November 7, 2007

Hire a babysitter and hit town to save the economy

Posted in International Economy · 24 comments ·

With stock markets all over the world tumbling and Irish banks being targeted, the big question is, why do economies go into recession? Why do apparently sound economies turn down? Why is our economy heading south with tax revenues falling and housing prices slumping? Why did Japan go pear-shaped? Did it not produce the finest consumer goods in the world? How come the Asian Tigers — outlandishly praised as late as 1997 by the IMF — experience a meltdown in 1998? Why did Californian land prices plummet in the late 1980s and why is the stock market now worried about a recession in the US?

Surprisingly enough, most economists cannot answer those questions. Many of us are fantastic at telling you what has happened last year or promising more of the same when times are good, but precious few spot the early warning signals that can flash amber well ahead of the tailspin. The fact that every paid analyst in Ireland predicted that house prices would rise above the rate of inflation 2007 evidences this myopia. Maybe it’s because the economy is such an extraordinarily complex beast that nobody can read the tea leaves consistently well.

That said, the simplest way of looking at the economy is usually the best. And last night, when trying to find a babysitter, I remembered the babysitting model of the economy (made famous by the US economist Paul Krugman) which best explains why recessions happen.

Babysitting co-ops are big in the US. Typically, a number of couples form a co-op. The idea is that the Kellys will go out, have a few drinks, get a bit messy and the Murphys will mind the Kelly kids plus their own and so on. The co-op runs on the basis of babysitting coupons. Everyone gets a limited number of coupons when they join. If the Murphys want to go out tonight, they pay the Kellys in coupons. Eventually, if the Murphys are party animals, they will run out of coupons and have to babysit for everyone else to replenish their stock of coupons. In time, they can go out again. In theory, the supply and demand for coupons should always match: there should be enough babysitters and every couple should be able to get a few nights out on the tiles.

In practice, a study of the way a babysitting co-ops works revealed that things turned out differently. Initially, things worked well. People were polite and the coupon system operated smoothly with most couples getting out fairly regularly. But over time, some couples with a few free evenings coming up opted to stay in. Why stay in alone, when you can stay in, babysit and get a few coupons? So they offered to babysit with the view to hoarding coupons for special occasions.

There were two problems with this ‘hoarding for special occasions’ approach. First, trying to accumulate coupons for future occasions was only achieved if someone ran down their reserve of coupons today. Second, every couple wanted to keep a few coupons in store for emergencies. As some couples stayed in, others, believing that their reserve of coupons was slightly low, stayed in more often as well. But as one couple’s opportunity to build its reserves could only be offset by someone else going out, the couples collectively started going out less.

In time, there were fewer and fewer babysitting opportunities. The fewer opportunities to build reserves, the more people panicked about having insufficient reserves for the future, the less they went out and the less babysitting opportunities emerged. This went on and on until the system completely dried up. Nobody went out and nobody babysat. In short, the co-op went into recession.

What has this got to do with post-boom Ireland? Well, our modern economy works in a similar fashion. The recession in the babysitting co-op was real, as real as a recession in any normal economy. Demand dried up and supply remained idle.

Why did the babysitting co-op go into recession? There wasn’t anything wrong with it in principle. The Murphys and Kellys were not bad or inefficient babysitters. Did it lose competitiveness vis-a-vis some other co-op? Not at all. Was there a great, unexpected shock from the outside that jolted the co-op? Hardly. Was there a huge shift in the use of technology, creating a ‘new paradigm’ babysitting co-op elsewhere and our babysitting co-op failed to react and fell behind? No. Did the internet accelerate its downturn? No.

The co-op didn’t stop producing things, demand simply dried up because people chose to hoard the coupons. Similarly, business cycles and their vulnerability have little to do with shocks from abroad, competitiveness or so-called ‘economic fundamentals’. Bad things happen to good economies and it is almost impossible to predict.

When confidence evaporates you know about it pretty quickly. People hoard and spending collapses, precisely in the same way that hoarding of coupons in the babysitting model caused a babysitting recession. Confidence can disappear for no apparent reason. Once people think that they need more of a comfort zone in their bank balance, confidence vaporises.

On the positive side, the lesson of the co-op also reveals what to do in a recession. The only lasting answer was to issue more coupons, which worked a treat. In no time, there were loads of babysitting opportunities, parties and hangovers. Similarly, the answer to a downturn is to print money. Recessions happen because people stop spending cash and they save it instead. Printing money kick-starts spending and, by printing cash, countries can get out of recessions very quickly. In the real world, the coupon issuers are central bankers.

