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"Whenever the legislature attempts to regulate the differences between masters and their workmen, its counsellors are always the masters. When the regulation, therefore, is in favour of the workmen, it is always just and equitable; but it is sometimes otherwise when in favour of the masters. Thus the law which obliges the masters in several different trades to pay their workmen in money and not in goods, is quite just and equitable" (Smith 1976 [1776]), I.x.c.61, pp. 157–158).

John Maynard Keynes consistently offered qualified endorsement of Abba Lerner's "functional finance" doctrine—the qualifications particularly turning on Keynes's attentiveness to policy management of the psychology of the debt market. This article examines Keynes's understanding of the possible influence of public debt on interest rates, from 1930 forward. With the multiplier a mechanism whereby debt-financed public investment generates matching private saving (net of private investment) plus public saving, it becomes possible for Keynes to conclude that increasing public debt need not place upward pressure on the level of interest rates, so long as policy can successfully manage the psychology of the debt market. This particularly concerns long interest rates and hence the term structure of rates. His theory of the term structure enables Keynes's conviction that policy can manage and shape long rates. The conclusion considers also whether Keynes's caution concerning public debt and interest rates retains relevance today.

This essay examines Keynes's views on public debt, taking as its point of departure his 1943 confrontation with Abba Lerner on the issue. It also exhaustively considers the wider intellectual relationship between the two men, as well as Keynes's other commentaries on public debt in the 1930s and 1940s. The essay concludes that the key issue distinguishing Keynes's rather more cautious view of feasible and desirable public debt trajectories, vis-à-vis Lerner's position, is Keynes's attentiveness to the psychology of the debt markets, which is, in turn, an expression of his sensibility toward theory versus practice.