Rethinking Economic Policy in the Age of Financialization: Why the Barro-Ricardo Theory Cannot Make Sense

Abstract

The 2008 crisis brought forth a rethinking of the role of economic policies. We would like to analyze a specific point of this debate: the effect of financialization on fiscal policy. In doing so, we find it useful to analyze the debate on the Barro-Ricardo equivalence (BRE), which, since the 1970s, has played an important role in molding the economic policies that fostered the crisis. The original Barro article (1974) attacked counter-cyclical policies as futile, claiming that they could not boost the economy due to private investment crowding-out. We will try to explain why the traditionally understood assumptions of this theory and its conclusions are not helpful for analyzing the contemporary economy before finally offering alternative interpretations.

Keywords: Barro Ricardo Equivalence, Financialization

JEL Classification: E62, H23, F65