Functional Finance changes everything - Part 2.

We can insulate ourselves from the effects of inflation and end unemployment.

In her press conference on the Reserve Bank’s most recent decision to raise interest rates, Governor Michelle Bullock was asked a question about the so-called “dual mandate” of the bank’s Monetary Policy Board to achieve both price stability and full employment. The question was:

Do you still believe in the narrow path to ease inflation gradually while maintaining full employment or are you seeing it as more urgent to address inflation at the moment?

Bullock was direct in her answer:

The narrow path was something that my predecessor talked about and it captured the idea that we had a dual mandate. But it’s also true that we don’t give equal weight to both and it depends a little bit on where we think the relative risks lie. So in early 2025 when inflation was coming down, unemployment was drifting up, we thought, okay. Maybe we need to pay a little bit more attention to the downside [meaning, unemployment]. But then it became clear in late 2025 and early ‘26 that actually the risks had all shifted to the upside [sic.] so we had to shift our focus and that’s why we’re ending up where we are today. Having said that, we still are conscious of the dual mandate. We are still conscious that we want to try and slow the economy enough to bring inflation back to target and we would rather not have unemployment or employment slow anymore than it has to. That is still part of it. But we do have to pivot depending on where we think the risks are lying.

This reflects an understanding of reserve bank responsibilities that most central banks have followed since the mid-1990s. And in Australia’s case it’s been used to justify forcing hundreds of thousands and even more than a million adults at any one time into unemployment and underemployment. The implication is that Australians can’t have lower interest rates unless they have higher unemployment and that unemployment for a few (or even upwards of a million) is a tolerably small price to pay for lower prices for all.

RBA governors are prone to expressing unemployment rates in percentage terms, perhaps hoping it might make us feel like the unemployment problem they are deliberately creating is small. And so as Bullock – with neither embarrassment nor apology – said later in the press conference:

I would hope that we can continue to have an unemployment rate in the 4’s.

At the time of her statement, the unemployment rate was 4.3%. But this means that she was happy to consign over 665,000 adults to joblessness at the same time as another 910,000 remained underemployed (that is, they couldn’t get enough hours of work).

The millions of hours of workforce capacity that is lost by the bank’s strategy for inflation control is incalculable, but in effect it means that, while she was speaking, over 10% of Australia’s willing workforce was underutilised, and had been so for more than two years. Well over 1.5 million people who needed to work were being forced to live without incomes sufficient to cover their needs, and all so that the economy could be perversely “slowed”; all so that demand could be stifled; all to force us into being able to spend less.

As shown in Part 1 of this article, there is a cruelty in the bank’s insistence on this strategy. And we are not talking just a little bit of cruelty. It’s embedded cruelty; it is a degree of unemployment that the bank does not want us to escape. There is no hint in any of Bullock’s statements that real full employment – the degree that gives the whole willing workforce enough hours of work to cover the essentials of a decent life – would suit the bank’s purposes. On the contrary, in Bullock’s view a growth in unemployment is desirable and even essential if she is to be able to do her job – or at least the part of it that she is willing to do, the part where she can wield the tool of interest rate adjustments, regardless of how it will affect the bank’s statutory obligation to achieve its “dual mandate” of contributing to full employment.

Bullock sees interest rate rises as giving her two shots at stabilising prices:

1. they allow her to build a pool of unemployed workers that is large enough to suppress the demand for wage increases (which she hopes will then take the heat out of demand); and

2. the resultant unemployment also lowers expectations about what employed people will be able to spend (which she hopes will reduce the time it takes for her choices within monetary policy about interest rates to stabilise prices).

But if monetary policy ever lowers prices, it only does so long after it has raised them. If interest rate rises work to reduce inflation at all, they are unlikely to take effect inside a year or more. So we must expect that the Governor will not give up the chance to create as much unemployment as she thinks she needs. She will stop millions of people doing their jobs if it helps her do hers. And anything that reduces unemployment – like public spending – will be discouraged, lest it adds to the time needed for monetary policy (theoretically) to help her “restore the balance between demand and supply.”

Monetary policy is unlikely to be effective in pursuit of this balance. But it would seem that the RBA has lost the capacity to interrogate the effectiveness of its policy preference. There are multiple reasons for this, most of them to do with the command that neoclassical economists and neoliberal policy advocates have built up over the last thirty years. But some of it arises from an unwillingness to admit the part that monetary policy plays in aggravating and even causing inflation. And some of it arises from a genuine but blinkered conviction that inflation can only be controlled by a growth in unemployment.

From the Governor’s point of view:

You can’t have low [sic.] and full employment if you don’t have low and stable inflation.

But given the “downsides” of monetary policy that Bullock acknowledges, and the fact that, since Covid, prices have stubbornly resisted the bank’s attempts to stabilise them, isn’t it time to question this? Is it actually necessary to trade away employment to achieve price stability? And even if inflation comes down into the bank’s preferred range of 2-3%, won’t it constitute a pyrrhic victory if we lose jobs and millions of hours of production? It’s certainly worth asking these questions if there is an alternative strategy. And there is.

The advantage of functional finance

Functional finance would suggest that the trade-off between price stability and full employment isn’t necessary at all. The rules of functional finance offer us a way out of this odious exchange. In direct contradistinction to the Governor’s belief, functional finance shows that you can’t have low and stable inflation until you have full employment. It is the latter that leads to the former, not the other way around as the governor implies. And here’s why.

Functional finance shows that the solution to inflation is not to stifle demand (as Bullock prefers) but to simultaneously increase public spending and stimulate investment so that employment grows. It is not to lower demand for whatever we can be organised to produce, but to arrange the macroeconomy so that we can boost production (that is, supply) to the level necessary to meet our demands especially for the essentials of life. In short, functional finance tells us not to pull demand back but to pull supply forward.