This is what is happening in the US at the moment. The Federal Reserve is printing money, cutting interest rates and causing the dollar to plummet. Unfortunately for us, as confidence evaporates here we will not have the ability to print money because our interest rates are set in Germany. Our exchange rate will be rising and our banks, reeling from the bad property debts on their books, will not be keen to lend.

The ECB runs a big European babysitting co-op, it will have no reason to issue coupons to specifically help the tiny, Irish baby-sitting co-op. At that stage, it will be too late to stomp our feet, scream or throw our toys out of the pram.

  1. Interesting analogy David. Of course, if the Muphy’s and the Kelly’s of this world weren’t so obsessed with propagating the planet, population wouldn’t have increased to the point where it’s heading for a non-too-distant 9 billion. Perhaps needing more coupons is the least of the Kelly’s and Murphy’s problems.

  2. andrew

    Good analogy, but I see a few reasons why Irish families will not be hoarding the coupons in the near future.

    1- there’s nothing good on TV here- it’s just too boring staying at home
    2- the weather is so bad that sooner or later people will break and book a holiday in the sun. the neighbors will hear about it, get envious and book their own, even if they have to go into debt for it (I put a trip to France on my credit card just to escape from Dublin last “summer”)

  3. Vince

    They can print all that they and their little printing presses can put out. It still will not answer the root cause of the issue. To find that one has to ask why something is sub-prime, and as important measure the per-cent relative of those who are prime.
    If only Dr. can get prime and everyone else sub-prime, well, how far and how many.

  4. David I have come across a proposal at one stage that suggested that an inflation proof purpose made hoarding currency be instigated. The hoarder’s by converting their coupons into this form will put the more transitory currency back into circulation, necessitating their further participation in the babysitting scheme, but now feel safe in the knowledge that their hoard is maintained. Recession is avoided and sentiment is maintained. I lack the knowledge to critically analyse this model, what is your view?

  5. John Dooley

    The key is confidence. If, like most people, you are in private employment you cannot be sure of the next months paycheck and the natural urge is to hoard and save money especially if you are in the middle of a group of highly qualified people and aren’t in great demand. More and more people are finding their jobs turned into temporary ones and more and more are finding the qualifications required for even routine jobs getting higher and higher. In the name of economic efficiency the hirers of labour have turned the workers, who are also consumers, into cautious misers.
    Government can help by increasing part-time and adult education and training opportunities and upskilling people into new and more relevant skill-sets so that people will be more confident in their market saleability and will not be as afraid of unemployment and poverty as they are now.
    Employers, especially in this era of globalisation, should be keenly aware of denting public confidence by offering only temporary jobs and poor pay and then expecting this new workforce to spend like they did in former times. It won’t and can’t happen.

  6. Dónall Garvin

    I liked the analogy but couldn’t care less for what it means in today’s world as you don’t bring anything new up that you haven’t already mentioned.

    What i do think is interesting is the fact that these co-ops have in effect created a currency (coupons) which can be exchanged, traded, earned and spent.
    I read a book years ago called “The Future of Money” by B.A. Lietaer.
    The author has a lot of experience and insights and the book is a good read (in fact after reading your article I am going to go back over it.)

    In the book he says that the current monetary system is unstable and may well collapse (like the USD)
    Co-ops using these coupons are not new; he gives lots of examples of when alternative currencies are used – especially in times when you measure money by the barrow-full.

    One solution to the hoarding issue is to make the coupons valid for a certain period, after which they expire.

    Community-based initiatives have a great deal of potential to make this world a better place.
    It has been discussed here before that Irish people have lost the warmth and trust in other people and “confidence” in the world – but the new found materialism or the cult of individuality of the new Ireland can not permanently mask the true identity of a people. (This last point is just how i am feeling right now and i’m sure i’d argue against it if someone else brought it up)

    In summary – we don’t have to be led by the ECB, US, government to enhance our lives – look at what “microfinance” can do in places like Bangladesh that Billions of $ spent on hydro-electric power stations etc… can’t.
    The people have the power – we just don’t use it.


  7. Pat McCarten

    A not a good model. In most markets, price balances supply and demand!

    If you had 10 babysitting couples, and 20 baby sitting coupons, and suddenly the opportunities for all 10 to babysit and obtain coupons dried up, because everyone wanted to stop spending on babysitting and save up their baby sitting income, the COUPON PRICE of the over supply of baby sitting services would then go down as thier are too many suppliers! – A couple spending would offer only half a coupon for a night off with all these desperate savers! The ‘price’ of each coupon would determine the demand and supply.

