THE BLOG of John Gelles
September 13. 2008
— ABRIDGED —The following Working Paper by Mathew Forstater nine years ago applies today as never before in American history.
If it were taken as gospel by the voters responsible for their future success in a world held hostage by
o globalization of labor markets,
o globalization of terrorist actions,
o madness and asymmetrical warfare, and
o globalization of capital investment systems,we would see full immediate funding of America's energy, environment, education, infrastructure and military, urgent needs.
Without such voter faith, in functional finance over dysfunctional finance, we may look forward to economic, environmental and geopolitical threats and anxieties of an order not experienced in decades.
.
Copyrighted work reprinted here, if any, is for educational non profit purposes—and at the teachable moment. It was offered free to me on the internet (as a member of a wide audience) and is copied here free to others adding to its value)—it is fair use of the work.
The Jerome Levy Economics Institute
Working Paper No. 272
See above Original for reference pages
Functional Finance and Full Employment:
Lessons from Abba Lerner for Today?by Mathew Forstater
July 1999[ LESSONS BELOW IN THIS VERSION ARE ABRIDGED TO ONE PARAGRAPH. ]
The Asian Crisis, with the fallout in Latin America and the transition economies; the Russian default; continuing troubles in Japan; weaknesses in the structure of the new European EMU; volatility on Wall Street; deflationary pressures in the global economy:
recent economic developments invite a reconsideration of some of our most deeply held beliefs concerning economic theory and public policy. Even within the hallowed halls of mainstream economics, voices of dissent can be heard. Paul Krugman, Joseph Stiglitz, and Jeffrey Sachs are among those whose recent proclamations indicate that we have entered a period in which orthodox views are being openly questioned, creating an atmosphere characterized by a crisis of confidence.
Such periods of impending crisis and open expressions of self-doubt, questioning our most deeply held beliefs about the way the world works, creates a climate in which the ideas of the great unorthodox thinkers of the past may be revisited. The work of those who in the past dedicated their lives to formulating solutions to the challenges of modern capitalist economies may contain lessons applicable to the contemporary situation. It is in this spirit that this paper revisits the early works of Abba Lerner, outlining fifteen such lessons regarding macroeconomic theory and policy, as fresh in the context of the current scene as they were some five decades ago when they were first formulated.
Lesson #1: Full employment, price stability, and a decent standard of living for all are fundamental macroeconomic goals, and it is the responsibility of the state to promote their attainment.
Lesson #2: Policies should be judged on their ability to achieve the goals for which they are designed and not on any notion of whether they are "sound" or otherwise comply with the dogmas of traditional economics. This, of course, is Lerner's functional finance. The state has the ability to promote full employment and price stability and should use its powers to do so:
Lesson #3: "Money Is a Creature of the State": The ability of the government to conduct fiscal and monetary policy according to the principles of functional finance is made possible by the fact that "money is a creature of the state". The state has the power not only to tax, but to designate what will suffice to retire tax (and other) obligations, that is, what it will accept at its pay offices. By determining public receivability, the state can create a demand for otherwise worthless pieces of paper, leading to general acceptability. The state can issue this currency and use it to purchase goods and services from the private sector:
Lesson #4: Taxing is not a funding operation. Since money is a creature of the state and the government budget should be judged purely on its macroeconomic effects, decisions concerning taxation should be made only with regard to the economic effects in terms of the promotion of full employment, price stability, or other economic goals, and not ever "because the government needs to make money payments": "... taxes should never be imposed for the sake of the tax revenues".
Lesson #5: Government Borrowing is not a funding operation. Likewise, for the same reasons as taxation, Lerner argued that "borrowing" is not a funding operation. Since it is not a funding operation, it is questionable whether we should even use the term "borrowing." Perhaps it would be best to simply refer to bond sales. Thus Lerner argued that "the government should borrow only if…the effects" of borrowing are desired.
