The New Paradigm Papers of the Month of June

The Political Economy of Industrial Policy 

Réka Juhász, Nathaniel Lane

This study analyzes how industrial policy is influenced by its political environment. The authors consider both the political forces that affect the way industrial policy is chosen and the dimensions of state capacity that shape the implementation of industrial policy through the lens of modern political economy.

They argue that industrial policy should take into account the political realities that surround it. Those industrial policies that are chosen within the country’s capacity and its specific political constraints are the most successful ones.

Moreover, they find that the political challenges policymakers face are not unique to industrial policy. Nor are the governance constraints necessarily invariable. Instead, successful industrial policies are often aimed to ease these constraints.

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Mission Critical: Statecraft for the 21st Century

Mariana Mazzucato

In her latest report, Mazzucato examines mission-driven government as an alternative form of statecraft that can address the extent of the challenges we face today. She applies this mission approach to the possible election of a progressive UK government in 2024/25.

According to Mazzucato, the UK government will need to take a radically different approach to meet today’s challenges. She proposes the introduction of a mission-driven government to deliver more growth that works for both the planet and people by investing in environmental and social aims.

Mazzucato claims that to succeed, a different kind of state is needed, namely, one that drives cross-sectoral investment and innovation and aligns growth with mission.

She also states that, mission-oriented statecraft as a whole focuses on delivery, connectedness, collaboration and innovation.

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People’s Understanding of Inflation

Alberto Binetti, Francesco Nuzzi, Stefanie Stantcheva

The authors of this paper examine how people in the US perceive the causes, consequences and distributional effects of inflation. Respondents to their large-scale survey name government policies, especially rising foreign aid and production costs due to the covid pandemic, oil prices and disruptions in the supply chain as causes of inflation.

When it comes to the consequences of inflation, above all, participants perceive that inflation complicates their daily economic decisions. Moreover, respondents expect negative distributional impacts of inflation, specifically that lower-income households experience greater losses. They also find a partisan divide in the perceptions of all aspects of inflation.

Another finding is that people don’t see the trade-offs of inflation. Instead, they regard inflation as something solely negative. Furthermore, participants don’t think that policymakers face any trade-offs in trying to control inflation. They view inflation as a high policy priority, and most don’t favor monetary tightening measures to fight inflation. Instead, they prefer, for example, taxing high incomes and increasing corporate taxes, because they perceive these policies as having other benefits as well. Respondents also support such policies that help vulnerable households cope with inflation. This is true even if the policies themselves are inflationary.

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Monetary Policy and Radical Uncertainty

Paul de Grauwe, Yuemei Ji

This paper examines the impact of radical uncertainty on the movements of macroeconomic variables. The authors claim that in the presence of radical uncertainty, the frequency distributions of macroeconomic variables deviate from normality, becoming distributions with fat tails. This means that in a world of great uncertainty, it is not possible to predict the transmission of major shocks.

They refer to a recent article on the macroeconomic implications of climate change in which the authors use a similar behavioral model, i.e. one with agents that are confronted with cognitive limitations in trying to understand the world’s complexity.

According to this article, compared to a model that assumes agents with rational expectations, it is more difficult to keep inflation low and stabilize the economy in the presence of climate change in this model. That is because when agents have cognitive limitations, it is more difficult for them to understand climate change. As a result, they don’t take the necessary precautions regarding consumption and saving. This in turn undermines economic stability.

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Carrots with(out) Sticks: Credit Policy and the Limits of Green Central Banking

Katie Kedward, Daniela Gabor, Josh Ryan-Collins

This paper explores what role of central banks could play in fostering decarbonization. The authors find that by the priority central banks give to short-term price stability and the structural requirements of global market-based finance, they are restricted in the greening of financial flows.

As a result, they have limited themselves to de-risking and market-fixing policies, thereby outsourcing the green transformation to the private financial sector.

The authors discuss the lessons learned from the Post-World War II credit guidance regimes and how they could be modernized to address the challenges arising from market-based finance. They argue that this will require central banks to challenge current norms of market neutrality and independence, i.e. a broader evolution in their role as public authorities.

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