What is functional finance?

Functional finance is an approach to government fiscal policy developed by economist Abba Lerner in the 1940s, and it's a key intellectual foundation for MMT.

Lerner argued that government fiscal policy should be judged by its results - its function - not by arbitrary rules about balanced budgets or debt levels. The government should spend whatever is necessary to achieve full employment, and tax whatever is necessary to prevent inflation. Whether this results in deficits or surpluses is irrelevant; what matters is the outcome.

Lerner proposed two principles:

1. The government should adjust its spending and taxation to ensure total spending in the economy is neither too little (causing unemployment) nor too much (causing inflation).

2. The government should borrow or repay debt only to achieve desired interest rate effects, not because it needs to 'finance' spending.

This was radical in its time and remains controversial today. It directly contradicts the 'sound finance' view that governments should balance budgets like households. Lerner argued this view confuses means with ends - a balanced budget is not inherently virtuous; it's only good if it produces good outcomes.

MMT builds on functional finance, adding a detailed understanding of how modern monetary operations actually work. Where Lerner described what governments should do, MMT describes what they actually can do and already do, often without realizing it.