Developing my lecture on Keynesianism, I’ve developed some reservations about my objection to fiscal stimulus. I’ll write more on that when I get my thoughts better organized. But in re-reading one of Krugman’s famous analogies, about the babysitting co-op, I was struck by the lack of clarity about where the line between Keynesianism and monetary policy is drawn. The story is found in his book Peddling Prosperity (recommended), in the first chapter, titled “The Attack on Keynes,” in a section subtitled “Infantile Keynesianism.” I emphasize those titles, because clearly he wants us to know this is about Keynesianism.
Here’s the story, as told by Krugman.
A group of young professional couples with children formed a baby-sitting co-op [using] coupons worth one hour of baby-sitting. Every hour of baby-sitting would involve a transfer of a coupon to the baby-sitters from the baby-sittees…
After the co-op had been in existence for some time, it got into trouble…the number of coupons in circulation became rather low. This had peculiar consequences. Since on average members of the co-op had fewer coupons in hand than the reserves they wanted, couples tried to increase their reserves by baby-sitting more and going out less. But one couple’s decision to go out is another couple’s opportunity to baby-sit, so the increase caution of the co-op’s members about spending their coupons made it increasingly difficult to find chances to earn coupons. The result was a sharp fall in the volume of baby-sitting actually taking place…
In other words, the baby-sitting co-op had managed to get itself into a recession.
This is a great Keynesian description. It’s all about a fall in aggregate demand. “The number of coupons in circulation became low” = “people were saving, not spending.” So surely Krugman demonstrates a Keynesian solution, which presumably would involve a central authority–the co-op board or something like, borrowing those coupons and spending them?
Only after a considerable time did the co-op increase the quantity of scrip in circulation. When it did, the results were…miraculous: couples began going out more, making baby-sitting opportunities more plentiful, which made couples still more willing to go out, and so on.
That’s a monetary solution! The central banking authority, the co-op board, created more money. Now I don’t have any problem with Krugman’s analogy. It’s a good one, and it’s great for explaining…monetary theory. And of course Krugman believes monetary theory works in most cases, so it’s not like he’s really perjuring himself, but he claims to be making an analogy to Keynesianism.
Here’s where the lines blur. The increase in the money/coupon supply apparently led to an increase in the velocity of circulation, which is Keynesian theory (and is not monetarism). But Keynesian theory doesn’t attribute increases in velocity to an increase in the money supply, so it’s not Keynesian. Too little money causing people to hoard it is neither strictly Keynesian nor strictly monetarist. There’s more here than I think Krugman recognized. But the key policy initiative he emphasizes is a monetary policy, not a Keynesian stimulus policy.
In fact Krugman even says at one point that “the problem was essentially monetary,” yet he purports to be writing about Keynesianism. It’s a puzzle.
David Henderson suggests another critique of the analogy.
But nowhere does Krugman mention that another way to solve a problem of excess supply is to let prices fall. This missing piece is interesting, given that it was explicitly discussed in the article from which Krugman draws the analogy. The Sweeneys pointed out that because the founders of the co-op economy imposed price controls, decreeing that one unit of scrip must always exchange for a half-hour of baby-sitting services, there would be shortages when demand was too high and surpluses when it was too low.
In other words, the problem was actually a policy problem of fixed exchange rates, neither an aggregate demand problem nor even a monetary problem.