Institutionalist and Post Keynesian approaches to political economy both
reject the orthodox view of markets as tending to produce optimal outcomes.
Instead, these alternative approaches view capitalism as a system that is
inherently crisis-ridden, with unemployment the normal state of affairs. A
different view of economic policy is therefore implied. Instead of policy
addressing market imperfections, policy must be used to shape outcomes that
are in some cases antithetical to capitalist systems. It is a basic theme of
this paper that aspects of both Institutionalist and Post Keynesian traditions
are necessary for a more comprehensive approach to economic policy that either
tradition, by itself, falls short of providing. Post Keynesian economics
focuses on aggregate macro relations and balances, monetary and financial
factors, and aggregate employment determination. Institutionalist economics
concentrates on intersectoral relations and balances, technological and
structural factors, and sectoral employment considerations. Of course, these
are basic generalizations, and some authors in both traditions address the
considerations usually associated with the other.
The ideas of two figures well-known to Post Keynesians and Institutionalists,
Abba Lerner and Adolph Lowe, contain overlapping and complementary insights
and themes, and have rather specific practical policy implications. Lowe
called his approach instrumental analysis, while Lerner's approach is known as
The works of Lerner and Lowe serve as an interesting point of departure in
thinking about such a new approach to macro theory and policy. While there are
some important areas of overlap in their work and thought, Lerner and Lowe
also have some important differences in areas of emphasis, which, it shall be
argued, are strikingly complementary. Lerner's functional finance deals with
aggregate proportionality and balance, while much of Lowe's work additionally
emphasizes sectoral relations. While full employment and price stability were
lifetime concerns of both, Lerner—following Keynes—focused more on monetary
factors, while Lowe emphasized issues of structural and technological change.
A Lowe-Lerner synthesis offers a powerful starting point in fleshing out an
alternative approach to macroeconomic theory and policy, one which—because of
its careful attention to historically changing social and institutional
structures—is as fresh and relevant today as it was when Lerner and Lowe began
formulating their historical and institutional approach to macroeconomic
theory and public policy.
Instrumental Analysis and the Method of Functional
Lowe's investigations of the technological and structural features of
contemporary capitalism from the 1920s to the 1950s led him to the position
that modern industrial systems exhibit inherent macroeconomic instability,
necessitating an abandonment of the traditional deductive method and its
replacement with an alternative instrumental method for economic theory and
public policy. Rather than taking only the initial conditions as given, and
employing deductive analysis to predict and explain, Lowe proposed also taking
as given a vision of desired macro-outcomes. These macro-goals would not be
determined by economic analysis, but rather would be independently determined
by democratic political process. Analysis would then "work backwards" from
the macro-goals to the economic means for their attainment (Lowe, 1965;
Forstater, 1999a; 1999b).
Such a conceptualization of the means-ends relation is also found in Lerner's
functional finance. Functional finance was first put forward by Lerner in his
article, "Functional Finance and the Federal Debt" (1943) and in his
Economics of Control (1944). Sound finance confuses the means and the
ends; a balanced budget is taken to be the end. It is seen as "good" in and
of itself. In many cases it is even a politically stipulated goal. For
Lerner, what matters are the effects of the government budget and other fiscal
and monetary policies. Is the current fiscal stance goal-adequate? Does it
promote our macroeconomic goals?
Traditional economics would say we are mixing up our positive and normative
economics here. But both Lowe and Lerner rejected the overly dichotomous
positive-normative distinction. Lowe refers to the approach that begins
analysis without consideration of macro-outcomes as "a radical positivism
interested only in the explanation and prediction of movements 'wherever they
might lead'" (Lowe, 1969, p. 7). For Lowe, the separation of the positive and
normative "can no longer be justified; ... recent developments
demand the conscious integration of the analytical and normative aspects"
(1967, p. 180).