    If more coupons are printed – from 20 to 2000, then there would be many more coupons to earn as people dump thier coupons on the market, but as thier are only 10 couples, the price of the service would soon shoot up to over 100 coupons, rendering the saved coupons worthless as everyone tries to get rid of them, and getting the organisers of the scheme lynched hopefully.

  8. paddy cullen

    Bertie Ahern calls for wage restraint

    Thursday, 8th November 2007 04.15pm

    The Taoiseach has called on trade unions to show restraint in their pay demands when talks get under way in the Spring on the next national pay agreement.

    Mr Ahern was addressing a meeting of the social partners in Farmleigh today.

    He said that the current agreement Towards 2016 would have cost the government 1.7bn euro in extra wage costs in its full term.

    Mr Ahern also defended recent award of large pay rises for ministers and senior civil servants.

    He said that members of trade unions would understand that the pay hikes had been awarded by an independent mechanism.

    Addressing the same meeting, finance minister Brian Cowen said: “It is important that expectations be kept in line with the economic realities we face.

    “The national partnership agreements have served us well over the last decade and I would hope that this well tested approach can once again be relied on.”

    IBEC director general Turlough O’Sullivan, who also attended the meeting, said employers would be happy to go ahead with a new national pay deal if it helped the economy and maintained competitiveness. SIPTU president Jack O’Connor said that the recent pay review for senior staff showed that people at top levels in business were awarding themselves ‘multiples of pay increases’ at the expense of the people at the bottom.

    what a joke ……

  9. Joseph Smith

    Why assume that recessions a. last forever, b. are inherently bad. The babysitter analogy falls down because people have to buy things to keep living – they don’t have to keep going out to dinner. Allowing the government (or in the case of the federal reserve, a private bank) to stop a recession only makes the problem worse. In this case, the fix to the huge economic crises is to raise interest rates, and make money harder to get – afterall in a risky economy nobody wants to lend money, and that is what the market would naturally do.

    However, by lowering interest rates, the fed just causes rapid inflation – rapid devaluation of the dollar – which only ends up hurting the little guy, while leaving the big corporations mostly unaffected. Further, it encourages nations all around the world, which the US relies on to keep operating, due to huge foreign debt, to dump their dollars on the world market before they turn into American pesos.

    The analogy is flawed as compared to normal economies and the solution is not artificially inputting more money into the economy. That simply doesn’t fix anything in the long term, and this time it’s not going to work for the US.

  10. I cannot belive that, in the middle of an internationl credit crash, where confidence in the price of money is completely unstable, you are seriously suggesting that we print money to get ourselves out of it. The US is printing more dollars, and the Chinese are talking out loud about cashing in their dollar reserves. your idea is just plain daft.

  11. [...] very quickly. In the real world, the coupon issuers are central bankers.”(David McWilliams, ‘Hire a babysitter and hit town to save the economy‘, 7 November [...]

  12. MK

    Hi David,

    You gave a reasonable analogy to try to help people understand what Central Banks do when they print money. However, I see that many responders are in the ‘analogy-bashing’ camp. No analogy is perfect, and people that analogy-bash are not really grasping the key points you are trying to get across.

    Economies are very complex and there are a wide range of effects going on, not only debt and value changes, but work input, productivity, etc, not to mention our human perception of it all, and soft factors, such as confidence, risk taking, individual, private, government, etc.

    People save and spend in varying amounts, and it was ever thus. Over-spending (such as via credit), like the drinker on the town, will inevitably lead to the ‘hangover day’. There will be a payback. But when and to whom? It may not be this generation, or the next or the one after that either. When Rome was expanding, not all Roamns were affected, only the last.

    But, there are no simple analogies that can describe the full set of nuances in economies, and economics is not a science. I am also a firm believer that each set of problems/challenges that any county/area faces at any particular time is unique, as we as a world have not been here before with the exact same set of circumstances, factors and indeed history. We can draw lessons from the past, and apply them, and no doubt human error in the collective will rear its head as it always does (eg: sub-prime, dot com bubble, Irish property market(?)), but no challenge is exactly the same as the last one.


