The baby sitting co-op story is here: http://www.slate.com/id/1937/
To summarize, he tells the true story that, like Moses contemplating the burning bush, changed his life forever. God, or even better, John Maynard Keynes, had spoken to Paul Krugman directly through this little story. It is about this tale that he said that whimsical stories contain great truths.
So what's the story? Simply this, a group of 150 housewives got together to baby sit for each other. Each time Housewife A baby sat for Housewife B, Mrs. A got a coupon signed by Mrs. B entitling her to a free baby sitter from one of the 150 members. The idea was to have a pool of free baby sitters available, in exchange for baby sitting when someone needed you.
But the system did not work. Housewives were reluctant to use their precious coupons, hoarding them for emergencies. So Mrs. A did not use the coupon she got in our previous paragraph for months at a time. Which is fine for her, but bad for everyone else. Say Mrs C needs a baby sitter tonight. She can only get one if she has a coupon. And she will only have a coupon if someone had used her services. But nobody was using her services; they were all acting like Mrs. A, saving up the right to use Mrs C for the future.
In short, Mrs C could only get a free baby sitter today if she had sat for someone previously. But nobody wanted her to sit for them until months into the future. There was an acute shortage of sitters.
Krugman goes on about how they tried everything to fix this mess, and the only thing that worked was when the wise leaders of the group printed out loads of coupons and handed them out, entitling the bearers to demand a night of babysitting. With no need to hoard coupons, because there were plenty, people started hiring baby sitters, which in turn meant they would be committed to sitting for someone in return, and everyone was happy.
The moral of the story? The hoarding of coupons had put the economy into a recession. The recession was ended by printing lots of coupons. So too, the solution to any and all recessions is to print ooodles of money, just like they printed those coupons, and everyone will be happy.
Is he right? Is a country's economy analogous to that baby sitting club? I see some vital differences that blow the comparison to bits.
When the new coupons are issued, they do not water down the value of the old ones. The old coupons can buy an hours worth of sitting, just like before. But when new dollars are printed, both the old and the new dollars have less purchasing power.
It's as if the baby sitting community printed new coupons that said, "From now on, you have to sit for two hours to get back one hours worth of baby sitting. Not only that, all the old coupons which you got by sitting for an hour will only get you half an hours worth of sitting".
Why is this? Why do dollars lose worth, but coupons did not? Very simple. Those coupons represent a promise. They are IOUs. When Mrs A sits for Mrs B, Mrs B now owes her something, an hours worth of labor. Well, a promise is a promise. It is not weakened or diluted by other promises you have made. If Mrs B hands out coupons promising to sit for ten other people some day, she still has to sit that full hour for Mrs A. No getting out of it.
In short, the value of the coupon comes from it being redeemable for something of value. It is like paper money backed by gold. But our fiat money is not backed by anything. Holding a dollar doesn't mean anyone has to give you gold, or baby sitting, or anything at all. Thus, it is a slave to the law of supply and demand. The more dollars there are, they less they are worth.
Bottom line, printing coupons solved their problem; printing dollars will make our problems worse. Ask Zimbabwe and the Wiemar Republic.
Tune in next blog for more flaws in Krugman's ridiculous analogy.
[EDIT: 11/17/11 Bob Wenzel does a nice job right here about the co-op. He adds that the co-op stopped working because of taxes! Interesting take, worth reading. You may note that we share some of the same ideas.
Also, Krugman has not been lying down on the job defending his thesis. As Wenzel quotes him, Krugman has refuted criticisms of his co-op analogy with a great one liner. His "harassers" are getting "bogged down in the details". OK.]