Functional Finance: A Practical Approach to Economic Management

Functional Finance, a radical departure from orthodox economic thinking, offers a pragmatic perspective on government fiscal policy. Championed by economist Abba Lerner, it posits that the primary goal of government finance is to achieve desired economic outcomes, such as full employment and stable prices, regardless of traditional budgetary constraints.

Unlike balanced budget dogma or adherence to predetermined debt levels, Functional Finance prioritizes the function of government spending and taxation. Specifically, a government should:

Spend when there is insufficient private spending to achieve full employment.
Tax when there is excessive aggregate demand that threatens inflation.
Borrow when it desires to shift the interest rate structure.

The focus shifts from balancing the budget per se to achieving macroeconomic equilibrium. A budget surplus or deficit is merely a consequence of pursuing these functional objectives, not an end in itself. The traditional worry about accumulating government debt is largely dismissed as long as the debt is denominated in the government’s own currency and the economy operates below its productive capacity.

A core tenet is the understanding that a sovereign government, which issues its own currency, cannot become insolvent in that currency. It can always create more currency to meet its obligations. This refutes the household analogy, which likens government budgets to personal budgets. A household faces genuine constraints on its spending based on income; a sovereign government issuing its own currency does not face the same limitations.

The implications of Functional Finance are significant. It justifies government intervention in the economy to address unemployment, inequality, and other societal challenges. For instance, during periods of economic recession, the government can and should actively engage in deficit spending to stimulate demand and create jobs, even if it means increasing the national debt.

However, Functional Finance is not without its critics. Concerns are raised about potential inflationary pressures resulting from excessive government spending, even if the initial intention is to boost employment. Critics also point to the potential for political abuse, where governments might use Functional Finance as a justification for unsustainable spending policies. Furthermore, the impact on exchange rates and international trade relations also needs consideration.

Despite these criticisms, Functional Finance remains a powerful and influential framework for understanding the role of government in managing a modern economy. Its emphasis on achieving desired economic outcomes, rather than adhering to rigid fiscal rules, offers a flexible and potentially more effective approach to economic management, particularly in times of crisis or significant economic challenges. Understanding its principles is crucial for navigating the complexities of modern economic policy.