Thread by @StephanieKelton

THREAD
We should talk about Functional Finance. Abba Lerner put forward the approach in the 1940s. He explicitly offered it as an alternative to the more timid pump-priming approach expounded by people like Alvin Hansen. Here’s the seminal paper. gc.cuny.edu/CUNY_GC/media/…

MMT ≠ Functional Finance, but we incorporate some basic insights. I explain the overlap and extensions to FF in this talk.

I see people like Larry Summers warming up to FF but continuing to express reservations about MMT on the grounds that (among other things), MMT advocates “printing money.” So let’s look at what Lerner’s Functional Finance was all about.

Like MMT, Lerner understood that a government had expanded policy space if it’s money was a “Creature of the State.” In MMT parlance, we call it a “currency issuer.” Here’s Lerner: modernmoneynetwork.org/sites/default/…

Against this backdrop, Lerner tells us how he believes gov’t should run fiscal policy. He rejected the principle of “sound finance,” the idea that the budget outcome itself should ever be the target of policy. He wanted everything judged based on real, not budgetary, effects.

He laid out two guiding principles or “laws of functional finance.” The first said that the government should bear primary responsibility for maintaining a full employment economy. Adjusting taxes and government spending—in real time—to backfill any shortfall in aggregate demand.

He couldn’t care less whether this req’d a fiscal deficit, a balanced budget, or a fiscal surplus. Any of them was justified, provided that was the budget outcome that delivered a balanced economy—i.e. full emp and price stability. So the budget pictured below is doing its job!

Here’s how Lerner put it. He was like an early James Carville. “It’s the [real] economy, stupid!”

Here’s a place where MMT is exactly in synch with Functional Finance. Taxes are for subtraction, not for “raising revenue” or “paying the bills.” Lerner would have approached the federal budgeting process *very* differently. PAYGO would have been a NOGO.

Lerner saw the purpose of taxation as removing spending power and, hence, mitigating inflationary pressures. If the government’s own spending would otherwise risk pushing inflation higher, then (and only then) are offsets—what Congress dubs “pay fors” called for.

ASIDE: MMT recognizes that taxes are important for other reasons. Inequality foremost among them. We have cited former NY Fed president Beardsley Ruml on this for decades. bilbo.economicoutlook.net/blog/wp-conten…

Back to Lerner. His Second Principle of Functional Finance articulated the manner in which he wanted the government to carry out the First Principle (maintaining spending at the level needed to keep the economy at full employment). But what is this? Lerner was an OMFer. 😉

Overt Monetary Financing, meaning that he wanted the government to simply (deficit) spend and leave any resulting reserve balances in the system, rather than draining them via bond sales. Like MMT, Lerner saw bond sales as a tool for interest-rate maintenance not “financing.”

So here are two really significant observations made by Lerner and incorporated into MMT. (1) Taxes are for subtraction. They do not finance (federal) spending. (2) Bond sales aren’t about “borrowing.” Bonds were used to support + interest rates.

Larry (and others) have WRONGLY argued that MMT = “printing money” and warned of hyperinflation. beta.washingtonpost.com/opinions/the-l…

Lerner anticipated this reaction. It’s about the spending, not whether bonds are sold or not.

This is something @stf18 and I wrote about ftalphaville.ft.com/2013/12/12/172…

And it’s a point Larry seemed to agree with at one point. “My view is that money-financed fiscal policy is the same thing as bond-financed fiscal policy + open-market operations. It’s exactly the same thing.“

So how is MMT (un)like Functional Finance? First, we don’t think it is good enough to rely on real-time adjustments in G&T to maintain full employment. You will never get to zero involuntary unemployment that way. Enter the Job Guarantee.

The Job Guarantee is the MMT solution to both the economic and political problem of maintaining full employment. Because it’s an auto-stabilizers, you don’t have to rely on Congress to pull the levers in real time. Maintains full employment across the business cycle.

The fiscal response—bigger deficits in the downturn and smaller deficits in the upturn—happen automatically.

Second, we have published countless articles, book chapters, etc. walking people thru the monetary operations to show how gov’t finance works under *current* arrangements. Bond sales are fine (apart from the personal/political anxiety they cause). You don’t have to go to OMF.

On debt sustainability, MMT goes further than Blanchard, Summers, etc. @stf18 has published a dozen or so articles on this. Here are just a couple of them:
papers.ssrn.com/sol3/papers.cf…
wer.worldeconomicsassociation.org/files/WEA-WER-…

Jamie Galbraith comes down on the MMT side as well. Here’s the bottom line. levyinstitute.org/pubs/pn_11_02.…
At the end of the day, this is where MMT and mainstream part ways on sustainability. They see interest as something markets determine. We see it as a matter of political economy.

/End