Lerner echoes this view when he distinguishes between "objective" and
"normative," not based on whether one considers macro-outcomes, but whether
one does so openly and honestly:
Objectivity turns out to be not the avoidance of concern with what is
desired in a pure concentration on what is, but merely the
avoidance of smuggling in an advocacy of desired objectives without making it
clear that this is being done or making it clear whose are the desires being
considered. (Lerner, 1969, p. 131, original emphasis).
In 1941, Lerner used the analogy of driving an automobile to defend the use of
government controls to "steer" the economic system onto the right path. While
respecting market forces, Lerner likened laissez-faire to a refusal to
take hold of the "economic steering wheel." We may now add that it also helps
to know your destination. In Lowe's instrumental framework, once we know our
destination and from where we begin our journey we may consider alternative
suitable routes for successfully completing the trip.
While Lowe claimed that "the ultimate concern of [On Economic
Knowledge] is not methodological" certainly he explicitly deals with
methodological matters and offers instrumentalism as an alternative
methodological approach for economic theory and public policy. Lerner's
outline of functional finance was not presented with regard to methodological
issues, but it constitutes an important methodological position that is fully
consistent with Lowe's instrumental method. In fact, in his contribution to
Economic Means and Social Ends, a symposium exploring issues raised in
Lowe's On Economic Knowledge, Lerner explicitly and fully embraced
instrumentalism, writing that: "Only through the conscious application of
instrumental analysis can there be any hope of further development or even
survival of the economic or any other aspect of human society" (Lerner, 1969,
Lowe and Lerner share some important methodological positions. First, by
emphasizing the incorporation of macro-goals from the beginning of theoretical
analysis, they reject not only the traditional positive-normative dichotomy,
but also the standard treatment of the State as "outside" the economic system.
Mainstream economics, as well as a number of heterodox traditions, have tended
to take the approach of analyzing a pure market system, or the logical
operation of capitalism, prior to consideration of the role of the State.
Instead, with Lerner and Lowe, the State is part of the economic system, and
must be part of analysis from the start. Second, both Lerner and Lowe reject
the view of the economic system, including both market and state, as static
and unchanging. This view is implicit if not explicit in all approaches that
believe there to be universal economic "laws" for all societies, or at least
all stages of capitalism, throughout history. Lack of recognition of
fundamental change in the nature and role of the State also has serious
implications for the range of conceivable policies and their effectiveness.
Thus, constant, careful attention to historical, institutional, structural,
technological, and associated social and environmental change is fundamental
to the Lowe-Lerner approach. Lowe and Lerner go to great lengths to discuss
the dangers of authoritarianism and how precious freedom must be defended, but
they simply do not buy the argument that economic policy necessarily violates
individual freedom or that the absence of policy necessarily guarantees and
protects it. While both support a democratic political process as the means
by which macro-goals should be stipulated, it is clear that historical
experience, study of the economy, and legislation such as the Full Employment
bill and Humphrey-Hawkins have led each to assume some basic set of macro
goals as desirable: at the most fundamental level, full employment and price
stability (e.g., see Lowe, 1965, 1976; Lerner, 1943, 1951, 1972). They also
both considered a decent standard of living for all as a fundamental goal, and
in a sense the ultimate goal to be achieved by job creation and the
maintenance of the purchasing power of income. These goals thus serve as the
point of departure in their analyses.
More recently, another author whose work may be fairly described as
Institutionalist Post Keynesian, Luigi Pasinetti has also embraced the
Instrumental method, taking policy goals as the analytical point of
departure in economic theory. There are other aspects of Pasinetti's work that
make it relevant here: full employment is also perhaps the defining
policy goal; he attempts to bring in both the monetary and financial factors
and the technological and structural factors, he is interested in aggregate
and sectoral balances and their relation, and he recognizes both the effective
demand concerns and the technological change concerns in his analysis (see
Forstater, forthcoming, 2001).
