Explain the differences among an annually balanced budget, a cyclically balanced budget, and functional finance.
An annually balanced budget is what we typically think of when we think of a balanced budget. This is a budget in which the government’s spending matches the revenue that it takes in over the course of a year. In each year, then, the government must not spend any more money than it takes in.
A cyclically balanced budget is somewhat different. This sort of budget does not need to be balanced each calendar year. This philosophy recognizes that government might need to spend more in some years and less in others because of the business cycle. Business cycles do not follow the calendar so neither should government spending. In this philosophy, the government balances its budget over the business cycle. During a recession it spends more and runs deficits. When the economy is recovering, it spends less and runs surpluses. Over the course of the entire business cycle, these surpluses and deficits balance.
Functional finance is altogether different. It does not require the government to balance its budget at all. Instead, the government simply identifies how much economic activity it wants and spends enough to achieve that. The government need never balance its budget.