Babysitting Indian economy

In 1930s young US senators with babies had a problem. Senators and their wives normally attend a lot of parties and babysitting cost was huge. So they formed a cooperative among themselves where they baby sit each other whenever they don’t have parties. Co-op issued tokens that can be exchanged for an hour of babysitting. Therefore to use tokens they had to be earned. The system was thus equitable.

Due to unforeseen circumstances, the number of tokens in circulations became low. A few nervous senators were more willing to baby sit than attend parties. This exacerbated the situation as the token circulation became fewer. The co-op had fallen into a recession.

The co-op tried to regulate the group by making it mandatory for senators to go out at least twice a week. But it was found that the problem was not legal but technical. They then found a more viable alternative.

The co-op gave out more tokens. The situation became normal as more tokens were now in circulation. But the co-op overdid it. Now everyone had a lot of tokens and no one was willing to baby sit; a different kind of recession.

Instead of simply offloading more tokens into the market, Co-op allowed lending of tokens for an interest. So if interest rate is 5%, the senators should return 105 tokens for every hundred borrowed. Now whenever there is a sign of recession all they had to do is change the interest rates. When circulation is fewer, lower the interest rate and in case of a glut, raise it.

This is the gist of the influential paper on macroeconomics "Monetary Theory and the Great Capitol Hill Baby-Sitting Co-op Crisis." By Joan and Richard Sweeney, Journal of Money, Credit, and Banking (1977). Where is the connection?

Tokens - money, cooperative - RBI.

What happens when the government wants to encourage savings and discourage spending? The RBI prior to 1990s maintained a high interest rate regime. Banks gave a high interest on FDs and charged a high interest on loans. As a result there was a lot of saving and little spending and Indian economy crawled at a hindu rate of growth of 3-4% of GDP. It was only after the reforms and a low interest regime did the spending was stimulated, demand picked up and there were more investment in productive capacity of the economy resulting in high growth.

What happens during liquidity overhang – the cute expression means a lot of tokens in circulation, thereby raising inflation? RBI raises interest rates. This is precisely what RBI did September last year when it increased cash reserve ratio (CRR)-reserve maintained by banks with RBI by 50 basis points (0.5%). Money was sucked up, people bought less, demand lessened and inflation was put under control.

So next time you see something about interest rates, monetary policy, inflation or recession, extend the babysitting theory. It is worth a year of studying macroeconomics.