Paul Krugman in End This Depression Now! and elsewhere uses a story about a babysitting cooperative near Washington, D.C., to illustrate how Keynesian stimulus policies work. Each of the families in the cooperative needed a babysitter if it wanted to go out for an evening. Every family was given a certain amount of scrip, each unit of which was good for half an hour of babysitting services. If a family wanted to go out, it could use its scrip to purchase the hours of babysitting services it needed.
Unfortunately, the families got so little scrip to begin with that almost everybody preferred to offer to be a babysitter, in order to accumulate scrip, than to go out. But if almost no one wants to go out, there will be almost no demand for babysitters and people will be unable to accumulate scrip. The system was at an impasse.
As Krugman tells the tale, the problem was solved by giving everybody more scrip. After doing this, people were more willing to go out, because they now had enough scrip to purchase babysitting time; and then those who wanted to accumulate scrip were able to find purchasers for their services. Krugman uses the story to show the merits of a Keynesian policy of stimulus. An increase in government spending can, he says, get us out a situation where almost no one wants to spend but almost everyone wants to save.
According to Tim Harford, in his recent The Undercover Economist Strikes Back, Krugman did not tell the full story. Just as Krugman says, the increased distribution of scrip got the babysitting cooperative going. What he failed to mention was that the cooperative soon broke down again. The amount of scrip grew beyond the amount needed to balance supply and demand for babysitting , and now people wanted to go out but there were few babysitters available. Because people had large amounts of scrip already, they saw no need to add to their supply of scrip through offering to babysit.
Krugman’s story, though designed to show the merits of Keynesian stimulus, actually shows, as Austrians have long pointed out, that. a stimulus policy can quickly become inflationary.