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
1 comment:
The following is not a criticism of the linked post. Just a couple of observations.
From the post:
"Conventional policy and functional finance represent two different choices about which instrument to assign to which target. The former says the interest rate instrument should focus on demand and the fiscal-balance instrument should focus on the debt-ratio target, the latter has them the other way around. ... In this sense, the functional finance position is less radical than either its supporters or its opponents believe."
Scott Fullwiler has explained in the past (for example, in this excellent 5-part series http://neweconomicperspectives.org/2012/12/functional-finance-and-the-debt-ratio-part-i.html ) that functional finance, far from being reckless or radical if assessed on orthodox criteria, turns out to be "ricardian" in the sense the mainstream use that term. So, I think it is quite clear to the leading MMTers that functional finance is not radical in this sense.
I think what is radical -- for want of a better word -- is that functional finance turns the current conventional wisdom on its head. I would say the same thing about MMT and PKE (and Marx, in most respects) in general. The mainstream, like the devil ;-), seeks to turn everything upside down, so that reality is obfuscated. The task of heterodoxy has been to turn things right way round again, so that things can be seen clearly. For instance, loans create deposits, not the other way round; injections create leakages, not the other way round, and so on.
Functional finance is another clear example of this.
As noted in the quoted passage above, the mainstream is saying, control demand through interest rates and try to stabilize the public debt-to-GDP ratio (as if it mattered) through fiscal policy.
This amounts to saying, we will try to boost demand (spending) by doing anything other than actually spend. And we will try to control any macro effects of public-debt issuance by doing anything other than controlling the terms on which that debt is issued.
In this way, the matter is turned upside down. Everything has been obfuscated, which of course serves a political function.
Functional finance is a "radical" reversal of this logic.
It amounts to saying, we will try to boost demand (spending) by actually spending. And we will ensure that debt-servicing requirements do not pose an inflation risk by
directly controlling the terms on which debt is issued.
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