One pole of current debates about U.S. fiscal policy is occupied by the “functional finance” position—the view usually traced back to the late economist Abba Lerner—that a government’s budget balance can be set at whatever level is needed to stabilize aggregate demand, without worrying about the level of government debt. At the other pole is the conventional view that a government’s budget balance must be set to keep debt on a sustainable trajectory while leaving the management of aggregate demand to the central bank. Both sides tend to assume that these different policy views come from fundamentally different ideas about how the economy works.
A new working paper, “Lost in Fiscal Space,” coauthored by myself and Arjun Jayadev, suggests that, on the contrary, the functional finance and the conventional approaches can be understood in terms of the same analytic framework. The claim that fiscal policy can be used to stabilize the economy without ever worrying about debt sustainability sounds radical. But we argue that it follows directly from the standard macroeconomic models that are taught to undergraduates and used by policymakers.
Here’s the idea.…WCEG — The Equitablog
Functional finance vs. conventional finance: What’s really at stake?
J. W. Mason | Assistant Professor of Economics at John Jay College, City University of New York
Lost in fiscal space: Some simple analytics of macroeconomic policy in the spirit of Tinbergen, Wicksell and LernerJ.W. Mason, Assistant Professor of Economics, John Jay College, City University of New York, and Arjun Jayadev, Associate Professor of Economics and Graduate Program Director, University of Massachusetts, Boston