There is a lot of talk nowadays about returning to “real capitalism” as opposed to the perceived state of socialism which many conservatives imagine that they live in today. I’m certain that I could shock nearly anyone by explaining the economic rules which we governed our nation by during the time which is referred to as “the golden age of capitalism” in the US. (roughly defined as the years between the WWII and the early ’70s)
Hows this for a quote…
“An interesting, and to many shocking, corollary is that taxing is never to be undertaken merely because the government needs to make money payments.”
- 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 the principles of ‘sound finance’, balancing the budget, limiting the national debt or other dogmas of traditional economics, so much the worse for these principles.
A few quotes from Lerner
“Apart from the necessity of winning the war, there is no task facing society today so important as the elimination of economic insecurity. If we fail in this after the war, the present threat to democratic civilization will arise again. It is therefore essential that we grapple with this problem even if it involves a little careful thinking and even if the thought proves somewhat contrary to our preconceptions.”
“The central idea is that government fiscal policy, its spending and taxing, its borrowing and repayment of loans, its issue of new money and its withdrawal of money, shall all be undertaken with an eye only to the results of these actions on the economy and not to any established traditional doctrine about what is sound or unsound.”
“… the government may find itself collecting more in taxes than it is spending, or spending more than it collects in taxes. In the former case it can keep the difference in its coffers or use it to repay some of the national debt, and in the latter case it would have to provide the difference by borrowing or printing money. In neither case should the government feel that there is anything especially good or bad about this result.“
What in the world is this guy on about?
“In brief, Functional Finance rejects completely the traditional doctrines of “sound finance” and the principle of trying to balance the budget over a solar year or any other arbitrary period.”
“First there were the pump-primers, whose argument was that the government merely had to get things going and then the economy could go on by itself. There are very few pump-primers left now.”
“The unfounded assumption that current interest on the debt must be collected in taxes springs from the idea that the debt must be kept in a reasonable or manageable ratio to income (whatever that may be).”
And these might get the prize for top shockers…
“it had to be recognized that the result might be a continually increasing national debt… At this point two things should have been made clear: first, that this possibility presented no danger to society, no matter what unimagined heights the national debt might reach, so long as Functional Finance maintained the proper level of total demand for current output; and second (though this is much less important), that there is an automatic tendency for the budget to be balanced in the long run as a result of the application of Functional Finance, even if there is no place for the principle of balancing the budget. No matter how much interest has to be paid on the debt, taxation must not be applied unless it is necessary to keep spending down to prevent inflation.”
“There are four major errors in the argument against deficit spending, four reasons why its apparent conclusiveness is only illusory…” (I’ll leave it to readers to read the reasons in the paper, some of the arguments apply to issues which are not very relevant today.)
“Functional Finance is not especially related to democracy or to private enterprise. It is applicable to a communist society just as well as to a fascist society or a democratic society.”
A quick analysis
That’s a lot to deal with… for anyone who hasn’t completely written Lerner off as a mad man and want to understand why this process actually worked, and why we moved away from his ideas somewhat, keep reading.
The argument is that principles of “sound finance” are derived from intuitions applied from one’s understanding of a household or company’s finances. Reality is far from this, and “sound finance” applied to a government with a fiat currency is far less sound than a government which practices Functional Finance. The fundamental idea is that government spending be large enough to buy goods and services at a rate which encourages maximum employment and therefore maximum output, maximum economic growth, and hence maximum prosperity. The cost of any government debt would easily be covered by growth from the investment. This assumes that the average investment made from government spending was done on productive projects. This is one area that also needs to be modeled better, as we currently seem to have a significant proportion of non-productive spending. For example, war spending might never be considered a financially productive investment, but its likely to be a requirement from time to time. An MMT model would then be able to better tell us the real economic impact of such spending.
One important area of improvement we could offer for an MMT/Functional Finance model would be to include a metric for government vs. private investment efficiency. I’ll post more on this some other time, but public sector inefficiency is a serious concern and should be factored into these models. Once modeled, this feature would allow us to determine the impact and importance of efficiency improvements, and it would bring to light the difference between effectiveness of public vs. private investment. I’ll do this soon, along with a few other obvious improvements.
As demonstrated in my previous post… seemingly simple systems can display baffling nonlinearity. The modestly simple model which I use to run economic simulations is based on a system of roughly 15 differential equations. Anyone who claims intuition can predict the output of such a complex system is either lying or a fool. A far deeper understanding of the system is required. We seem to have lost the basic understanding of what government spending, taxation, and borrowing represents.
There are a few problems with this approach which have been identified over the years. One of the major problems was related to the unexpected supply-side inflation related to oil price shocks in the 70′s. This issue is now more understood and can be applied to a Functional Framework model, however this was one of the major downfalls of Functional Finance… as a result, the problem of stagflation at that time was causing the rules of Functional Finance to suggest contradictory policies. This has been improved, and I’ll have to write something else about this later.
I’ll close with a quote from the Functional Finance page on the future of Lerner’s legacy
“Global financial concerns in 2010 that surround national debt, national and global aggregate demands, and proposed inconsistent applications of austerity and reduced government spending, on the one hand, and quantitative easing and increased government spending on the other hand, have made functional finance relevant again. If unemployment is minimized rapidly by application of functional finance (modified to require green production of the material wants that prevents unacceptable environmental stress and/or financial inflation,) and its principles would in fact achieve freedom from want, Lerner will be one of the fathers of reforms suggested in the 20th Century that finds favor in the 21st.”