The central idea is that government fiscal policy, its spending and taxing, its borrowing and repayment of loans, its issue of new money and its withdrawal of money, shall all be undertaken with an eye only to the results of these actions on the economy and not to any established traditional doctrine about what is sound and what is unsound. This principle of judging only by effects has been applied in many other fields of human activity, where it is known as the method of science opposed to scholasticism. The principle of judging fiscal measures by the way they work or function in the economy we may call Functional Finance …
Government should adjust its rates of expenditure and taxation such that total spending in the economy is neither more nor less than that which is sufficient to purchase the full employment level of output at current prices. If this means there is a deficit, greater borrowing, “printing money,” etc., then these things in themselves are neither good nor bad, they are simply the means to the desired ends of full employment and price stability …
Lerner, A.P. (1947), “Money as a Creature of the State”, American Economic Review, 37 (2), May, 312-17
“Depression occurs only if the amount of money spent is insufficient. Inflation occurs only if the amount of money spent is excessive. The government-which is what the state means in practice-by virtue of its power to create or destroy money by fiat and its power to take money away from people by taxation, is in a position to keep the rate of spending in the economy at the level required to fill its two great responsibilities, the prevention of depression, and the maintenance of the value of money” (1947, p. 314).
The budget is just an accounting statement at the level of numbers. What the government should be aiming to fix is the increasing unemployment and under employment, which is a symptom of low economic growth that is currently not generating enough employment relative to the willing and able labour force.
It all comes down to the goals of macroeconomic policy. The budget balance should never be a goal of government. The budget balance should be whatever it takes to achieve other goals, after taking into account non-government spending and saving decisions.
It is these other goals that matter and need attention from government. These goals relate to the level of economic activity and income generation in the economy and the way in which that income is distributed. Other goals are also relevant and you can fill in the blanks.
It is quite clear that given the state of the real economy in Australia the budget deficit is probably half the size that it should be relative to GDP. The direction of policy is to reduce the budget deficit because successive treasurers have claimed they have to do fix the deficit. The upshot has been rising unemployment and other associated negative consequences.
Governments need to get back to practising the principles of functional finance which means they would assess the effectiveness of the fiscal position in relationship to how functional it was – that is, how it was allowing the nation to achieve these important real objectives.
Focusing exclusively on some numbers on a bit of paper – the budget balance or the debt ratio – ensures that the government is distracted from its main purpose as noted above.