  13. Whether we want to talk in metaphors or facts, the coupon – or Irish printed Euro – cannot be printed ad-hoc to dig us out of this (not that it would work.) However, the fact remains that we’re tied into the ERM here and aren’t even allowed to wipe our own fiscal backsides let alone print money or set interest rates. Being tied into the Euro helped Ireland’s economy immensely (past-tense) and played it’s part in kick-starting and – more specifically – feeding the cetic tiger. But, that aside, the fact remains that in the eyes of the power-mongers in Brussels, Ireland is still an insignificant player. Rates are set by Brussels to look after the heavyweights – namely Germany and France, but mostly Germany – Ireland will either reap or suffer the consequences of whatever Brussels decides. Perhaps it is now time, with the Cetic Tiger going lame, that we should now be discussing whether Ireland can survive outside of the ERM. Most of Ireland’s international trade is with the UK and USA. I don’t know the answers, but I think there are definitely strong arguments to seriously consider this question (and my apologies for the NFL analogy here):

    Do we sit on the bench and watch the clock wind down until it’s too late, or is it time once more to take a Punt?

  14. Aidan

    Joe Soap, leaving the Euro is something that Ireland should discuss. It can do no harm to weigh up the pros and cons. However, if most of Ireland’s trade is with the UK and the USA another option might be to reduce this dependency by increasing trade with the Eurozone.
    In Holland I see almost no Irish products in the shops. The only time Ireland is in the picture is when you need to deal with a multinational based there or somebody is flying Ryanair. I don’t think that the Ireland brand is out there as much as it could be. If you see adds for Spanish regions or tourism they are nearly all branded under the ‘Passion For Life’ banner that has so successful in the last numer of years. Egypt had similar success with the ‘I wish I was in Egypt’ tourisam campaign. Ireland is being sold with that ‘Irish Mind’ campaign. The only people reading that as are Irish people cringing at the arrogance of it.
    Brand Ireland should go back to basics and promote a country with a rich history, wonderful nature and great food products to mention one strength. Forget about trying to convince people that the Irish mind is superior, nobody will buy that when the best universities in the world are in the US, UK and northern Europe.

  15. When your argument fails, shoot the analogy.

    Let me quote from David’s post:

    “the answer to a downturn is to print money. Recessions happen because people stop spending cash and they save it instead. Printing money kick-starts spending and, by printing cash, countries can get out of recessions very quickly. In the real world, the coupon issuers are central bankers.

    This is what is happening in the US at the moment. The Federal Reserve is printing money, cutting interest rates and causing the dollar to plummet. Unfortunately for us, as confidence evaporates here we will not have the ability to print money because our interest rates are set in Germany. Our exchange rate will be rising and our banks, reeling from the bad property debts on their books, will not be keen to lend.”

    There is no analogy in David’s call for the EU to physically print more money. His babysitting analogy is there to explain that point. I am not criticising his analogy – I’m criticising what he is actually calling for: a dance with hyperinflation. That is what is completely daft, not his babysitting analogy, but his call for hyperinflation through the issuing of paper money in a vain hope that we’ll be able to spend our way out of this one.

  16. Brian Cowen

    Good idea david, we are running a big party soon

    details are here

  17. john

    I also agree with Aidans comment about ‘Irish Mind’ campaign. Its stupid nobody will buy into it, I can just picture the ‘team’ that came up with it probably 30 somethings with only a superficial grasp of the irish identity, probably studied ‘morkiting’ or ‘media studies’ in college, probably with little industrial experience or real international experience with irish products.

  18. Stephen

    I guess you can extend the analogy to account for inflation:
    Everyone’s got loads of coupons, so everyone wants to go out more. There are too few people prepared to stay in. The Kellys are having their 25th wedding aniversery on the same day that their child was awarded their degree, that happpened to coincide with the publication of Mr Kellys first book on economics, and opening of Mrs Kelllys first exhibition at the city’s gallery of contemporary art. The Murphys just fancy a pizza to get away from the kids for a couple of hours. The Murphys confer, and agree to accept two coupons to stay in for the evening. With so many coupons in circulation, everyone feels really confident about their ability to get a baby sitter, and still have a couple of coupons in reserve. After a while, it starts to dawn on people that although “I promise to pay the bearer one evening’s baby sitting’ is on the coupon, it actually takes 2 to get someone to stay in. Solution? Double the number of coupons. After a while, start printing coupons with “200,000 Dollars” on them, then devalue the coupon by replacing them with a new ‘Weimar Coupon’ to save people from having to wander around with wheel barrows……

  19. Okay, while we’re all on the metaphor train, I’ll add another thought (sorry David, but you started it.)

    It’s all academic while Ireland is the German whipping boy (or should that be footstool) in Europe. And whie many of us bemoan the departure of the Irish Pound or Punt, I wonder if we’re now in a situation where it will either be too little too late, or a case of Ireland being the captain of the ill-fated economic Titanic, the iceberg has struck and the ship is sinking, and nobody thought about the fact that they traded in all the lifeboats for Euros.

