Functional finance is an economic theory proposed by
Abba P. Lerner, based on
effective demand principles and
chartalism.
It states that government should finance itself to meet explicit goals, such as taming the business cycle, achieving
full employment, ensuring
growth, and low
inflation
In economics, inflation is an increase in the average price of goods and services in terms of money. This increase is measured using a price index, typically a consumer price index (CPI). When the general price level rises, each unit of curre ...
.
Principles
The principal ideas behind functional finance can be summarized as:
[Edward J. Nell, Mathew Forstater, ''Reinventing functional finance: transformational growth and full employment'', , Edward Elgar Publishing 2003]
*Governments have to intervene in the national and global economy; these economies are not
self-regulating.
*The principal economic objective of the state should be to ensure a prosperous economy.
*Money is a creature of the state; it has to be managed.
*
Fiscal policy
In economics and political science, fiscal policy is the use of government revenue collection ( taxes or tax cuts) and expenditure to influence a country's economy. The use of government revenue expenditures to influence macroeconomic variab ...
should be directed in light of its impact on the economy, and the budget should be managed accordingly, that is, 'balancing revenue and spending' is not important; prosperity is important.
*The amount and pace of
government spending
Government spending or expenditure includes all government consumption, investment, and transfer payments. In national income accounting, the acquisition by governments of goods and services for current use, to directly satisfy the individual or ...
should be set in light of the desired level of activity, and taxes should be levied for their economic impact, rather than to raise revenue.
*Principles of 'sound finance' apply to individuals. They make sense for individuals, households, businesses, and non-sovereign governments (such as cities and individual US states) but do not apply to the governments of
sovereign states
A sovereign state is a State (polity), state that has the highest authority over a territory. It is commonly understood that Sovereignty#Sovereignty and independence, a sovereign state is independent. When referring to a specific polity, the ter ...
, capable of issuing money.
Rules for fiscal policy
Lerner postulated that government's fiscal policy should be governed by three rules:
# The government shall maintain a reasonable level of demand at all times. If there is too little spending and, thus, excessive unemployment, the government shall reduce taxes or increase its own spending. If there is too much spending, the government shall prevent inflation by reducing its own expenditures or by increasing taxes.
# By borrowing money when it wishes to raise the rate of interest and by lending money or repaying debt when it wishes to lower the rate of interest, the government shall maintain that rate of interest that induces the optimum amount of investment.
# If either of the first two rules conflicts with principles of 'sound finance' or of balancing the budget, or of limiting the national debt, so much the worse for these principles. The government press shall print any money that may be needed to carry out rules 1 and 2.
See also
*
Government success
*
Government failure
In public choice, a government failure is a counterpart to a market failure in which government regulatory action creates economic inefficiency. A government failure occurs if the costs of an intervention outweigh its benefits. Government failu ...
*
Market failure
In neoclassical economics, market failure is a situation in which the allocation of goods and services by a free market is not Pareto efficient, often leading to a net loss of economic value.Paul Krugman and Robin Wells Krugman, Robin Wells (2006 ...
*
Modern Monetary Theory
Notes
References
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External links
Functional Finance: What, Why, and How? – a case for functional finance in most of the developed world (1999)Lerner, Abba: Functional Finance and the Federal Debt (1943)
Public economics
Unemployment
Keynesian economics