The lessons of the baby-sitting co-op reconsidered

During the depths of the Asian Financial Crisis, Professor Paul Krugman wrote an essay for Slate where he argued that central banks can prevent recessions by manipulating interest rates. To make his point, the professor used a real-life example of a baby-sitting cooperative from the 1970s. It is well worth reading, particularly the second footnote at the bottom.

The original article on which Krugman’s piece was based is even more interesting. The authors came to a very different conclusion from the professor, however, which has significant implications for today’s debates on monetary policy and the economy.

This is how Joan and Richard Sweeney (the authors of the original article) described the Capitol Hill Baby-Sitting Co-op:

For the uninitiated, it may help to know that there are several forms of baby-sitting co-ops. One popular form is the bookkeeping system. In the most rudimentary version, members earn one credit for each hour of sitting, and lose one credit for every hour someone tolerates their kids. A co-op at this stage develops rules—for fairness, usefulness, for expediency—and to make the thing go at all. For example, people want to go out on Friday and Saturday more than on other days. Either there are rules—”If you go out on weekends, you must sit on weekends”—or there are rewards—”Time-and-a-half on weekends.” And, of course, there must be rules to keep people from moving away when they’re “down” on hours.

The major alternative to the bookkeeping system, if there are many people involved, is a “scrip” system—the scrip is pieces of heavy paper. In the Capitol Hill Baby Sitting Co-op, a splendid organization to which we belonged for two years, a unit of scrip “pays” for one-half hour of sitting time. There are good reasons for preferring scrip to bookkeeping. An arithmetic bookkeeping mistake will show members as a whole “ahead” or “down” in hours, and the problem can be hard to resolve. With scrip, the hours earned automatically cancel against the hours spent when the sitter is “paid.”

The cooperative is a wonderful example for macro economists to study because it is similar enough to an actual country with a sovereign currency to be useful but simple enough to be intelligible. Moreover, it is not a model of what people ought to do but an historical record of what they actually did. Only the story of the British economist in a German POW camp can surpass it.

Krugman’s account focused on the way the co-op used monetary policy to deal with its “recession” after it had already occurred:

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.

By contrast, the original story focused on the cause of the “recession.” The problem was that the co-op economy was very sensitive to monetary shocks because the price of going out was fixed:

There was a shortage of scrip. There was so little scrip to go around that holders were reluctant to squander it by going out. Those who wanted to go out but didn’t have scrip were desperate to get sitting jobs. The scrip-price of baby sitting couldn’t adjust, and the shortage worsened.

The bolded passage makes all the difference in the world. Recall that a unit of scrip was defined in terms of the number of hours of baby-sitting it could purchase. The price of going out was fixed in terms of scrip, so when the supply of scrip fell, the cost of going out surged.

This is the first lesson: flexible prices make the economy more resilient to monetary shocks, while a regime of inflexible prices requires very stable money.

But why was the supply of scrip in circulation falling in the first place? Krugman’s account was unhelpful but luckily for us, the Sweeneys provided a clear answer:

First, consider co-op “expenses.” Each “monthly secretary” (the poor person who gets all the requests for sitters and tries to fill them) receives 1 hour per month for every member-family in his section, and there are now four sections. Using the average membership of 150 for 1973 for convenience, these monthly secretaries “cost” the co-op 1,800 hours per year. The officers of the co-op are even more underpaid—they earn 102 hours per year. So with 150 members, yearly expenses were 1902 hours.

But each member-family pays yearly dues of 14 hours, so total co-op “income” is 2,100 hours per year. With no membership turnover, then, co-op outgo would be 1,902, and the amount of scrip outstanding would fall by 198 hours per year. So if the amount outstanding this year is just right, next year it will be 198 hours too small. Since 4,500 hours (equal to 30 hours times 150 members) are initially outstanding, in somewhat under 30 years there would be no scrip outstanding—no one could go out.

In other words, the government was running budget surpluses, which were sucking money out of circulation. The recession was “cured” when the government eliminated its surpluses by giving everyone a one-time tax rebate plus a permanent tax cut. (They changed the rules so that every new member got more scrips than every departing member had to repay.)

This is the second lesson: the distinction between “fiscal policy” and “monetary policy” is illusory.

While recession was no longer a threat, the Sweeneys explained that this created a whole new set of problems:

Recall, each new member is given 30 hours and pays only 20 when leaving. Thus, a one-family turnover that does not change total membership increases this total volume of scrip outstanding by 10 hours. The amount of scrip will expand by 200 hours per year if the turnover is 20 families annually; the 192-hour shrinkage noted above is offset by the 20 X 10 hours, or since 20/150 is 7.5 percent, if the turnover exceeds 7.5 percent the amount of scrip will grow. Sadly for domestic tranquility, the turnover rate has somewhat exceeded 7.5 percent, being approximately 20 percent in 1973-1974.

Now, whoever promised that 7.5 percent would always be “it”? Indeed, given ups and downs, how many years in a row above or below 7.5 percent can the co-op take before it falls apart, even if the average is 7.5 percent?

It is not surprising that some members want to remedy the situation with rules to force sitting by those members who are shirking their duty. Indeed, a truth squad is envisaged to find out why individuals aren’t sitting enough.

They had created a system where money supply would change randomly because it was determined entirely by the rate of membership turnover. If the churn rate were too low, the co-op would return to recession.

What if it were too high? Here is the Sweeneys’ account:

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).

Regrettably, Professor Krugman did not bother to tell this part of the story.

The instability of the co-op’s monetary regime kept their economy on what the Sweeneys called “the recession-inflation seesaw.” Moreover, there was no obvious solution to the problem:

The short-run answer is to make the “income” and “outgo” mesh with the turnover rate. As things now stand, there is too much scrip outstanding and it is growing—one good idea is to reduce the amount through a one-time tax. But this would have to be repeated over and over, to mop up the growth in scrip due to membership turnover. Each time, it would require a majority vote in favor of this in a referendum.

The system was broken. The Sweeneys’ fix was a constant per-capita money supply. They wanted to take human agency out of the equation.

This is the third lesson: experts cannot manage the economy.

As they asked at the end, “if goodhearted people in an area that offers little scope for chicanery can so bungle economic management, can we really be surprised at the results of turning our economy over to the tender mercies of political experts?”

Krugman drew a very different lesson from their story. He thought it demonstrated the need for experts to supervise the economy and intervene whenever a recession threatened:

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.

This misinterpretation had serious consequences.

It encouraged the belief that every downturn was undeserved and needed to be offset by an increase in leverage or the “judicious” use of inflation. No wonder Professor Krugman thought that the proper response to the collapse of the tech bubble was to create a housing bubble.

His version of the co-op’s story also created excessive confidence in the ability of the central bank to affect the economy without any help from the tax and spending side of things. However, we know—like Bernanke—that stimulative monetary policy works best when it is accommodating fiscal deficits.

Professor Krugman should be thanked for bringing the story of the baby-sitting cooperative the attention it deserves. It is a pity that so many wrong lessons have been drawn from it.

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About Matthew C. Klein
I write about the economy and financial markets for Bloomberg View. Before that I wrote for The Economist on a fellowship provided by the Marjorie Deane Financial Journalism Foundation. I have worked at the world's largest hedge fund and read every FOMC transcript since May, 1987.

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