Pasinetti distinguishes the instrumental method of taking full employment as a
policy goal from the assumption of full employment or a tendency to full
employment in either economic models or economic reality. In response to the
criticism that he assumes full employment, Pasinetti has stated that: "in fact
I do not make any such assumption. I simply state the conditions that full
employment would require" (Pasinetti, 1984-85, p. 247). As Lowe,
quoting J. S. Mill in another context, pointed out, such a model, while
"insufficient for prediction" is "most valuable for guidance" (1965, p.
In arguing for a methodological position that takes the policy goal of full
employment as the reference point Pasinetti invokes the name of John Maynard
It is the really crucial merit of Keynes to have set out to demonstrate that,
at any given point of time, the market forces are inadequate to perform the
same task [of ensuring an inherent tendency toward]… the position of full
employment, and I hope to have shown the difficulties that the structural
dynamics of technology and demand interpose to the same task through time.
But it is equally a great merit of Keynes to have singled out the full
employment position, and by implication the full employment path through time,
as the natural point of reference for economic policy. The failure of market
forces to reach efficient positions does not justify our failure to pursue
them by other means. (1984-85, p. 248)
Lowe likewise interpreted Keynes in this regard:
By postulating a state of full employment as the overriding macro-goal,
Keynes has taken th[e] decisive step, thereby giving to his analytical
findings quite a novel meaning. All the obstacles to the attainment of the
postulated goal…can now be turned into so many reasons for active interference
with the autonomous course of events" (1965, p. 243).
Like Lowe and Lerner, Pasinetti insists on the distinction between a policy
goal or policy goals and the tools and policies for their attainment. The
tools and policies are:
means, and not ends in themselves. Once their instrumental role is properly
understood and recognised, it becomes much easier also to operate on them in
as detached a way as is possible; to treat them as instruments susceptible to
being continually improved and changed, in relation to their suitability (or
unsuitability) to ensure tendencies, or near-tendencies, towards agreed ends.
(Pasinetti, 1981, p. 155)
Students and colleagues of Pasinetti promoting and elaborating his approach
have explicitly referred to Lowe's instrumental method as well. Scazzieri,
for example, has argued that "the task of dynamic theory is not to suggest a
realistic interpretation of actual processes" (1996, p. 183). Instead,
shifts economic theory away from the theoretical reconstruction of actual
processes and turns it into an experiment in instrumental inference, which is,
using Adolph Lowe's words, an attempt ‘to discover the particular set of
causes that are suitable for the realization of some postulated effect'"
(Scazzieri, 1996, pp. 183-84; see also, Baranzini and Scazzieri, 1990)
Lowe's instrumental method and the method of Lerner's functional finance share
some important characteristics that can also be found in more recent work in
the Institutionalist Post Keynesian tradition. The instrumental or functional
method takes policy goals as the analytical point of departure. Economic
theory then works backwards to discover the suitable paths for
goal-attainment. Lowe, Lerner, and Pasinetti also share the view that full
employment and other macroeconomic goals such as price and currency stability
and economic growth are the reference point for an Institutionalist Post
Keynesian Political Economy. While Lowe focused on sectoral analysis and
questions of technological and structural change and Lerner concentrated on
aggregate analysis and monetary and financial factors, Pasinetti has attempted
to incorporate both the effective demand concern and the structural change
concern into a dynamic analysis that considers both sectoral and aggregate
relations. Key to Lerner's contribution is not only his proposal for
functional finance, but also his institutionalist analysis of modern
Functional Finance and Money as a Creature of the State
Lerner's insight was a fundamentally Keynesian one: the economy is likely to
find itself in an unemployment equilibrium with no inherent tendency to move
to full employment. Lack of effective aggregate demand requires that the
federal government run a deficit to exactly offset the shortfall so that there
can be aggregate balance at the full employment level of output. This is
based on fundamental accounting relations as represented in the national
income accounts. Keynesian unemployment is due to lack of effective demand.
Deficits are not one-time injections, but may have to be continually run,
permanently. The size of the deficit depends on the relation of actual and
desired net saving (see Forstater, 2000a).