    Frankly, I think that even if we could print money, it would be the height of foolishness and become an unmitigable disaster. Massive inflation would follow suit and despite having encouraged the Murphys, Kellys or even the McWilliams of Ireland to go on a massive spending spree, the fact remains that the property market has suffocted anyone’s hopes of loosening their belts and the reality is that they are more likely to tighten their bets further still.

    And all around is the echoing cry of, “Mayday! Mayday!”

  20. Forget child-minders study the Austrian school of economics’s business cycle if you want to understand why recessions happen. In fact most Austrian analysts have correctly analysed what is happening and what happens next.

    cut and paste this link into your browser and watch if you want to get the idea.

  21. Deco

    Leaving the Euro is all well and good, but what if the Irish politicians start running the Irish Central Bank, the same way they have been running all other Irish state bodies…. We are now entering fight for the scraps mode concerning the national state expenditure. The politicians, the public sector unions, various vested interests ranging from the Construction Industry Federation, the Pharmaceutical Union of Ireland, the Chambers of Commerce, RGDATA, the Football Association of Ireland, the state owned broadcaster and on to the Gaelic Players Association, have all stuck their knives into the cake. When all the various bodies of political influence (not just political parties by the way), the Irish private sector taxpayer will be forced to work harder for a more mediocre level of service.
    The solution is a PAYE taxpayers union, which will go on strike unless the powers that be start treating the public funds system with some respect.
    Ireland’s role in the coupon system, is that of the reckless teenager in the group, who has a low level of commitment, few savings, a decadent lifestyle, and who sometimes goes looking for coupons to sustain a weekend’s brain cell destruction.
    The US is in serious financial trouble, and has been mismanaged economically and societally for over a generation. With the average American having their intellectual development capped by repeat television, a rapidly declining level of intellectual discussion on most issues of national or societal importance, and a combination of retail, religious, and pop culture therapy, most Americans have become intellectually incapable of seeing the problem, let alone addressing it. It is safe to say, that Ireland is in a parallel situation, with listening to 2FM, nursing a hangover, reading the star, and wondering how come house prices are falling in Budapest as well as Blanchardstown. And from what I can see, the Irish are intellectually comatose. And societies with a more prudent, more attentive approach are slowly winning investments, jobs, deals, etc.. without creating the same societal fallout that the Celtic Binge Festival 1995-2007 has caused, as evidenced by soaring rates of gambling addiction, indebtedness, suicide, marriage breakdown, crime, drugs abuse, and drunks rampaging in Accident and Emergency units.
    The government should take a pay cut, not a pay rise..

  22. Deco

    Aidan. The Irish Mind campaign is a complete facade. We need an analysis of the Irish mind, in the hope that we might reduce all the reckless behaviour that we see today in Ireland. The truth is like something out of Phoenix magazine. The Amnesia bit(where financial matters are stored), the day dreaming on the M50 bit, the bit that was lost to binge drinking, the bit that is still reeling from the weekend in Amsterdam, the house prices bit(now dormant), the work bit(dormant most of the time), the honesty bit(also domant most of the time), etc..
    When I travel I see America’s influence in McDonalds outlets, and I see Ireland’s infleunce in Irish pubs. Both the source of obesity problems I suppose.

  23. Pay attention to the small print

    For anyone who believes that Britain is tolerant you should think again.

    All you need do is look at Quotes 416, 428 & 429. This was debated only just last thursday and the results of peoples opinions is overwhelmingly negative, and they have been dealing with Immigration for over 50 years and they are having enough.

    I found that the phrase “Ethnic Cleansing” quite frequent from their economic growth over the last 50 years!

  24. MB

    They can print more babysitting coupons until doomsday but if the trust the co-op members hold in the coupons has been irrevocably damaged then printing more coupons won’t be enough to save the co-op. Paul Krugman himself admits that in his recent NY Times columns on the US downturn – the Fed cutting interest rates is not the answer to their current malaise if confidence in the market and the dollar as a reserve currency is evaporating. The hangover from a credit-fuelled binge will not be cured by more credit. Japan learned that lesson the hard way in the 1990s with its near-negative interest rates that did nothing to stimulate the economy, largely because people had borrowed too much and overstretched themselves to the tune of decades worth of earning power.

    Ireland is in a similar situation now in terms of a debt hangover but luckily for Ireland, we’re in the eurozone so the value of our babysitting coupons is being maintained elsewhere and the number of members of the co-op is large and diverse enough to hold the coupons’ value for a while yet. The high eurozone interest rates are a blessing in disguise for Ireland: exactly what is needed to bring a dose of reality back to Irish life.

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