Abba Lerner first proposed the concept of functional finance. The idea behind functional finance is based on the principles of effective demand and chartalism. According to this theory, government finance should be aimed at achieving certain objectives, such as taming the business cycle and attaining full employment. Inflation should be kept at a low level to encourage growth and employment. These objectives are attainable only by making adjustments to the economy.
According to this theory, the government should borrow money from the private sector to meet its expenditures. It may also opt to undertake deficit financing if its current public revenue is inadequate. The deficit financing process involves printing more currency notes. Moreover, the main tenet of functional finance is the formation of an unbalanced budget. It is important to understand that, in addition to maintaining the monetary balance, deficit financing is also necessary to achieve the counter-cyclical goal of fiscal policy.
If a government follows the rule of functional finance, it can eliminate inflation and keep the economy at full employment. However, the functional finance proponents have to convince skeptics that this rule will be followed. If this rule is followed, the economy will eventually converge to b. It would be better to implement it and avoid the inflationary trap. There are some other important aspects of functional finance. This article will explore the concepts behind this method.
Modern Monetary Theory is also a product of functional finance. It pays particular attention to government finance and monetary operations. Government finance is viewed from a different perspective than that of the users of currency. By focusing on government finance, the theory opens up the possibility of implementing many different policy strategies. For example, the Employer of Last Resort program incorporates the principle of buffer stocks to achieve a higher level of economic growth. Further, the Employer of Last Resort program combines the concept of automatic stabilizers with the buffer stock principle to achieve this goal.
A primary deficit raises output and puts the debt on an unsustainable path. This rule is incompatible with functional finance. Therefore, monetary policy should be based on a long-term government budget position and satisfy the debt-sustainability constraint at the interest rate. The objective of functional finance is to adjust taxes and transfers until full employment is achieved. This rule is based on Taylor’s law of sound finance. The primary goal of sound finance is to achieve full employment.
Another limitation of Functional Finance is that it does not appeal to the majority of the public. While balancing the budget is popular amongst polling data, the constituency for this policy is small. Furthermore, politicians realize that contradicting the principles of Functional Finance is politically unfeasible and creates frustration amongst the public. And this is what causes most of the confusion and controversy in the field of finance. And it is no wonder that the concept of functional finance has not received as much attention as it deserves.