Lerner's policy prescription is thus also firmly in the strong fiscal
Keynesian tradition: government should run a deficit that closes the
recessionary gap. It not only rejects the deficit hawk position, it also
transcends the "deficit dove" stance. The confusions regarding national
budget deficits and the debt are important and real. There are measurement
problems, mistreatments (or non-treatments) of capital budgeting, fallacies
concerning "crowding out" and the relation of deficits and interest rates (and
of deficits and inflation), unfounded views on the "burden" on future
generations, and more (see, e.g., Heilbroner and Bernstein, 1989; Eisner,
1994; Cavanaugh, 1996). As Bator (1962) pointed out some time ago, however,
while these are all issues on which points may be scored in a debate,
concentration on these areas keeps the discussion at a level that actually
concedes too much. For example, it may be true that due to measurement and
accounting problems, the deficit (or debt) is "not as big as it looks," but
this line of attack implicitly condones the "sound money" view that smaller is
Functional finance simply refers to an approach to public finance that sees
the federal budget and the management of the national debt as means to
economic prosperity. This notion needn't assume any particular a
priori relation between government expenditures and revenues or a
priori most desirable absolute or relative size of the national debt:
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, 1943, p.
Thus, functional finance does not say anything about what the budget should be
prior to economic analysis. If it is concluded that under particular
circumstances, a balanced budget describes the best means to economic
prosperity, then even a balanced budget is not inconsistent with a functional
approach to public finance. "Sound money" is therefore only inconsistent with
functional finance if the balanced budget is seen as an end in itself, rather
than as a means to an end. If a balanced budget—or a surplus, to reduce the
national debt—is insisted upon, even if it may be shown to have negative
economic consequences (or be impossible), then this is not functional finance
(it is, actually, "dysfunctional finance"). Likewise, functional finance does
not stipulate that bigger deficits are "better" or that deficits are "good,"
in and of themselves; what concerns us are the effects.
Such an approach has an immediate result that at first glance may appear
shocking or surprising, but which it would do economists and policy makers
well to consider: neither taxing nor government "borrowing" are funding
operations (Bell, 2000). Decisions concerning taxation are to 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" (Lerner, 1943, p. 354).
Likewise, "the government should borrow only if... the effects" of borrowing
are desired, for example "if otherwise the rate of interest would be too low"
(Lerner, 1943, p. 355).
These points of view were repeated and elaborated by Lerner in his 1951 book,
The Economics of Employment:
[T]axes should never be imposed for the sake of the tax revenues. It is
true that taxation makes money available to the government, but this is not an
effect of any importance because money can be made available to the government
so much more easily by having some created by the Treasury. (1951, p. 131).
Likewise, "borrowing" is also not a funding operation for Lerner.
What are the purposes of taxation and borrowing, if not to fund government
spending? The purpose of taxation for Lerner is, first, the role it plays in
endowing otherwise worthless bits of paper with value and, second, its "effect
on the public of influencing their economic behavior" (Lerner, 1951, p.
131, original emphasis). Like taxation, borrowing is not a funding operation;
rather, it is a means of managing reserves and controlling the overnight
interest rate in the face of government spending and running budget deficits:
[T]he spending of money ...out of deficits keeps on increasing the
stock of money [and bank reserves] and this keeps on pushing down the rate of
interest. Somehow the government must prevent the rate of interest from
being pushed down by the additions to the stock of money coming from its own
expenditures.... There is an obvious way of doing this. The government can
borrow back the money it is spending (Lerner, 1951, p.
Note here the crucial implication that "borrowing" logically follows,
rather than precedes, government spending. In fact, this analysis
questions the accuracy and relevance of the term "borrowing" itself for
discussing government bond sales.