Lesson #6: The primary purpose of taxation is to influence the behavior of the public. If taxation is not a funding operation, then what is its purpose? The purpose of taxation, according to Lerner, is "its effect on the public of influencing their economic behavior".
Lesson #7: The primary purpose of government bond sales is to regulate the overnight interest rate.
Lesson #8: Bond sales logically follow from, rather than precede, government spending. Since government need not "borrow" to finance its expenditure, and instead bond sales are a means of managing bank reserves and hitting some target rate of interest, then it follows that, logically speaking, bond sales follow from rather than precede government spending:
Lesson #9: "Printing money" in and of itself has no impact on the economy whatsoever. For Lerner, there are six (or three pairs of) fiscal instruments of government: taxing and spending, buying and selling, and borrowing and lending. "Printing money" is not independent of these. Therefore, printing money, in and of itself, has no impact on the economy whatsoever. Suppose the government prints money and puts it in a rocket ship and blasts it to the moon. Will the printing of money have had any effect on the economy? Of course not:
Lesson #10: Without a full employment policy, society cannot benefit from labor-saving technological advance, that is, efficiency becomes inefficient. With a full employment policy, labor-saving technical advance becomes truly beneficial to society. Under conditions of continuous full employment, resources are scarce and so instituting a technical or organizational innovations that would free up some labor for other uses constitutes a welcome economizing of resources. But in an economy with persistent unemployment, what would have been efficient becomes inefficient:
Lesson #11: Without a full employment policy, a country must suffer over its trade balance. With a full employment policy, there is no need to worry about importing "too much" relative to exports. In the absence of full employment guaranteed by functional finance, a country must worry about rising unemployment stemming from an increase in the value of imports over the value of exports. Thus, an excess of imports over exports is considered an "unfavorable balance of trade" and the reverse is considered a "favorable balance of trade." But Lerner looks at foreign trade as "the means by which we obtain for our own use goods that are manufactured abroad":
Lesson #12: Attempts to argue that the deficit and debt are not really as big as they look, or that if we measure them differently or keep a capital account they are not really that bad, are counter-productive. For Lerner, "deficit doves," by trying to placate concerns about government budget deficits and the national debt, actually do harm to their own position as "proponents of organized prosperity":
Lesson #13: When there is unemployment, jobs and money, not resources and goods, are scarce.In a full employment economy, resources are scarce. Economizing is important, as resources can only be allocated to any use if they are removed from some other productive activity. In an economic system with unemployment, however, goods are not scarce, as more can be produced by employing the unemployed resources. But there are other kinds of scarcity in the economy suffering from unemployment: What is scarce is money. The lack of money to spend on the goods is what keeps the unemployed resources from producing more goods. Work, moreover, instead of being a curse, is desired more than anything else because the alternative is not the enjoyment of leisure but the suffering of unemployment and deprivation. Of course, if people could get income without having to work they would not object too much (although their self-respect in feeling they are useful members of society who are earning their income is too easily underestimated). But it is only by finding work that they can obtain the necessary income they need.
Lesson #14: Functional Finance is not a policy; it is a framework within which all sorts of policies may be conducted. There may be misconceptions that functional finance is equated with a particular policy, e.g., running a big deficit. Functional finance is rather a general approach within which a whole series of policies may be conducted. The actual policies which will be implemented will depend on the economic circumstances that exist at a particular time.
Lesson #15: To achieve full employment, government spending may have to include direct job creation. Traditional fiscal and monetary policies may be ineffective in achieving full employment. Direct job creation in the form of public works may be necessary in order to attain and maintain full employment and price stability.
Conclusion
The work of Abba Lerner on functional finance and full employment contains lessons as relevant today as when they were first put forward some five decades ago. At a time when orthodox theory and policy offers little in the way of either explanation of the causes of crisis or cures in the form of effective policy approaches, it would do well to revisit these ideas and the ideas of other great thinkers of the past. Their work is of more than antiquarian interest; they contain valuable lessons that can inform current analysis and formulation of approaches to macroeconomic policy.