Monetary bleg

Send me money bitcoin. Oh wait …

More seriously, send me information.

I’m sure Cats recall a story explaining liquidity traps. The story goes along the lines of a businessman paying a cash deposit to an innkeeper in a small town. The innkeeper then uses the cash  to pay his debts. The innkeepers creditor then uses the cash to offset his debts, and so on. Eventually the entire town has paid their debts and the cash is back in the hands of the innkeeper. At this point the businessman changes his mind and the deposit is refunded. The point being that an injection of cash would be a good thing.

I seem to recall that Paul Krugman originally told this story. But … I can’t find it anywhere. Krugman uses a story about a babysitting co-op to illustrate the liquidity trap.

So my question is: can anyone tell me who first told the story and were I can find it?

Many thanks.

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16 Responses to Monetary bleg

  1. Tim Neilson

    The debts have been eliminated from the perspective of the debtor, but they’ve also been eliminated as assets from the perspective of the creditor (including the innkeeper, if he gets the cash back at the end).

    You could do the whole thing by assignment of debts without any cash being involved.

    This is another Keynesian economists and the dog turds story, isn’t it?

  2. Sinclair Davidson

    P – thank you. That is the story.

  3. Mundi

    That story I think it’s very old and has been rehashed a lot. I think it dates back to Keyee and depression era… As much as I want Krugman to be the issue who said it first.

  4. .

    If only we could create liquidity without any cost or unintended consequences.

    That is what that story amounts to. Everyone is better off except for the innkeeper who is no worse off.

    This is no better than arguing for debt jubilees.

  5. vlad

    Dudeney died in 1930. That link – made a nice mess of the webpage, didn’t it – is to Martin Gardner’s edition, published 1967.

  6. .

    This is really an example of sloppy reasoning.

    There is no “need” for liquidity until the entire process completes and then the deposit is returned.

    In aggregate, there is ample liquidity anyway without creating more liquidity by fiat.

    Furthermore, the “need” for the liquidity is only temporary. The businessman either goes to another hotel or keeps his own money in the bank or does not use his company funds.

    There is no need to supply more credit by fiat – the townsfolk can simply borrow off the businessmen or his intermediary.

  7. JC

    There’s an accounting fault with the with the trail.

    1. businessman pays the innkeeper with a cash deposit.
    This works. Okay

    2. Innkeeper pays his debts
    This works too. Okay

    3. The entire town pays their debts.
    To whom? Does this mean the “town” is bigger than the cast of characters in this cheap play?

    4. Money goes back to the innkeeper.
    How so? Just like that? Presumably people have stayed at the inn. These aren’t people acting in this cheap play.

    5. The businessman changes his mind and the deposit is refunded.
    The innkeeper has received more money , presumably from people staying at the inn. If he can’t repay what he owes then the innkeeper is theoretically broke. Bankruptcy happens frequently.
    This example of money flows is so flawed, it’s hard to figure what it is trying to convey.

  8. Dan Dare

    The Inkeeper is down €100.
    That’s all folks.

  9. vlad

    This is the puzzle as stated by Dudeney, edited by Gardner (and my thanks to whoever fixed up my post above; I’ll do better in future):

    A banker in a country town was walking down the street when he saw a five-dollar bill on the curb. He picked it up, noted the number, and went to his home for luncheon. His wife said that the butcher had sent in his bill for five dollars, and, as the only money he had was the bill he had found, he gave it to her, and she paid the butcher. The butcher paid it to a farmer in buying a calf, the farmer paid it to a merchant who in turn paid it to a laundry woman, and she, remembering that she owed the bank five dollars, went there and paid the debt.

    The banker recognized the bill as the one he had found, and by that time it had paid twenty-five dollars worth of debts. On careful examination he discovered that the bill was counterfeit. What was lost in the whole transaction, and by whom?

    I don’t agree with the answer as given at the back of the book, but I’ll leave that for another time.

  10. Dan Dare

    Same again
    The bank is down $5

  11. Bruce of Newcastle

    I’m amused that Maduro has fixed the new Venezuelan bolivar (minus five zeroes) to the petro, which is apparently a blockchained cryptocurrency.

    It doesn’t seem to be working since Maduro now has gone off to beg the Chinese for money, by way of Istanbul for a nice steak.

    There may be a lesson in these antics.

  12. vlad

    This is what the book says as the answer (according to my copy, which uses pounds instead of dollars; I’ve changed it back over to dollars at the only place it matters):

    Since the identical counterfeit bill can be traced through all the transactions, these are all invalid. Therefore everybody stands in relation to his debtor just where he was before the banker picked up the note, except that the butcher owes, in addition, $5 to the farmer for the calf received.

    I don’t think much of that as an answer. But I think you could go around in circles forever with this one.

  13. RobK

    The story that P linked was a situation where everyone had equal credit and debit. A promissory note issued by the inn keeper could have made the round and settled all the debts on its way back to the inn keeper. The tax man misses out and they all go to jail.

  14. JohnA


    I don’t think much of that as an answer. But I think you could go around in circles forever with this one.

    Yes, and then, no.

    As Dan Dare said (twice), the banker is out because he accepted a loan settlement with what turned out to be a dud fiver. Everyone else believed the note was genuine and accepted payment in satisfaction of their respective debts.

    If the banker ignores the counterfeit status of the note and keeps it in circulation, then the money supply has been inflated by $5. If he burns the note, he is $5 poorer for having accepted it in settlement. His only other course of action is to declare the note counterfeit and then trace back all those transactions so they can be reversed.

    Likewise, the innkeeper example only works in a closed system as the answer from Artemis Gorgo shows. Each closed system only works because the townspeople only trade among themselves.

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