The role of taxation and borrowing, reserve management and interest rate
maintenance will become clearer upon examination of another, much less known,
Lerner article, "Money as a Creature of the State," which places him squarely
in the Keynes-Knapp Chartalist school, and which is key to fully understanding
the possibility and effectiveness of functional finance (Lerner, 1947). 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, as the
title of Lerner's paper states, "money [i]s a creature of the state":
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 of the
economy at the level required to fill its two great responsibilities, the
prevention of depression, and the maintenance of the value of money. (Lerner,
1947, p. 314)
In adopting this view Lerner followed Keynes in accepting the main thrust of
Knapp's "State Theory of Money" (Keynes, 1930, p. 4, p. 6n1; Knapp, 1924). Of
course, the basic starting point can be traced back at least as far as Adam
Smith, who put forward the idea that "a requirement that certain taxes should
be paid in particular paper money might give that paper a certain value even
if it was irredeemable" (Cannan, 1904, p. 312). The state has the power not
only to tax, but to designate what will suffice to retire tax 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:
The modern state can make anything it chooses generally acceptable as money
and thus establish its value quite apart from any connection, even of the most
formal kind, with gold or backing of any kind. It is true that a simple
declaration that such and such is money will not do, even if backed by the
most convincing constitutional evidence of the state's absolute sovereignty.
But if the state is willing to accept the proposed money in the payment of
taxes and other obligations to itself the trick is done. Everyone who has
obligations to the state will be willing to accept the pieces of paper with
which he can settle the obligations, and all other people will be willing to
accept those pieces of paper because they know that taxpayers, etc., will
accept them in turn. On the other hand if the state should decline to accept
some kind of money in payment of obligations to itself, it is difficult to
believe that it would retain much of its general acceptability...What this
means is that whatever may have been the history of gold, at the present time,
in a normally well-working economy, money is a creature of the state. Its
general acceptability, which is its all-important attribute, stands or falls
by its acceptability by the state. (Lerner, 1947, p. 313)
Thus, a variety of state powers, such as government's ability to tax, declare
public receivability, create and destroy money, buy and sell bonds, and
administer the prices it pays for goods and services purchased from the
private sector, constitute a menu of instruments with which full employment
and stability of the value of the currency may be promoted (see also,
We have cited Smith, Knapp, and Keynes, but perhaps we would do well to give
more recent examples of this view. It can be found in other "post-Keynesian"
authors after Lerner (see, e.g., Kurihara, 1950, pp. 34-39; Bator, 1962). But
the skeptic will argue that these pronouncements from the 1950s and 1960s are
of days long gone by. It thus may be constructive to provide the following:
In advanced societies, the central government is in a strong position to make
certain assets generally acceptable media. By its willingness to accept a
designated asset in settlement of taxes and other obligations, the government
makes that asset acceptable to any who have such obligations, and in turn to
others who have obligations to them, and so on. (Tobin, 1998, p. 27)
Goodhart has also used the 'Cartalist' framework to argue against the
Mengerian-metallist-monetarist position on optimal currency areas (Goodhart,
Mosler (1997-98) and Wray (1998) incorporate these insights into a framework
that draws on Post Keynesian monetary theory and a rigorous institutional
analysis of the relation of the Treasury, the Central bank, and the banking
system (see also Bell, 2001). The central bank does not control the money
supply; it does however have significant ability to determine the short-term
interest rate. The central bank is the lender of last resort, a necessary
function for the stability of the financial system. Open market operations,
government spending and lending, borrowing and taxation, all affect reserves
in the banking system. Excess reserves will cause short-term rates to tend to
zero, while insufficient reserves will send rates toward infinity. Thus bond
sales are essentially a reserve drain used to maintain a positive overnight
rate of interest (interbank lending rate). Government borrowing is not to fund
untaxed spending. Government spending comes first; then the government
borrows what it does not tax in order to drain reserves and maintain interest
rates. The national debt is "the total number of dollars that have been
drained from the banking system in order to maintain the fed funds rate
[overnight rate]. A more appropriate name [for the national debt] would be the
Interest Rate Maintenance Account (IRMA)" (Mosler, 1995, p. 14). Since money
is a creature of the state, the Government does not need to tax or borrow to
spend. Taxation is not to fund government spending, it is a means of creating
a demand for fiat currency, while "borrowing" is a reserve drain to support
short-term interest rates.
