First things first: Krugman is absolutely right that we learn a lot from well-chosen simple examples. But this particularly example seems poorly chosen.
The Capitol Hill Baby-Sitting Co-Op consisted of about 150 couples who baby sat for each other. They paid each other in scrip — pieces of paper each worth a half hour of baby-sitting time. New members received 20 units of scrip, which they were expected to pay back upon retiring. Aside from that, you earned scrip by baby-sitting, and you purchased baby-sitting with scrip, so that in the long run you’d sit exactly as much as you were sat for.
The problem was that people started hoarding scrip, thinking they might need it someday. As a result, the demand for babysitting services dried up. This made it harder to earn scrip, which encouraged even more hoarding, and so on around the vicious circle. The solution was to issue more scrip — each member got 10 more units. This made the hoarders a little less frantic and a little more willing to go out, which meant more sitting jobs were available, which eased the hoarder’s minds still further, and soon the co-op entered a golden age.
That, says Krugman, is the story of most recessions. People hoard money, which makes it hard to earn money, which makes people hoard still more money, which makes it even harder to earn money. The solution is to issue more money.
But here’s the part of the baby-sitting story that never made sense to me: Why didn’t prices adjust? If everyone’s hoarding scrip, and nobody can find a baby-sitting job, why doesn’t someone offer to babysit for half the usual amount of scrip? Why isn’t that enough to get things moving again?
Presumably the babysitting co-op enforced (implicitly or explicitly) some social norms that discouraged such behavior. The rules said that a unit of scrip was worth a half hour of babysitting time, and to trade at some other rate was to violate the rules. But there are no such rules in the macro-economy. If Dell can’t sell enough computers, and responds by lowering its prices, nobody yells that Dell broke the rules.
So Krugman’s favorite story about recessions — the one that he says “changed his life” — is really just a story about babysitting co-ops, unless it’s supplemented with some other story about what keeps real-world prices from falling. Until he tells us what that supplemental story is, Krugman’s got nothing.