How does an economic downturn happen in ‘everyday’ language?

Saturday May 23 2020

 

By Samuel Sejjaaka

There is a lot to learn from simple everyday anecdotes. Like the riddle of the traveller and the lodge owner. It goes something like this.

A lone traveller arrives in a town where business is slow and everyone is in debt. He is looking for a place to stay. He approaches the town’s only lodge and inquires about the availability of a place of abode.

The lodge owner is so happy to see him and convinces him to stay. Whereupon the traveller deposits $100 for his stay. He then goes upstairs to check out his room.

The lodge owner thinking that he has made an actual sale of services rushes to the butcher and pays of his debt.

The butcher, takes the $100 and rushes to pay the farmer, who being a man accustomed to earthly pleasures takes the $100 and pays off the village prostitute for her services. The prostitute in turn rushes back to the lodge and pays for the use of the facility in her enterprise.

Just as she finishes paying, the traveller comes down the stairs and informs the inn keeper that unfortunately he is not satisfied with the lodging he has been provided with and will not be staying.

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The inn keeper obliges and refunds the traveller who then leaves town.
Note that no one produced anything and no one earned anything, however the whole ‘town’ is debt free.

At the beginning each resident has a $100 liability. But each also has an offsetting financial asset of $100.
At the end, they all have neither. So the $100 bill acts as a clearing mechanism.

If we think of the town as a distinct economy, then the traveller has temporarily increased the town’s money stock by $100. In effect, he has made a short-term loan of a new $100 bill, thereby increasing liquidity.

The $100 provides the residents with a medium of exchange that allows them to clear their debts and illustrates a situation in a perfectly functioning market. (You can read more about this riddle at https://www.econlib.org/archives/2012/01/an_answer_to_a.html).

Things were flowing along as fairly as one could envisage before the lockdown. The inn keeper (read mall owner) who had borrowed money from the bank had paying tenants. The tenants had customers who came and bought goods for consumption or use in their businesses.

The tenants also bought goods from the industries for resale and the industries used their revenues to pay workers, suppliers and the banks. The workers used their pay to buy goods and services (including school fees) and loan servicing.

The schools then used their income to pay the teachers, buy inputs and also service their loans. The government watched all this activity and demanded a cut (taxes) for allowing the people to do as they wished.

In this narrative, we see five classes of economic agents who include (1) households, (2) businesses, (3) government, (4) the rest of the world, and (5) the financial sector.

Generally so long as lending is equal to borrowing the economy gets by. And thus we arrived at the lockdown. Some economic agents were denied the capacity to produce while being expected to continue consuming goods and services.

However, others who feature prominently in the circular flow of incomes (read financial institutions and government) continue demanding for payment for the use of their depositors’ money and taxes respectively from the other inoperative or comatose actors.

That is the bit about the riddle that needs watching. As long as every actor cooperates, there is no problem and the traveller never notices. Trouble is when the chain is broken as in the lockdown. That is when a stimuli is needed to get the ‘town’ back on its feet.

Unfortunately, the two (strongest) actors who can do that seem not to be in a position to do so. They still want you to service that loan and pay taxes.

Prof Sejjaaka is country team leader at Mat Abacus Business School.
sejjaaka@gmail.com
@samuelsejjaaka

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