What problems are likely to occur if the federal government were to employ the functional finance budgetary philosophy?
The functional finance philosophy is very closely related to Keynesian ideas of economics and of governmental fiscal policy. This philosophy says that the government should not concern itself with issues of balanced budgets or with “living within its means” the way that ordinary people do. The government can print money and therefore is not subject to the same sorts of constraints that people experience. Therefore, this philosophy says, the government should spend based on how much economic activity it wants to see. It should spend as much or as little as is needed to achieve this.
The major problem that we are likely to see with this approach is high federal deficits. Under this philosophy, the government has a great incentive to spend and little incentive to raise taxes to keep up with its spending. If the government runs large deficits, there are at least two problems that could occur.
First, there is the problem of crowding out. Increased governmental borrowing can lead to higher interest rates. This makes it harder for private sector firms to invest. Less investment means less potential for economic growth.
Second, there is the problem of inflation. If the government simply prints money to sustain its spending, money comes to lose its value. This, too, is damaging for the economy.