The babysitting co-op, central banks, and the global recession.

[Imperialism Inc.]

I'm currently reading Paul Krugman's The Return of Depression Economics and the Crisis of 2008. In it Krugman uses the real life story of a baby sitting co-op that experienced a recession to help explain recessions in general. He also expands the real story to model the situation Japan faced in the late 90's (and now the entire world). It may seem silly but by using an example of a small economy that is easy to get your head around it can help you to understand the issues involved. Luckily the story is available online in a very old article from 1998. Recessions, central bank money printing, interest rates, liquidity traps, and inflation expectations as means of getting out of the trap, it is all there.

Baby-Sitting the Economy
http://www.slate.com/id/1937/

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The Capitol Hill co-op adopted one fairly natural solution. It issued scrip--pieces of paper equivalent to one hour of baby-sitting time. Baby sitters would receive the appropriate number of coupons directly from the baby sittees. This made the system self-enforcing: Over time, each couple would automatically do as much baby-sitting as it received in return. As long as the people were reliable--and these young professionals certainly were--what could go wrong?
Well, it turned out that there was a small technical problem. Think about the coupon holdings of a typical couple. During periods when it had few occasions to go out, a couple would probably try to build up a reserve--then run that reserve down when the occasions arose. There would be an averaging out of these demands. One couple would be going out when another was staying at home. But since many couples would be holding reserves of coupons at any given time, the co-op needed to have a fairly large amount of scrip in circulation.
Now what happened in the Sweeneys' co-op was that, for complicated reasons involving the collection and use of dues (paid in scrip), the number of coupons in circulation became quite low. As a result, most couples were anxious to add to their reserves by baby-sitting, reluctant to run them down by going out. But one couple's decision to go out was another's chance to baby-sit; so it became difficult to earn coupons. Knowing this, couples became even more reluctant to use their reserves except on special occasions, reducing baby-sitting opportunities still further.
In short, the co-op had fallen into a recession.

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Be sure to read the link at the end as it has something important to say.