Bernanke Bankrolls a Rich-Kid's Card Game
Here, a group of young D.C. professionals traded scrip (measured in hours of babysitting) for babysitting services. However, as couples began to save their scrip for special occasions, the overall level of babysitting activity began to decline. To counteract this decline in economic activity, the co-op issued more scrip to new members, which increased babysitting activity for a while, until the co-op issued too much scrip, resulting in another recession.
While I don't agree with Krugman's assessment of this story (that monetary policy should be used to manage an economy), I do agree with his statement that "whimsical parables are not a waste of time but the key to enlightenment."
To that end, I'd like to offer my own parable -- actually, an observation from my college years.
My fraternity played poker on the weekends. Games were held in a tournament style, where every player bought in for a fixed amount of money. The buy-in wasn't large, so the games attracted a good amount of players. And because each player started on equal footing, the games lasted for a while, most hands were played out and, usually, the most skilled players won.
One day, one of our well-to-do brothers (whose father, amusing to me, was an investment banker) convinced us to abandon tournament play in favor of no-limit betting (heck, it would be stimulating). We went along with it, but the game was never the same. Here's what happened:
For the purposes of our games (which had historically seen $10 pots), some players now had "unlimited" funds. This allowed these players to "buy the pot." They didn't win because they had more skill, but because the other players no longer had the resources to compete.
Some of the bolder, if not richer, players bet headstrong with funds they didn't have (to some degree of success). But the smaller players folded more and more hands -- and, ultimately, left the game altogether.