Defaultnomics: Making Sense of the Barro-Ricardo Equivalence in a Financialized World

Levy Economics Institute, Working Papers Series #933

66 Pages Posted: 16 Jul 2019

See all articles by Lorenzo Esposito

Lorenzo Esposito

Bank of Italy

Giuseppe Mastromatteo

Catholic University of the Sacred Heart of Milan

Date Written: July 15, 2019

Abstract

The 2008 crisis created a need to rethink many aspects of economic theory, including the role of public intervention in the economy. On this issue, we explore the Barro-Ricardo equivalence, which has played a decisive role in molding the economic policies that fostered the crisis. We analyze the equivalence and its theoretical underpinnings, concluding that: (1) it declares, but then forgets, that it does not matter whether the nature of debt and investment is public or private; (2) its most problematic assumption is the representative agent hypothesis, which does not allow for an explanation of financialization and cannot assess dangers coming from high levels of financial leverage; (3) social wealth cannot be based on any micro-foundation and is linked to the role of the state as provider of financial stability; and (4) default is always the optimal policy for the government, and this remains true even when relaxing many equivalence assumptions. We go on to discuss possible solutions to high levels of public debt in the real world, inferring that no general conclusions are possible and every solution or mix of solutions must be tailored to each specific case. We conclude by connecting different solutions to the political balance of forces in the current era of financialization, using Italy (and, by extension, the eurozone) as a concrete example to better illustrate the discussion.

Keywords: Barro-Ricardo Equivalence, Financialization, Default

JEL Classification: E62, H23, F65

Suggested Citation

Esposito, Lorenzo and Mastromatteo, Giuseppe, Defaultnomics: Making Sense of the Barro-Ricardo Equivalence in a Financialized World (July 15, 2019). Levy Economics Institute, Working Papers Series #933, Available at SSRN: https://ssrn.com/abstract=3420080 or http://dx.doi.org/10.2139/ssrn.3420080

Lorenzo Esposito (Contact Author)

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

Giuseppe Mastromatteo

Catholic University of the Sacred Heart of Milan ( email )

Largo Gemelli, 1
Via Necchi 9
Milan, MI 20123
Italy

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