It is very difficult to talk about the economy and the steps the government is taking to fix the economy without at least a rudimentary understanding of how the economy works. One of the best explanations I’ve seen was an article written more than 10 years ago by Noble Prize winner Paul Krugman. One online version is here.
Krugman creates a hypothetical economy in the guise of a babysitting co-op. It’s easy to imagine an urban neighborhood with lots of young couples each with one or more kids, especially in these economic times. Imagine further that many can’t afford both a baby sitter and a night out on the town, so this neighborhood elects to form a babysitting co-op where each couple who baby-sits one baby for one hour earns the right to have one of their children baby-sat for one hour. To keep track of this they choose to use Popsicle sticks as currency. Thus a couple watching a baby for 4 hours would earn 4 sticks and if they watched 2 babies they’d earn 8 sticks.
We finish setting the stage by hypothesizing that there’s “pent up demand”. All the couples in this neighborhood have wanted to go out on dates, but couldn’t afford both the date and a baby sitter. It was only recently that someone suggested the babysitting co-op. Indeed the person who’s idea this was (let’s call him Paul) is putting the finishing touches on his proposal. An economy like this needs an initial dollop of capital. (Unlike the real-world economy which has been running so long that an initial dollop of capital is hard to conceive.) The reason is simple… if no one has any Popsicle sticks then no one can pay for their dates. All that’s left for Paul to do is decide how many sticks to give each family at the start.
Too Few Popsicle Sticks
If he gave each family one stick (or even better one stick per child) then this may not be enough to get their economy rolling. If a typical date is dinner and a movie, that’s probably a 3-4 hour event. Until a family has 3 or 4 sticks then a date that long is out of the question. Sure, some couples, with only one stick, may opt for a quick dinner out and eventually other couples may amass 3-4 sticks for themselves. If their chosen babysitter is another couple who wants a 3-4 hour date then there will quickly be a flurry of activity as this pool of 3-4 sticks circulates its way through their economy. But with only a small pool of 3-4 sticks circulating, it may be several months before any given couple is able to have another 3-4 hour date. It is clear that one stick per family is too few.
Too Many Popsicle Sticks
If he gave each family twenty sticks (or again, 20 per child), then he may have given so many away that inflation starts. Consider, at 20 per family (a clearly excessive number) each couple would believe they have enough sticks to afford five 4-hour dates. In this neighborhood, that’s a lot, so much in fact that very few couples would feel any need to babysit. What would they do with the extra sticks? Yet if that’s how most folks feel then again, no one would be able to go out since everyone would be looking for sitters and no one would be willing to work. Or at least no one would be interested in babysitting at the rate of one stick per child-hour.
Eventually someone will get so desperate to go on a date they’d offer two sticks per child-hour of babysitting and for some that extra incentive may be enough to get them to sit even though the sitting family doesn’t really need the extra sticks. When the price of the “good” goes from one stick per child-hour to two sticks per child-hour that’s inflation.
Many people who believe in the gold standard do so because they do not understand the constraints that limit how much money a government can print. In our “economy” Paul is the person responsible for “printing money” and the examples above show that there are constraints on how many Popsicle sticks Paul can effectively introduce into his economy. Too few and the economy doesn’t live up to its potential. There are both more people willing to earn sticks and more people wanting to spend sticks than what is happening in their economy. On the other hand, start with too many and inflation starts.
These principles are illustrated through the simulation that lies behind the image to the right. It simulates a babysitting co-op of 100 families where the main variable is the number of sticks each family initially gets. The economy just limps along when each family only gets 1 stick. Sometimes up to 6 couples are able to go out on a date each week, but sometimes it shuts down and after a flurry of activity no one can afford a date of their preferred length. Start with 4-5 sticks and the economy eems to be going quite well. At most 5 or 6 families are unable to go out on a date when they want to. But start with 6 or more sticks and the economy starts to wane. More specifically there are some families (looks to me to be about 10%) who have enough sticks for a date, but can’t find a sitter. (These are the houses that are green.) More detail is available on the simulation page.
I find it refreshing to consider the economy from this point of view (what economists refer to as “macroeconomics”). The economics problems we’re facing seem understandable. But more than that, this point of view gives new insights on other economic issues.
For example, in our simple economy we need both people who are willing to babysit and people who have enough sticks to pay for a sitter. Hold that thought while you consider whether there’s a market for “ultra durable goods” (in the real world). People buy a new car every 2 to 8 years and over a person’s lifetime she may buy 5 or so cars. Would people pay a little extra if they could own a car that would last 40 years? How would this affect the auto industry? If across the board… if everything were “ultra durable” would our economy suddenly shrink once everyone owned all the ultra durable goods they will ever need? Can you posit an answer in light of the “Popsicle stick economy”?
[An update to the simulation is available here.]