Wednesday, May 16, 2012

Want to understand the economic woes in Europe?

International Money Pile in Cash and Coins
Photo by epSos.de
Read Krugman Wishes He Were Wrong Amid EU Austerity Backlash. And if you're struggling to understand what a recession really is, read this story about a baby-sitting co-op that failed because ... it went into recession. This is relevant because in my post covering whether or not it's a bad time to move to Paris, one respondent argued that with the economic uncertainty in Europe, of course it's a bad time.

In the baby-sitting co-op mentioned above, couples agreed to baby sit for other couple's babies. They would receive a coupon if they babysat and pay one out if they needed baby-sitting. It worked well until at one point, a lot of couples wound up having babysat quite a bit and had reserves of coupons and there were few coupons in circulation. Other people were afraid to pay coupons for a baby sitter because they were worried that there wouldn't be coupons left for them to earn later. Thus, they only spent their coupons if they had to.

The co-op, thus, went into a recession. How could you get out? You could, um, try to force people to spend their coupons, but people aren't going to be very happy about that. What's the point of the co-op if it forces you to do something? You could try to take the coupons and forcibly redistribute them, but people certainly hadn't signed up for that! (For those who are thinking "taxes", don't forget that most major economies allow voting and people have a say in how taxes work).

Maybe pass rules against hording? How are you going to enforce those? Maybe you could fiddle with prices and say that you only need to spend a half coupon to hire a baby sitter and you still get a whole one to baby sit. That might work in the short run, but as any economist will tell you, you could easily have more people wanting to baby sit than to have their children babysat (this would make more sense if the coupons were fungible, but eventually a "black market" in coupons could arise quite innocently).

Well, you could print more coupons, but people argue that this would be inflationary. But that's the point! I've argued against this in that past, but now I'm pretty sure I'm wrong. Here you print more coupons, break the hoarding cycle and things are running smooth again, you remove some of the coupons from circulation or you invite more people into the co-op.

Which is the exact opposite of what most governments in Europe are doing. Nobody's buying, so the governments are demanding austerity programs where we continue to not buy. Anybody see a problem with that? Yeah, I thought so.

Interesting, the US government may come to Europe's rescue. The FATCA program is creating a huge new banking industry sector across the planet. I'm guessing it's not enough, by itself, to pull Europe out of its crisis, but it could certainly help.

7 comments:

  1. erm... remove some of the coupons? Before or after the coupon has devaluated? And how do we remove these coupons, do we take them by raising taxes? Once these coupons have been printed its rather hard to claim them back.
    And to invite more people in the co-op you better make sure there are more baby's to take care of first, or should these people bring their own babies too (read businesses).
    I'm afraid the only way out is to except that we have less coupons for a while, until we have actually more babies to generate more coupons etc.
    But since nobody wants less coupons today, we vote for governments that will print these just like the Americans do. This way we can pretend times are the same as a few years ago when we all lived on loaned coupons. Which banks foolishly lend us to receive big bonus-coupons.
    Since we can prepare for more print-coupons-governments we better make sure we hold real value stuff like food, houses and GOLD. So when hyper-inflation hits in max 5 years time, we are still able to get babysitters (who at that time use the coupons to wipe their arses).

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    1. You wrote: I'm afraid the only way out is to except that we have less coupons for a while. Except that fails abysmally because that's effectively the problem the co-op faced in the first place: people were afraid that if they spent their coupons for baby-sitting, they wouldn't be able to get any for later if they really needed them. Thus, saying "the system's failing because we're not spending enough coupons, so we're going to guarantee that people can't spend those coupons" is trying to put out a fire with gasoline.

      Remember: the problem in an economic downturn isn't that the money mysteriously disappeared. The money is still there, it's just not being spent, so a government program that decides to increase the tendency not to spend money is dangerous. And if austerity magically worked, why is Europe, after years of austerity, still struggling? If it's a light downturn, it's entirely possibly that it's a normal, self-recovering business cycle, but sometimes things get depressed enough that individual action isn't enough to overcome the problems, so government must act to jump start the economy.

      Obviously the story of a baby sitting co-op is an inexact analogy, particularly since the coupons are not fungible and you'd have to expand the coupons in many areas to get a better analogy with a real economy, but the basic process of a recession is the same. But you are correct to point out the problem of removing coupons after the economy has recovered. That's frequently done with a mix of both monetary and fiscal policy. Unfortunately, Europe doesn't have much flexibility due to a monetary union without a fiscal union. I'm sure many people holding Greek debt right now would be delighted if Greece could devalue their currency rather than default on their debt but Greece, stuck with the Euro, doesn't have many options.

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  2. I'm afraid the right approach is not known, we can only have believes. And the fact that Europe is still struggling after years (2-3 years) of austerity is not really solid evidence that printing money is the way to go. One can say that printing money is in fact keeping an artificial growth in place, only to come back at 30's style inflation, probably ending in war.
    But then again, if people start losing jobs now we might get social unrest (or worse) too in another approach.
    You are right in stating that people are afraid to spend their money causing part of the issue. However, money did disappeare though, and not mysteriously. It was lent out by banks and not paid back or not backed by any underlying value, causing mistrust and a credit crunch.
    Perhaps we should allow us to shrink with say 10%, we back at 2003 levels. Was it so bad then? Of course it is easier for me (working) to say than for a jobless single mom.
    If you wanna read some doom thoughts about governments buying their own dept with printed money and the coming big collapse...
    http://www.propertyinvesting.net/cgi-script/csNews/csNews.cgi?database=specialreports%2edb&command=viewone&id=397&op=t

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    1. I think you're right that we don't know the right approach, but only in that we may be too far down the road for any known approach to reasonably stave off a crash :(

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  3. Replies
    1. I do admit that I like what they did :)

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  4. Really lovely explanation of how a recession works. Thanks.

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