This is the opposite strategy to that preferred by the bank. But it is evident that the RBA’s strategy is self-defeating, and on so many fronts that it should be abandoned. Raising interest rates will not dampen prices, it will increase them; and because it will increase them long before it might reduce them and also dampen investment at the same time, it will eat away or even eliminate our capacity to shield ourselves from the effects of the inflation.

Nobody wins with the RBA’s strategy – not the employed, not the unemployed, and not even the bank itself (although it must be admitted that private banks do very well out of it).

Comes a point, then, where both the RBA and the government need to recognise:

1. that most types of inflation are not going to respond to monetary policy;

2. that they are sacrificing all our employment growth opportunities for nothing; and

3. that success will inhere in switching to the use of fiscal policy – that is, public spending and taxing – as the primary method of inflation control.

Time for Treasury to skill up in functional finance

Success in using this will depend, at least in part, on how skilled Treasury can be in the use of Rule 1 of functional finance. As Abba Lerner observed, Treasury’s main job in functional finance is simply to

keep the total rate of spending in the country on goods and services neither greater nor less than that rate which at the current prices would buy all the goods that it is possible to produce. If total spending is allowed to go above this there will be inflation, and if it is allowed to go below this there will be unemployment.

But this part of the job of macroeconomic stabilisation (that is, balancing demand and supply) is not difficult to master. Treasury staff can safely and easily make decisions every day on total government spending, the total amount of money that should be circulating in the economy, and the total amount they should withdraw from the economy (either by taxation or other forms of money withdrawal) to ensure that demand and supply are balanced. And they can achieve this balance without “downsides” simply by asking and answering these questions as a matter of routine:

1. When will they know the government has spent enough money into the economy to balance supply and demand? Answer: when unemployment declines to between 1% and 1.5% (close to the levels achieved in the post-World War II boom).

2. When will they know the government needs to tax more (because it has stimulated demand too much and has run out of the labour to meet the demand)? Answer: when and not before unemployment declines to 1.5%.

3. When will they know to stabilise government spending? Answer: when unemployment declines to less than 1.5%.

4. When will they know to start increasing government spending again? Answer: when unemployment rises above 1.5% (if not sooner).

Meanwhile, the RBA, as indicated by Rule 2 of functional finance, can play its most helpful part by holding interest rates in a band designed to optimise investment. For that purpose it will be advisable and necessary for the RBA to discard its current target inflation band of 2-3% (and any other inflation target) and replace it with a cash rate band of 2-3%. In other words it should abandon using interest rates to achieve inflation control and instead use other tools within monetary policy (mainly buying and selling government bonds) to achieve a cash rate target of 2-3% because that is probably the interest rate band that will lead to optimal investment in the economy. See why this is necessary in Chapter 2 of The Public Interest Economy by ACFP Founder Dr Bronwyn Kelly.

Finally, the bank and Treasury should be able to continue to work together every day, just as they do now, to facilitate flows of the right volumes of money into and out of the economy by use of Rules 2 and 3 of functional finance. But the fairness with which they do this must be governed by what Australians think is fair in taxation and necessary in public spending. For that we need an entirely new form of collaboration as a national community – we need the Australian Public Interest Collaboration. For advice on how this collaboration can be organised, see Chapter 6 of The Public Interest Economy.

As already noted in Part 1 of this article, there will be a phalanx of neoclassical economists and neoliberal policy adherents who will bellow that those aspects of Rules 1 and 3 which prescribe public spending and “printing” money, will rush us all headlong into inflation. And we may expect that the RBA will not readily abandon its inflation target. But the target of all monetary and fiscal policy should not be about inflation as such; it should instead be about ensuring the macroeconomy is arranged to protect us against its effects.

Functional finance protects our financial security

The beauty of functional finance is that it can prevent homegrown, demand-driven inflation by constantly keeping our spending capacity in line with our capacity for production. But it can also shield us against the effects of inflation, particularly externally driven inflation (such as shortages of essential imports) because it pushes always towards full employment, not away from it. When troubles come, everyone who needs a job has a job and so every family can still afford the essentials. In that regard, functional finance offers us a double security. Monetary policy as conducted by the RBA eliminates our financial security.

But this does not mean that functional finance is a full solution for inflation. Economic restructuring will be required in addition to functional finance if Australia is to shield itself from the effects of all types of inflation. To dampen down the potential for inflation, we will need to shift the economy towards a greater proportion of non-inflationary industries of wellbeing – those industries that consume less of our scarce natural resources. Excessive natural resource consumption causes inflation. So if – and hopefully when – the government and the RBA orient the economy towards full employment, they will need to ensure it is full employment in industries that cause as little inflation as possible. That will make Governor Bullock’s job easier and she can be released from the odious exchange.

Read about industries of wellbeing and how they help us reduce inflation in Chapters 2 and 4 of The Public Interest Economy.

Later articles in this series will expand on the need for economic re-composition. Further information on paths to a sustainable economic composition for Australia is available in Chapter 6 of in The Public Interest Economy.

Read Part 1 of this article

This is Part 2 of this article. For an introductory article on functional finance, read Part 1 here.

Read more about functional finance in The Public Interest Economy.

For information on functional finance see the ACFP information sheet, What is functional finance? Extracts from The Public Interest Economy.

The Public Interest Economy is available on Amazon Kindle here and in paperback here or by email here.

You can also listen to a full reading of The Public Interest Economy, available in weekly instalments on the Australia Together Podcast.

An interview with the author

Click on the picture to listen to a radio interview with Bronwyn Kelly about The Public Interest Economy.

Want to know more about ACFP?

Find out all about ACFP and how to become involved here.