Functional Finance

Functional finance is an economic theory proposed by Abba P. Lerner , based on the principles of effective demand and hartalism . This theory says that the government should finance itself to achieve explicit goals, such as taming the business cycle, achieving full employment, ensuring growth and low inflation.

Principles

The main ideas behind functional finance can be summarized as follows:

• Governments must intervene in the national and global economies; these economies are not self-regulatory.
• The main economic goal of the state should be to ensure a prosperous economy.
• Money is the creation of the state; they need to be managed.
• Fiscal policy should be aimed at developing the economy, and the budget should be managed accordingly, that is, the “balance of income and expenses” is not important; prosperity is important.
• The amount and rate of government spending should be set taking into account the desired level of activity, and taxes should be levied for economic impact, and not for increasing revenues.
• The principles of “reasonable financing” apply to individuals. They make sense to individuals, households, businesses, and non-sovereign governments (such as cities and individual US states), but do not apply to sovereign state governments that can issue money.

Fiscal Policy Rules

Lerner postulated that the fiscal policy of the government should be governed by three rules:

1. The government must maintain a reasonable level of demand at all times. In the case of too low expenses and, consequently, excessive unemployment, the government must reduce taxes or increase its own expenses. If there are too many costs, the government should prevent inflation by reducing its own costs or by increasing taxes.
2. By borrowing money when the government wants to raise the interest rate, and by borrowing money or paying debts when it wants to lower the interest rate, the government should maintain such an interest rate that stimulates the optimal amount of investment.
3. If one of the first two rules contradicts the principles of “reasonable financing”, or a balanced budget, or restriction of public debt, the worse for these principles. Government printing press should print any money that may be needed to comply with rules 1 and 2.

Use History

Lerner 's ideas were most actively used in the period after the Second World War, when they became the basis for most textbooks on Keynesian economic theory and the basis of economic policy. Thus, when Keynesian politics came under fire in the late 60s and early 70s, most people attacked Lerner's idea of ​​functional finance. In the post-war period, US unemployment reached a low of 2.9% in 1953 during the Korean War, when inflation averaged 1.1%.