Tuesday, March 4, 2014

Email: Stimulus

So, I got this in an email.  And the author/forwarder apparently thinks it is an obvious knock-down argument against Keynesian "stimulus" packages.

I'm not so sure.  What do YOU think?  Is there fraud, or is this simply an odd euvoluntary exchange?

$100.00 Bill 

This is great and says it all! It 's a slow day in the small town of Pumphandle and the streets are deserted. Times are tough, everybody is in debt, and everybody is living on credit. A tourist visiting the area drives through town, stops at the motel, and lays a $100 bill on the desk saying he wants to inspect the rooms upstairs to pick one for the night. 

As soon as he walks upstairs, the motel owner grabs the bill and runs next door to pay his debt to the butcher. (Stay with this..... and pay attention)The butcher takes the $100 and runs down the street to retire his debt to the pig farmer. The pig farmer takes the $100 and heads off to pay his bill to his supplier, the Co-op. The guy at the Co-op takes the $100 and runs to pay his debt to the local prostitute, who has also been facing hard times and has had to offer her "services" on credit. 

The hooker rushes to the hotel and pays off her room bill with the hotel owner. The hotel proprietor then places the $100 back on the counter so the traveler will not suspect anything. 

At that moment the traveler comes down the stairs, states that the rooms are not satisfactory, picks up the $100 bill and leaves. No one produced anything. No one earned anything. However, the whole town now thinks that they are out of debt and there is a false atmosphere of optimism and glee. And that, my friends, is how a "government stimulus package" works!


  1. It's an interesting story, but it's not true that "no one produced anything". Everyone "produced" they simply did so on credit regarding money payment.

    At first glance, it seems that what makes the story work is the author has assumed a cash poor system and then built on that. There appears to be plenty of production happening, but no one has introduced enough money to make things work smoothly.

    Conclusion: That town needs a bank.

  2. Ummm, a circular chain of everyone owing someone else $100 is exactly economically the same as a situation where no one owes anyone anything. There's no stimulus. People had a net position of zero before the tourist (they owed $100 and someone owed them $100) and had the same position of zero after the tourist. It's not stimulus, hell it's not even exchange!

    1. Nailed it. Remember what Buchanan said about cost and choice. The cost is incurred at the time of choice. Everything else is economically irrelevant accounting, perhaps slightly wasteful as everyone runs around town slipping a piece of paper back and forth.

  3. Ummm, isn't this an example of money easing the transaction costs of, and thus facilitating economic activity in, what otherwise would be a barter economy?

  4. First, why the scare quotes on the prostitute's services? The story's author is perhaps totally committed to euvolutary exchange.

    The story would have been better if the $100 bill took a few minutes longer to make its circuit. What fun when the traveler comes down to find his money missing! Of course, these people could exchange their debt without the physical vehicle. The moral seems to be Keynesianism is for dummies.

  5. Richard Koo would say that this would be a much more important and powerful effect than the traditional "Keynesian" effects that Krugman thinks stimulus has.

  6. This example often is used to demonstrate the importance of money shortages (or more precisely, excess money demand) in its role as a medium of exchange. Money lowers transaction costs, including those that apparently rose in this small town that prevented these parties from settling their accounts. This story is entirely consistent with the new monetary search models that were started by Lagos and Wright (2005).


Do you have suggestions on where we could find more examples of this phenomenon?