There is no problem "financing" full employment. From the functional finance
perspective, the goals are full employment and price stability, not any
particular relation between government expenditure and tax revenues or the
sales and purchases of government bonds. Obsession with budget balancing for
its own sake makes no sense whatsoever, threatening the health of the economic
system and blocking the way to full employment.
The importance of the Lernerian contributions of functional finance and money
as a creature of the state are hard to overstate. There are two—in some
respects related—problems, however, or areas where this framework remains
incomplete by itself. Lerner recognized one quite early on, and he dedicated
a good bit of his life to this issue. In his early versions of functional
finance, inflation was seen as the result of excess aggregate demand, and
therefore increasing taxation was seen as the cure. But as it became apparent
that there were other sources of inflation, this simple policy for demand side
inflation was no longer sufficient for managing the value of currency. Thus,
Lerner dedicated himself to the study of stagflation, and the evaluation and
formulation of various income policies, MAPs, wage-price controls, and so
The second issue regards the meaning of full employment. In addition to other
types of inflation, Lerner also began to notice that inflation did not begin
at true full employment, but well before that point. Thus, he even began to
use terms like "low full employment" and "high full employment," neither of
which actually meant zero involuntary unemployment (Lerner, 1951). For those
who reject NAIRU and "natural rates" of unemployment, and who are interested
in zero involuntary unemployment, these terms are not adequate. As Lerner
admits, then, functional finance, as formulated and by itself, is not capable
of attaining and maintaining zero involuntary unemployment.
There are a number of reasons why this is true. This brings us to the work of
Lowe. Lowe denied that what he called "primary interventions" (traditional
fiscal and monetary policies) were adequate to bring about true full
employment. They were part of the story, but not sufficient by themselves.
This is because, even assuming that such policies can bring an economy to full
employment, there is then the issue of maintaining full employment in
the face of ongoing structural and technological change, by which he meant
things like changes in the supply of labor and natural resources, capital- and
labor-displacing technical change, and changes in the composition of final
demand. This requires that we must not only look at aggregate proportionality
and balance, but sectoral relations as well. And it requires that we
recognize that in addition to Keynesian unemployment, we must also deal with
structural unemployment, meaning unemployment due to structural and
This was the precisely the focus of Lowe's "structural analysis." We must
confront issues of structural rigidity and elasticity of the production
system, we must deal with issues of technological unemployment and the reserve
army of labor, and we must deal with issues of sectoral relations. All of
which will bring us back to issues of price stability.
Lowe's Full Employment Proposal
Lowe's structural analysis is concerned with a realistic analysis of the
elasticity of the production system, the adaptability of the production system
in the face of structural and technological changes, such as capital- or
labor-saving technical innovations, changes in labor supply or the supply of
natural resources, and changes in the composition of final demand. A viscous
system will have trouble adapting quickly to such changes and thus may be
characterized by bottlenecks in production, sluggish growth, inflationary
pressures, significant structural, frictional, and technological unemployment,
and stretches of underutilization of plant and equipment. Conversely, the more
elastic the production system, the better the system is able to respond to
structural and technical change without resulting in structural rigidities.
Such a climate is more conducive to high employment economic growth without
Structural analysis highlights the impediments to rapid adjustment, the
structural disequilibria, the disproportionalities, and the physical-technical
consistency conditions for system viability (reproduction) that especially
confront an economy brought to full employment by, e.g., Keynesian demand
management. In neoclassical theory there is a trade-off between flexibility
and reality; in structural analysis there is a trade-off between flexibility
and full employment of resources.
Lowe's proposal for full employment, which he called "planned domestic
colonization," is what is better known as direct job creation by government.
