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In an earlier "Dismal Science" column titled " Setting Sun ," Dr. Krugman prescribed the useful medicine of inflation to rouse the Japanese economy. For a more technical treatment by Krugman about Japan's liquidity trap, see this article on his home page. Paul Krugman is a professor of economics at MIT and the author, most recently, of, The Accidental Theorist and Other Dispatches From the Dismal Science. His home page contains links to many of his other articles and essays. Illustrations by Robert Neubecker.











NOTE 1 We could move the story a bit closer to the way real economies work by imagining that

couples could borrow and lend coupons; the interest rate in this infant capital market would

then play the role that the "discount rate" of the co-op management plays in the text.

NOTE 2 Well, maybe not so obvious. The basic problem with the winter co-op is that people want to

save the credit they earn from baby-sitting in the winter to use in the summer, even at a zero

interest rate. But in the aggregate, the co-op's members can't save up winter baby-sitting for

summer use. So individual efforts to do so end up producing nothing but a winter slump. The answer is to make it clear that points earned in the winter will be devalued if held until

the summer--say, to make five hours of baby-sitting credit earned in the winter melt into only

four hours by summer. This will encourage people to use their baby-sitting hours sooner and

hence create more baby-sitting opportunities. You might be tempted to think there is

something unfair about this--that it means expropriating people's savings. But the reality is

that the co-op as a whole cannot bank winter baby-sitting for summer use, so it is actually

distorting members' incentives to allow them to trade winter hours for summer hours on a

one-for-one basis. But what in the nonbaby-sitting economy corresponds to our coupons that melt in the

summer? The answer is that an economy that is in a liquidity trap needs expected

inflation--that is, it needs to convince people that the yen they are tempted to hoard will buy

less a month or a year from now than they do today. The diagnosis that Japan is in a liquidity trap--and proposals for inflation as a way out of this

trap--has been widely publicized in the last few months. But they have had to contend with a

deep-seated prejudice that stable prices are always desirable, that to promote inflation is to

cheat the public out of its just reward for saving to create perverse and dangerous incentives.

Indeed, some economists and commentators have tried to claim that despite all appearances,

Japan is not in a liquidity trap, perhaps even that such a thing can't really happen. But the

extended baby-sitting story tells us it can--and that inflation is actually the economically

correct way out.



