Functional Finance: What it is, How it Works

What Is Functional Finance?

Functional finance is a heterodox or unorthodox macroeconomic theory developed by Russian-born, British-raised economist Abba Lerner during World War II that seeks to eliminate economic insecurity (i.e., the business cycle) through government intervention in the economy.

Understanding Functional Finance

Functional finance emphasizes the result of interventionist policies on the economy. It actively promotes government deficit spending as an effective way of reducing unemployment. The theory argues that the government's priority should be balancing supply and demand at full employment, versus trying to balance the budget.

Functional Finance Theory

Functional finance is based on three major beliefs:

1. It is the role of government to stave off inflation and unemployment by controlling consumer spending through the raising and lowering of taxes.
2. The purpose of government borrowing and lending is to control interest rates, investment levels, and inflation.
3. The government should print, hoard, or destroy money as it sees fit to achieve these goals.

Special Considerations

Functional finance also says that the sole purpose of taxation is to control consumer spending because the government can pay its expenses and debts by printing money. Furthermore, Lerner's theory does not believe it is necessary for governments to balance their budgets.

Abba Lerner

Lerner earned a B.A. in economics from the London School of Economics in 1932 and was an instructor there for four years. Later, he attended the University of Cambridge, where he studied John Maynard Keynes’s The General Theory of Employment, Interest, and Money (1936).

The Impact of Keynes

Lerner was a follower of the extremely influential economist and helped to develop and popularize some of his ideas. Keynesian economics embraced the concept that optimal economic performance could be achieved by using economic intervention policies by the government to influence aggregate demand. It is considered to be a demand-side theory.

Lerner's Work

Lerner sought to explain the correlation between high employment rates and inflation. He also invented a strategy for measuring the power of monopolies that was known as the Lerner Index. He was receptive to socialist arguments much of his life, and argued for planned economies, as demonstrated in his 1944 book, The Economics of Control: Principles of Welfare Economics.

In his lifetime, he taught at a number of American universities, including Columbia and the University of California, Berkeley and ended his teaching career at Florida State University. He died in Tallahassee, Florida in 1982 at the age of 78.