Lowe was very skeptical about the possibility of attaining or maintaining full
employment through indirect means such as stimulating private sector demand,
while seeing a number of clear advantages to public employment programs:
Unlike private investors, public investors are not hampered by uncertainties
about future demand, because they themselves determine the purpose that
investment and its final output is to serve, for instance, the items that make
up the infrastructure. (1988, p. 107).
Lowe saw in public works a degree of variability and flexibility not possible
in the private sector, where competitive pressures legislate methods of
production, the composition of output, and the types of capital equipment and
natural resources utilized, and where private decisions governed by narrow
economic motives may not be consistent with what is best for society as a
whole (Forstater, 1998a; 2000b).
Lowe saw some of the major obstacles to full employment as being rooted in the
technological conditions of production. Employing workers available as a
result of labor-displacing technical change or increases in labor supply
depends on the prior construction of real capital. But the public sector has
the ability to vary the labor intensity of productive activity in ways that
the private sector cannot. The public sector may choose to utilize a more
labor-intensive method of production that would be "inefficient" for a private
firm, but which is quite reasonable from the perspective of social well being.
The public sector may also vary public sector employment between different
tasks, for the purpose of altering overall capital-labor ratios or easing the
utilization of certain types of capital equipment or increasing the
utilization of yet other types. The spectrum of choices open include
activities which approach the level of "pure services in the fields of
health, education, and general welfare" as well as activities that do not use
or make more limited use of precious natural resources and that do not pollute
(1988, p. 107). A public sector employment program can also deal with the
unequal geographical distribution of unemployment, which highly aggregated
demand stimulus programs do not necessarily address.
Functional Finance and Full Employment ... and Price
Lerner himself recognized the weaknesses of functional finance for attaining
true full employment, and he himself wrote of the role to be played by direct
job creation by government (Lerner, 1944, pp. 315-16). Others of his time
also spoke of the need to go beyond highly aggregated demand management to
direct government job creation, if true full employment were the goal (see
especially, Pierson, 1945, pp. 33ff). More recently, a number of proposals
along these lines have appeared (see, e.g., Harvey, 1989; Collins, et al.,
1994; Gordon, 1997; Mosler, 1995, 1997-98; Mitchell, 1998; Papadimitriou,
Wray, and Forstater, 1998a; Wray, 1998; Kregel, 1999; Nell, 2000).
An important recent proposal for what Papadimitriou, et al. have termed the
"job opportunity" approach put forward around the same time as Lowe's came
from Hyman Minsky (1986; see also Forstater, 1998b). Like Lowe, Minsky
believed full employment approaches based on "subsidizing demand" are limited,
as they are likely to result in inflation, financial crisis, and serious
instability (1986, p. 308). He thus sought an alternative to reliance on
schemes based on stimulating private sector demand:
The main instrument of such a policy is the creation of an infinitely elastic
demand for labor at a floor or minimum wage that does not depend on long-or
short-run profit expectations of business. Since only government can divorce
the offering of employment from the profitability of hiring workers, the
infinitely elastic demand for labor must be created by government. (1986, p.
While functional finance -- again, as originally formulated and by
itself -- cannot provide for zero involuntary unemployment, it does provide the
framework for making the question of how to pay for full employment a
non-issue. Instead of government simply concerning itself with aggregate
spending to close the gap between actual and potential employment, government
closes the gap by hiring the unemployed. The figures look the same in the
aggregate, but the composition and not simply the amount of government
spending comes to the fore. Spending must be on job creation. Functional
finance provides the rules for such spending and the rules for the management
of reserves and control of interest rates under such a system.
