How can the example of a babysitting co-op help us understand the financial crisis?

Economist Paul Krugman's latest book "End this Depression now!" is a passionate and well-argued call to action. He challenges the conventional understanding of the financial crisis and claims that "we have both the knowledge and the tools to end this suffering."

Krugman lambasts the proponents of austerity in both the Republican and Democrat parties. "They think of the US economy as if it were a family fallen on hard times, its income reduced by forces beyond its control, burdened with a debt too large for its income." Krugman's thesis is that on the contrary, the financial woes on both sides of the Atlantic persist because we are not spending enough to stimulate growth and demand. So if the metaphor of an indebted household is misleading and inaccurate, how should we understand the financial crisis?

Krugman proposes a story about a babysitting co-op which first appeared in the Journal of Money, Credit and Banking in 1977. The story involves 150 couples who group together to share babysitting. Each couple is given 20 coupons which can be traded to pay for a babysitter. This way, each couple has reciprocate for the babysitting it desires and the hours balance out.

But the co-op hit difficulties when there weren't enough coupons in the system. Couples became worried about running out of coupons, so they kept a supply of them in reserve. This meant that the total amount of babysitting slumped, as there were less hours available. As Krugman puts it, the key message from this is that "your spending is my income, and my spending is your income." Saving coupons, cutting spending or "tightening our belts", whatever we call it, hurts the economy around us. Everyone in the co-op was going out less because of the shortage of coupons. The only way to get the co-op going again is to increase the number of coupons.

The cause of the babysitting co-op's difficulties was not  that members were abusing the system. They weren't bad parents and they didn't lack babysitting experience. The issue was simply a lack of supply. The same thing goes for the financial situation in the USA and the crisis in the Eurozone. It has nothing to do with government overspending, overgenerous benefits or a glut of "shirkers" as Labour minister Liam Byrne put it.

Historically, recessions such as the Great Depression before World War II or the recession of 1979-1982 have been overcome by spending our way out of them. Massive government borrowing to invest in industry and infrastructure create jobs, enabling people to buy products from others, thereby stimulating the economy as a whole.

Despite the fact that Paul Krugman won the Nobel Prize in Economics in 2008, governments continue to ignore his advice, at an extraordinary cost to the economy and the population. Essentially, the economy of the US is not using its resources. In 2011 there approximately 24 million people unemployed in the US. This is sometimes been blamed on a lack of skills in the workforce, but Krugman points out that unemployment has affected people across the board, regardless of qualifications. When MacDonalds advertised 50 000 vacancies in 2011 it received one million applications.

Between 2006 and 2010, the number of cars bought in the US dropped from 16.5 million to 11.6 million, and the number of houses built fell from 1.8 million to 585 000. Krugman claims "the US economy is operating at 7% below its potential," leading to a loss of one trillion dollars of value per year. And "what makes this disaster so terrible - what should make you angry - is that none of this need be happening."

It's high time governments in the US and Europe thought about the recession in terms of a babysitting co-op.