Functional Perspective Finance - Financial Business

Functional finance, a theory championed primarily by economist Abba Lerner, offers a radical perspective on government’s role in economic management. Unlike traditional views focusing on balancing the budget or adhering to specific monetary rules, functional finance prioritizes achieving desired economic outcomes, like full employment and stable prices, regardless of the budgetary consequences. The core principle is simple: the government’s fiscal and monetary policies should be judged solely on their effectiveness in achieving economic goals, not on whether they result in budget surpluses or deficits. Lerner argued that worrying about the national debt is secondary. The primary objective is to maintain economic stability and prosperity. If achieving these goals requires running a deficit, then a deficit it should be. This approach rests on two key rules. First, the government should maintain a reasonable level of aggregate demand to ensure full employment. If private spending is insufficient, the government should step in through increased public spending or tax cuts. Conversely, if aggregate demand is excessive and threatens inflation, the government should reduce spending or raise taxes. This continuous adjustment aims to maintain the optimal level of economic activity. Second, if borrowing is needed to finance government spending, the government should borrow. However, this borrowing shouldn’t be viewed as a burden to be avoided at all costs. It’s simply a tool to manage the economy. If borrowing causes undesirable consequences, like inflation, then the government should print money to cover the expenses, or raise taxes to reduce aggregate demand. A crucial distinction is made between “real” debt and “internal” debt. Real debt is owed to foreign entities and represents a claim on future domestic production. Internal debt, owed to domestic creditors, is essentially a transfer of wealth within the nation. Functional finance posits that internal debt is less of a concern, as it primarily redistributes income rather than draining resources from the economy. However, functional finance faces several criticisms. One major concern is the potential for inflation. Critics argue that unrestrained government spending, even with the intention of stimulating the economy, can lead to excessive money creation and hyperinflation. Maintaining control and accurately predicting the impact of government interventions is paramount and potentially challenging. Another critique revolves around political feasibility. The theory requires a government that is both technically competent and immune to political pressures. The temptation to overspend for political gain or to avoid unpopular tax increases could undermine the discipline required for effective functional finance. Furthermore, the long-term effects of consistent deficit spending on interest rates and investor confidence remain debated. Despite the criticisms, functional finance provides a valuable framework for understanding the government’s role in economic stabilization. It shifts the focus from abstract budgetary targets to concrete economic objectives. While not without risks, it highlights the potential for government policy to actively shape economic outcomes and address critical societal needs. Whether it can be successfully implemented in practice hinges on careful planning, rigorous monitoring, and a commitment to prioritizing economic well-being over short-term political considerations.