The New Paradigm Papers of the Month of May

Are We Fragmented Yet? Measuring Geopolitical Fragmentation and its Causal Effects

Jesús Fernández-Villaverde, Tomohide Mineyama, Dongho Song

As a result of the increasing economic integration around the world, the world economy has become fragmented. In their recent study, the authors analyse this global economic fragmentation by using various empirical indicators to introduce an index of geopolitical fragmentation.

One of their findings is that higher levels of fragmentation have a negative impact on the global economy, with emerging economies being more affected than advanced economies.

In addition, they show that there is an asymmetry, namely that the benefits of reducing fragmentation accrue only gradually over time, whereas fragmentation harms the global economy immediately.

They also conducted a sectoral analysis within OECD economies, illustrating the negative effects on industries such as construction and retail trade, i.e. industries that are closely linked to global markets.

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How Far from Full Employment? The European Unemployment Problem Revisited

Meryem Gökten, Philipp Heimberger, Andreas Lichtenberger

This study examines the deviations from full employment in the EU countries and compares them with those in the US and the UK. The Beveridge rate of unemployment (BECRU) is used as a measure of full employment. It shows the relationship between unemployment and job vacancies, indicating the level of unemployment that minimises the unproductive use of labour.

The authors show that the selected EU countries (Germany, Austria, Finland, Sweden) experienced periods of full employment in the 1970s. The problem of unemployment only emerged in the 1980s and 1990s.

The full employment gap – i.e. the difference between actual unemployment and the BECRU – narrowed before the global financial crisis, while it widened again during the Great Recession.

They also note that the labour supply surplus initially increased during the Covid pandemic and then decreased again with the recovery from the pandemic. However, only a few countries reached full employment afterwards.

Using panel regressions, the authors show that structural, macroeconomic and political factors, as well as labour market institutions and hysteresis, contribute to explaining the full employment gaps.

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The Cost of Money is Part of the Cost of Living: New Evidence on the Consumer Sentiment Anomaly

Marijn A. Bolhuis, Judd N. L. Cramer, Karl Oskar Schulz, Lawrence H. Summers

Although inflation is falling and unemployment is low, consumers are still unhappy. Why is that?

This study suggests that the cost of borrowing money explains much of it. These costs have recently risen much more than in previous decades and are not included in any of the conventional price indices. The authors claim that this might explain why there is a gap between the traditional measures used by economists, such as inflation and unemployment, and the true costs faced by consumers.

They find a strong correlation between consumer dissatisfaction in the US that can’t be explained by inflation and unemployment and the cost of borrowing money as well as the supply of consumer credit. Recently, concerns about borrowing costs reached new highs.

The authors develop alternative measures of inflation, including borrowing costs, that can explain almost three quarters of the gap in the sentiment among consumers in 2023. They also find a strong correlation between the gaps and changes in interest rates.

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Shaping the EU’s Financial Architecture for the Future – Impulses for the EU Reform Debate

Philipp Heimberger, Margit Schratzenstaller

Tackling climate change requires a transformation of Europe’s financial architecture. In this policy paper, the authors outline what such a restructuring could look like.

Massive investment is needed if the EU is to meet its climate change targets, secure public services, increase competitiveness and create sustainable jobs.

According to the authors, this requires financial instruments that are coordinated at the European level. At the EU level, fiscal policy should aim to enable cross-border green investments with added value for the EU. In addition, existing sectors need to be made sustainable and future technologies need to be produced in Europe, which can be achieved through a coordinated industrial policy.

EU Member States should use green investment to support the development of the social-ecological infrastructure urgently needed to ensure the success of the socio-ecological transition.

In essence, the authors make three concrete proposals on how to design a sustainable European financial architecture. First, the multiannual financial framework needs to be adapted. Second, permanent EU investment funds should be established. Thirdly, new sustainable EU own resources should be created.

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Economics of Energy Innovation and System Transition: Synthesis Report

Michael Grubb et al

As part of the Economics of Energy Innovation and System Transition (EEIST) project, the authors have developed analytical concepts and methods in the context of innovation and structural change that could be useful for policy makers. This report presents some of the main findings of the project.

According to the authors, the challenge of decarbonisation is one of choice, where lower-carbon investment pathways require deep systemic changes in many sectors.

They find that policies that encourage investment in emerging technologies are the most successful and propose an opportunity-risk analysis and principles for change – including that governments should invest and regulate to reduce technology costs, and actively manage risk to attract investment.

The authors stress that there is a growing need for empirical models that can realistically represent the evolving economy, technological change and a wide range of policy options, and better explain and predict the impact of the low-carbon transition on jobs, economic growth, finance and trade.

They also emphasise that an intellectual shift in the economy is needed to manage the energy transition.

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