Question: Explain and assess the arguments for ‘sound finance’ and 'austerity' to reduce public debt, and weigh them against the arguments in favour of Keynesian ‘functional finance’

Expert answer

Sound finance and austerity are often promoted as the best way to reduce public debt. However, there are arguments in favor of Keynesian "functional finance" that suggest this approach may not be the most effective way to reduce debt.

Arguments in favor of sound finance and austerity typically focus on the need to create a sustainable budget and avoid excessive borrowing. These proponents argue that public debt must be reduced in order to avoid a fiscal crisis. They also point to historical examples where countries have implemented austerity measures and successfully reduced their debt levels.

However, there are several problems with this approach. First, it can lead to economic recession and higher unemployment levels, which can actually increase the debt-to-GDP ratio. Second, it can be politically unpopular, making it difficult to implement and sustain. Finally, there is evidence that austerity measures often fail to achieve their desired results.

In contrast, Keynesian "functional finance" focuses on using fiscal policy to stabilize the economy. This approach argues that public debt should be reduced when the economy is strong and increased when the economy is weak. This counter-cyclical approach can help to avoid recessions and ensure that the debt-to-GDP ratio remains sustainable over the long term.

Overall, there are pros and cons to both approaches. The best solution is likely a mix of both sound finance and Keynesian economics. Reducing public debt is important, but it must be done in a way that does not jeopardize economic growth.