Academic journal article Journal of Money, Credit & Banking

The Great Capitol Hill Baby Sitting Co-Op: Anecdote or Evidence for the Optimum Quantity of Money?

Academic journal article Journal of Money, Credit & Banking

The Great Capitol Hill Baby Sitting Co-Op: Anecdote or Evidence for the Optimum Quantity of Money?

Article excerpt

SWEENEY AND SWEENEY'S (1977) report on the Great Capitol Hill Baby Sitting Co-op, which has been popularized by Krugman (1999), is without doubt an entertaining anecdote to illustrate the optimum quantity of money. This paper analyzes whether this story is more than a mere anecdote.

The Great Capitol Hill Baby Sitting Co-op was a "cooperative" of about 150 couples, with the goal of sharing baby-sitting fairly among themselves by introducing a coupon system. One coupon entitled each member to receive half an hour's worth of baby-sitting. Initially, one coupon of baby-sitting was issued to each couple. Supposing that coupons circulated, each couple would, over time, do as many units of baby-sitting as they received in return. After a short while, however, the system collapsed, because there was not enough demand for baby-sitting. Krugman (1999) attributes this breakdown to precautionary savings. The Co-op solved this problem simply by issuing more coupons. Having found out that each couple was better off with an increase in the number of coupons available, the Co-op continued to issue more coupons, which eventually resulted in a breakdown of the system. The moral of this anecdote is that a market in which prices are fixed only works efficiently for a specific, "optimal" quantity of money.

The Great Capitol Hill Baby Sitting Co-op is just one example of a trade circle. Trade circles, which have become increasingly common, provide a field for clinical studies on the role of money. Trade circle members can buy or sell services at fixed prices. The supplier of a service receives "artificial" money, or coupons, which he/she can then use to buy services. Prices are fixed by fairness considerations and credit is limited. Money usually has a positive value in exchange for services, and its introduction leads to a Pareto-improvement over the situation without money.

While the importance of the quantity of money has not been reported from other trade circles, the Capitol Hill Baby Sitting Co-op is a beautiful anecdote to illustrate the role of money in simple markets with idiosyncratic uncertainty and fixed prices. It suggests that individual rationality is typically at odds with collective rationality, and that only a specific amount of money helps to overcome this problem if prices are fixed. From a collective point of view, it is preferable that all participants hold more money if there is an excessive amount of it. If money is scarce, then precautionary savings are contrary to the common interest.

The report on the Capitol Hill Baby Sitting Co-op only gives anecdotal evidence for this quite general claim on the existence of an optimum quantity of money. It could still be conjectured that the reasons for these observations are totally different from those put forward above. For example, one might argue that money holdings are determined by myopic expectations on the future resale value, so that the market breaks down because expectations are incorrect in the long term. Whether the Capitol Hill Baby Sitting Co-op is, in fact, more than an anecdote for the optimum quantity of money can only be decided by extracting the underlying fundamental mechanisms and by studying them in a formal model. This approach will provide us with analytical results, and it will make the above reasoning testable under controlled conditions in a laboratory experiment. A sound theory, in combination with additional experimental observations, can provide more solid evidence for the story told by the Capitol Hill Baby Sitting Co-op.

In pursuit of this goal, we develop a formal model of a monetary economy with a perishable good that can be traded in a centralized market. Competitive behavior is ensured by assuming a continuum of agents, each having stochastic preferences. According to this specification, no agent thinks of him/herself to be in a position to change market averages resulting from the actions of all agents. …

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