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Functional finance is type of economic approach that calls for direct intervention on the part of a government in order to create and preserve the economic stability of a nation. This concept was first developed as an organized economic theory during the World War II era, and was based on the understanding that national as well as local and state governments could intervene in an economy in order to reverse any negative economic trend that were emerging. This would make it possible to restore a financial equilibrium that avoided the extremes of recession and inflation, which in turn would aid in minimizing the possibility of the economy entering into a depression.
As part of the basic platform of functional finance, the government is seen as having both the ability and the responsibility to use means that would help to keep unemployment under a certain level, while also seeking to minimize the incidence of inflation within the economy in general. The idea is that the government could use its legislative powers to adjust taxation in whatever direction was required to produce the desired result. Depending on the exact circumstances of the emerging economic trend, this could mean lowering or raising taxes on both a national and a state level.
In like manner, the idea of functional finance holds that the government would intervene in setting standards for the interest rates that would apply to all types of loans. Doing so could be used to encourage businesses and individual consumers to borrow more money for purchases, which in turn would help to stimulate the economy with the increased circulation of cash within that economy. At the same time, if there was a need to reduce spending, increasing the average interest rate would deter at least some consumers from taking out loans and slow the economy before it could move into a period of inflation.
Functional finance also holds to the understanding that it is both the right and the responsibility of the government to control the distribution of currency within the national economy. This means that at any given point in time, the government can increase the amount of currency in circulation or reduce that amount, depending on what needs to be done in order to move the economy away from an undesirable trend. Money may be taken out of circulation by choosing to hold the currency in check for a period of time, or even physically destroying some of the currency, removing it from circulation on a permanent basis.
While many of the ideas contained in functional finance are widely accepted, other concepts are considered controversial. For example, this approach does not make it necessary and possibly not even practical for a government to operate with a balanced budget. As long as the goal of a stable and prosperous economy is achieved, the status of the government’s indebtedness should not be considered a priority issue.