. The reasons for which people resist adjusting nominal prices (namely, that the benefits of doing so fall largely on other people) are irrelevant in the latter case.

Silas Barta October 6, 2011 at 2:51 pm

But if, as you seem to be claiming now, people *don’t* have money illusion, then the situations are still the same, becase in the latter case, for one to accept the debased currency as if nothing had changed (rather than keeping one’s real price the same), would give the benefits to *other* people just the same.\

Also, injecting money does not spread through the economy uniformly or instantly, nor do people have access to how much is being added and what they need their prices to adust to in order to avoid being Cantillon’d.

david October 6, 2011 at 3:00 pm

Nope.

Think about it like this: devaluation is a coordination problem. If nobody does it, prices are generally too high and we have a recession. If only you do it, then you’re a sucker selling your goods or labor at lower prices whilst still having to pay everyone else high prices for their stuff. Insert monopolistic competition and a little adjustment costs and this is wholly rational behavior.

Note, interestingly, that the rigidity is only in one direction: in the other, there is no need for coordination, since you benefit from the socially beneficial course of action.

The central bank has a unique lever that avoids this particular coordination problem, since it can alter real prices without requiring coordinated adjustment.

Silas Barta October 6, 2011 at 3:05 pm

If only you do it, then you’re a sucker selling your goods or labor at lower prices whilst still having to pay everyone else high prices for their stuff.

Bzzt. No, the benefit is that I actually get an income while others sit around with their wagners in their hands saying, “huh, what a dummy … he’s not smart like us, who sell nothing”.

david October 6, 2011 at 3:14 pm

No; your real income declines. This is a general equilibrium point, not a partial equilibrium one. Your lower prices only drive out your some of your competition, but most of the economy is not competing with you – the economy has more than one good!

Thus the “others” sit and continue to sell at their previous prices and quantities and this is profit-maximizing for them, whereas you sell at a lower price, higher quantity, but at a non-maximal level of profit (possibly negative).

Silas Barta October 6, 2011 at 3:54 pm

Wait, wait, I thought the problem was that they *aren’t* selling at their current prices? Or does the truth just shift around based on what you need to be true at that particular stage in the argument?

Also, could you expand out what you mean by general vs. partial equilibrium so as to make the dynamics you’re referring to more explicit?

david October 6, 2011 at 4:15 pm

No, see, there is a shock which makes existing prices “wrong”, but it can also be the case that not adjusting in response to this shock is individually rational but socially costly in the aggregate.

I’m not going to walk you through EC20. Here, have one summary from N. Gregory Mankiw himself. A paper (warning: PDF).

Silas Barta October 6, 2011 at 4:53 pm

Fine, I won’t walk you through why some income is better than no income, so printing money and giving it away to failed banks doesn’t actually produce a font of prosperity.

David Wright October 6, 2011 at 1:14 pm

Sometimes one hears explanations of Keynsian recessions based on liquidity preference (everyone decides he wants to keep a larger store of cash, or in this annecdote babysitting scrip), and sometimes based on wage/price stickiness (there is a real shock but the market doesn’t equilibrate to the new prices because participants refuse to change their asking prices). I have never really understood if these are seperate phenomena (some models rely on liquidy preference, others on wage/price stickiness) or really just the same phenomenon (wage/price stickiness somehow implies liquidity preference and vice versa).

I am most interested in answers based particular mathematical models (either toy models or complex general equilibrium models) rather than hand-waving reasoning about how the macro-economy should work.

david October 6, 2011 at 1:20 pm

A change in liquidity preference is one possible nominal shock that moves the economy out of its equilibrium. The economy remains in disequilibrium because of the wage and price stickiness. Without stickiness, prices would just adjust to respond to the nominal shock.

Silas Barta October 6, 2011 at 1:45 pm

Why not just charge people who hoard too much cash with “economic terrorism” and then seize their money to spend on SUVs? That’s like, three birds with one stone(ing): more NGDP, less cash hoarding, more SUV sales, which of course need to get back to their 2005 levels.

Whaddaya say?

david October 6, 2011 at 1:49 pm

That seems like a particularly expensive way to restore equilibrium.

Silas Barta October 6, 2011 at 2:48 pm

But still “better than nothing” … right?

David Wright October 6, 2011 at 2:02 pm

Thanks for the explanation. You are basicly saying that liquidity preference isn’t really central; it’s just an example of a possible shock. Price stickiness, on the other hand, is central.

Doesn’t this make the baby-sitting co-op story a bit misleading? In that story, the monetary authority is able to fix the recession because it actually, directly negates the shock. (The cause of the shock was people wanting larger bank balances; it makes everyone’s bank balance go up). But in most recessions, no monetary or fiscal authority can directly negate the shock. (The US government could not have made OPEC simply go away in 1973.) So in a more realistic annecdote, the monetary authority only helps indirectly, by inflating the currency, allowing real prices to equilibrate without requiring nominal prices to change.

david October 6, 2011 at 2:07 pm

You cannot make the shock go away, but you can make the across-the-board unemployment from the maladjusted response go away. Nominal prices have a hard time equilibrating, so this is not insignificant.

Scott Sumner on the point (that regardless of whether unemployment is alleged to be cyclical, aka monetary shock, or structural, like an oil crisis, monetary policy is nonetheless capable of speeding adjustment).

Daniel October 6, 2011 at 1:47 pm

Always interesting to read these analogies, but always frustrating to read the “conclusions”.

It is akin to listening to people discuss competing ideas about how to drive a car, and all too frequently, listening to important people speak as if the car should steer itself.

In the meantime, most of us are becoming increasingly upset to be sitting in a car, in a driveway, not moving, not knowing the destination, and listening to the arguments.

God help us all when the ‘unlicensed’ finally decide to take matters into their own hands?

James C October 6, 2011 at 3:35 pm

i dont know if that analogy is relevant when we have self-driving cars poised to enter the market. things like licenses arent going to be needed anymore. inevitably, itll be easier to just not own a car, and just call for self-driving cabs, especially in congested areas.

Becky Hargrove October 6, 2011 at 3:17 pm

Daniel, your last two sentences have definitely been on my mind. Perhaps the only thing worse than the unlicensed taking matters into their own hands is someone among the licensed who say, “You know what, money is worthless! Let’s use a system without money and no one need worry about economic activities anymore, the wise among us will take care of that.”

Scrip is a wonderful thing because it is so flexible. However, it gets hoarded because it doesn’t always accomplish what we actually want to do or buy. Let’s figure out those things for ourselves instead of letting a few of the “wise” do it for us. And when we do decide to find value beyond money, let’s do it in ways that we still get to make the economic decisions ourselves, and make the most of our skills in the process.

Mark T October 6, 2011 at 3:57 pm

Seems to me the problem is the expansion and contraction of the script.

Just make the income (currently 2100 “hours”) and expenses (currently 1902 “hours”) balance. Then make the initial allotment and payback when leaving be equal. The market will then be balanced and will not be flooding the system with new script or sucking it out of the system. The only expansion or contraction of the script would be when membership changes.

The parallel to the economy would be that we only expand based on population size. The problem is that the baby-sitting co-op is a well defined population, which is not true of a global economy.

Will October 7, 2011 at 12:48 am

The article seems a bit weird. First, everything that happened followed a Keynesian sticky-price model, the only problem being the unrealistic source of the sticky prices. It is true, Krugman should have been more clear about that, but he did not need to go into detail about “and then there was too much money! and then too little again!” or whatever.

Second, for the payoff being that Paul Krugman tried to start a housing bubble. Few people make controversial-sounding statements and don’t explain them, many make controverisal-sounding jokes and don’t explain them.

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