E Between Keynes And Von Hayek – Checks And Balances

Try Abba Lerner’s ideas! John Llewellyn and Russell Jones, two establishment economists, have come up with an unorthodox economic policy to get the world back on the growth track. On its own, “structural reform is ill-equipped to combat a chronic shortage of expenditure and dormant animal spirits.” Perhaps the solution is “less conventional macroeconomic policy, perhaps adoption of so-called ‘functional finance’”.

Functional Finance

They write about functional finance:

“This term was coined by Abba Lerner, a Russian-born British economist who in the 1930s worked alongside both Friedrich von Hayek and John Maynard Keynes, and then emigrated to the US, where he taught at universities.

“A maverick, albeit a brilliant one, Lerner’s macroeconomics ca[me] down to the idea that so strong [is] the economic, social and moral case for achieving high employment and relative price stability, policymakers should not be fussy about how they went about it. Policies should be judged on their ability to achieve these goals, and not whether they were considered ‘sound’ or comply with the dogmas of traditional economics. It was maintaining an adequate flow of expenditure that mattered.

“Lerner’s view would be that if direct financing of budget deficits by the central bank is the only option to boost aggregate demand and keep output in line with potential, then it should be employed.

“Modern-day policymakers may come to the same conclusion. Direct debt monetisation would break the policy logjam produced by a requirement for simultaneous deleveraging in both the private and public sectors. Because it makes no call on private sector savings, it should also prove more expansionary than QE or orthodox fiscal expansion on a unit-by-unit basis. Furthermore, by acting to rebuild shattered confidence, it could ’crowd in‘ additional private expenditure. Finally, as long as programs of direct debt monetisation were confined to closing large output gaps, the inflationary impact should be limited.

“Arguments against direct debt monetisation fall into two categories: the moral hazard it encourages, and its inflationary potential. The disruption of the connection between government decisions on the budget deficit and the willingness of the private sector to fund that deficit at reasonable interest rates destroys at a stroke one of the most important disciplines the market imposes on politicians. And with that discipline swept away, the door is open to irresponsible and ultimately inflationary policies. This, it would be argued, would at the very least encourage a significant increase in inflation expectations and risk premia.

Latin Juntas and Zimbabwe?

“Despite the logic of Lerner’s philosophy, taboos about outright ‘monetary financing’ cannot easily be cast off. In Latin American dictatorships and Robert Mugabe’s Zimbabwe, debt monetisation is the route to hyperinflationary purgatory. But these taboos are ‘man-made‘ rather than ’God-given‘. Monetary financing need not always be bad and lead inevitably to a catastrophic loss of price stability. There can be circumstances where it is appropriate. Key considerations are: whether it has been subject to a rigorous cost-benefit analysis, how it is operat[ed], and whether it can be ‘turned off’ once it filled its objectives.

For the public and markets not to fear the worst, robust checks and balances need to be in place before direct debt monetisation: an explicit inflation, price level, or nominal GDP target framework, and all the transparency that goes with it.

“It would also make sense that any final decision [on debt monetisation be given to] an independent central bank’s policy-making committee, rather than a government. Direct monetary financing [sh]ould be [for] a specific amount over a specific period – say 3% of GDP over 3 years. It must be finite.


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