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Reinventing Functional Finance

Transformational Growth and Full Employment

Edited by Edward J. Nell and Mathew Forstater

This ambitious book seeks both to revive and revise the idea of ‘functional finance’. Followers of this doctrine believe that government budgets should concentrate solely on their macroeconomic impact on the economy, rather than reflecting a concern for sound finance and budgetary discipline. Reinventing Functional Finance examines the origins of this idea and then considers it in a modern context. The authors explore the concept of NAIRU and argue that modern economies can operate at the level of full employment without provoking unmanageable inflation. They also contend that budget deficits do not have the deleterious effects commonly ascribed to them; the belief that they do rests on a misunderstanding of modern money. In this context, they highlight the relevance of Abba Lerner’s famous dictum, ‘money is a creature of the State’. The authors also debate the merits of various proposals for ‘Employer of Last Resort’ programs, which combine automatic stabilizers with the buffer stock principle.
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Chapter 8: Functional Finance and Fiscal Function

Richard A. Musgrave


s Richard A. Musgrave While I have no paper to present, I have been asked to contribute some comments, and I am happy to do so. I will first review Abba LernerÕs model of Functional Finance with its focus on budget policy as an instrument of stabilization, and then consider its relation to my three-branch model. FUNCTIONAL FINANCE AND THE ROLE OF BUDGET POLICY AS AN INSTRUMENT OF STABILIZATION The Functional Finance model, when presented six decades ago, proposed to lay bare the logic of fiscal stabilization in stark terms, acting as a shock therapy intended to correct popular misunderstandings, specifically those regarding the role of taxation and the nature of public debt. THE STRUCTURE OF FUNCTIONAL FINANCE The structure of Functional Finance (Lerner, The Economics of Control, 1944, Ch. 24) can be summarized as follows: The function of public expenditures is to render public services at the level required for efficient resource use at full employment. By contrast, the function of taxation does not provide such necessary finance. The state can always print money for that purpose. Taxation, rather, serves to hold down aggregate demand Ð public and private Ð to its full employment level. The same is true for borrowing and debt finance. Both taxing and borrowing (debt issue), while thus serving to depress demand, differ in their impacts. Taxation primarily checks consumption by curtailing disposable income, while debt-issue primarily restrains investment by raising the rate of interest. Stabilization policy may thus assure full employment along with maintaining price...

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