In addition, Lerner's recognition of money as a creature of the state, when
combined with Lowe's employment strategy provides a framework for price
stability that draws on the ideas Benjamin Graham. Graham (1937) outlines a
program for price stability based on commodity buffer stocks. This is an idea
that of course has been made familiar to economists and policy makers through
the work of such eminent figures as Nicholas Kaldor and A. G. Hart, among
others. But the idea here, as put forward recently by Kregel, Mitchell,
Mosler, Wray, and others, is that a Public Service corps can be conceived as a
buffer stock of labor. Thus, the national currency itself can be defined by
the wage paid to the Public Service workers. Of course, changes in the Public
Service wage will constitute a redefinition of the currency. Nevertheless, the
Public Service wage may serve as a regulating anchor to which the currency is
tied. Because labor is a basic commodity, employed directly and indirectly
into the production of every other commodity, the job opportunity program
offers a mechanism for regulating the value of the currency and thus
controlling the price level.
There are a number of other reasons why the job opportunity program need not
be inflationary. First, Public Service workers may be engaged in public works
such as infrastructure revitalization that promotes private sector
productivity growth. Second, such workers may be employed in activities that
help reduce expensive social and environmental costs, such as environmental
protection. Third, the increase in expenditure on Public Service workers will
be at least partially offset by decreases in other forms of expenditure on the
unemployed, or the effects of unemployment. Thus, expenditures on unemployment
insurance and some other forms of general assistance should be expected to
decline with the job opportunity program. There may also be expected to be
savings in the form of decreased expenditures on the indirect costs of
unemployment. These factors range from reductions in spending on crime
prevention and prosecution, and criminal justice related to unemployment,
reductions in medical bills, and savings on other social and economic costs of
unemployment. Fourth, public works tend to be less inflationary than "the
dole" because the former increases both supply and demand, while the latter
increases only demand. Fifth, as Lowe pointed out, government has a degree of
discretion not available to the private sector in choosing between alternative
methods of production and alternative productive activities, which can be used
to avoid bottlenecks and structural rigidities without sacrificing
The work of Lowe and Lerner challenges us to go beyond the received wisdom of
current economic theory and policy. It challenges us to reconsider the
methodology of economics and its relation to public policy. It also provides
theoretical insights that may inform the work of crafting a new
macroeconomics—a political macroeconomics, an institutional macroeconomics, an
historical macroeconomics, a structural economics: an Institutionalist Post
Keynesian Economics. A Lowe-Lerner synthesis also provides a framework for
incorporating both monetary production and structural and technological
change, and for analyzing both Keynesian and technological unemployment.
Instrumental analysis and functional finance are more than oddities to be
studied in history of thought journals, or worse, simply forgotten. These are
approaches that must be carefully considered for their potential contribution
to the formulation and implementation of effective practical policies for
today and the future. Recent work in an Institutionalist Post Keynesian vein,
by Pasinetti, also employs the instrumental method, while attempting to
address both monetary and financial factors and structural and technological
factors, the effective demand concern and the structural change concern, both
aggregate and sectoral balances and relations, taking seriously the role of
the state in capitalist economies.
Conventional and even some heterodox approaches to economics begin with some
given data, and then conduct analysis to predict or explain the direction of
the economic system, wherever that might lead. The instrumental method and
the method of functional finance begin by taking also as given a vector of
macro goals. Analysis then works backwards from the macro goals to discover
suitable paths to the initial conditions. Such a method reveals aspects of
the policy challenge left unnoticed when analysis proceeds from initial
conditions and works forward. For example, traditional macro policies to
stimulate aggregate demand often fail to consider the challenges of
maintaining full employment once it is attained, and reserves of
labor and excess productive capacity are no longer available, robbing the
system of structural flexibility. The properties of a full employment system
are different than a system with excess capacity and reserve pools of labor.
Maintaining full employment in the face of ongoing structural and
technological change requires alternative institutional arrangements. These
properties and these institutions remain hidden when analysis in confined to
working forward, while working backward assists in making them transparent.
Instrumental analysis and functional finance provide a useful methodology for
economic policy crucial for an Institutional Post Keynesian Political Economy
concerned with the real world and better worlds that might be
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