Friday, June 30, 2017

The solution is obvious, once the problem is identified

In the baby-sitting co-op story told by Paul Krugman, there was a problem:

... 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.

Krugman seems to think that the great lesson in this story is that a central bank can

stimulate a depressed economy by reducing the interest rate and cool off an overheated one by raising it.

I think the great lesson is that monetary problems create real problems like recession. The great corollary is that it is difficult to convince people the problem is monetary.


jim said...

The fundamental fallacy in Krugman's presentation of the interest rate fable is that he assumes that it is a closed system when it is not. The baby sitting co-op members have access to other means of getting baby sitters and they have the means to exchange coupons other than by baby sitting. What that tells me is the market will end up in control of the interest rates, because if the central authority controls interest as Krugman describes it will drive the coop out of business. What I'm saying is that the central control would quickly learn to let market rates prevail or face extinction.

What Krugman fails to describe is the process for creating/destroying coupons. This tells me Krugman hasn't got a clue about how monetary systems work. I can imagine numerous different scenarios by which the co-op coupons could come into (and go out of existence) all of which would have far more impact on the effectiveness and efficiency of the baby-sitting/coupon exchange process.

Krugman completely missed the mechanism by which the problem of supply and demand in his story arose and injects a solution that only works by hand-waving and very determined disregard for reality.

The Arthurian said...

Jim: "...if the central authority controls interest as Krugman describes it will drive the coop out of business."

This is related to what you were saying in our discussion of Richard Werner's work, and it is starting to make sense to me.

For the record, though, I did say "Krugman seems to think that the great lesson in this story" is about the manipulation of interest rates, and I don't think that at all.

jim said...

You have to be an mainstream economist to think the lesson is about interest rates.

The story apparently was true and didn't have anything to say about interest rates at all. Krugman turned it into fiction by introducing interest rates. That according to Steve Keen, is pretty standard operating procedure for mainstream economists,

Krugman thinks that the fictional central bank in his story would adjust interest rates based on its perception of supply and demand of sitters and sittees. You have to wonder what he thinks market driven interest rate scheme would look like.