Opinion by Leonardo Badea, First Deputy Governor of the National Bank of Romania

We are living through a moment of inflection in which the economy, after decades of dominance of efficiency and globalization, is once again becoming subordinate to geopolitics. If the beginning of the millennium was marked by the illusion of perpetual stability, the rapid succession of recent crises – from the financial shock of 2008 and the pandemic of 2020 to the return of war on the European continent in 2022 and the chronic instability in the Middle East – confirms that we are living in a new normal. In this fragmented landscape, classic macroeconomic variables can no longer be analyzed in isolation. We are witnessing a paradigm shift: military security, energy sovereignty, and technological advancement (especially Artificial Intelligence) have ceased to be niche topics, becoming the central pillars that dictate the fiscal health of a state. For Romania and the European Union, the challenge is no longer just managing an economic cycle but adapting to a development model in which resilience is more precious than cost optimization.

At the national level, the security we enjoyed until 2022 when the war in Ukraine broke out, is a thing of the past. If until then, the defense budget was a national option, with systematic allocations of less than 2% of GDP, the new geopolitical and security configuration requires a minimum level of 2.5% of GDP. This level represents a significant budgetary effort, which will not be a one-off, but on a permanent basis. It may seem like a lot, but if we look at Poland, for example, with a geostrategic situation similar to ours, it has a defense budget allocation of 4% of GDP and even more. Also, the Baltic countries or some Scandinavian countries aim to allocate over 3% of GDP. So, security in this area of ​​Europe has become expensive and even very expensive, and in this sense, think about what it would mean to have to increase the defense budget to over 2.5% of GDP. This new configuration imposes a permanent budgetary effort, bringing to the fore the risk of a geopolitical “crowding-out”, and the fundamental challenge lies in managing this pressure on public resources, so that massive allocations for defense do not suffocate productive civilian investments. In such a paradigm, the efficiency of state spending becomes the critical variable and only through a rigorous selection of projects and an orientation towards investments with high added value can the security imperative be accommodated, without significantly compromising the potential for long-term economic growth.

I will paraphrase a famous work in the field of monetary policy – Some Unpleasant Monetarist Arithmetic (1981) by Thomas Sargent and Neil Wallace, which describes the situation in which monetary policy is dominated by fiscal policy. In the current context, there is, in my opinion, a development of this concept, in the sense that fiscal policy is the dominated one, while defense policy has become the new dominant policy. In the general context of the policy mix, at this moment we are witnessing the emergence of a new dominant policy in relation to both monetary and fiscal policy, namely, energy policy. Thus, energy policy becomes the link between geopolitical and macroeconomic decision-making.

In a synthetic way, we can note that the price of energy is determined globally by five important factors: i) global demand and supply, ii) trading hubs, iii) electricity market structure, iv) geopolitics and OPEC decisions, v) the cost of carbon on financial markets. As a brief parenthesis, in most energy markets, the price is not set by the average cost of energy, but by the cost of the last unit of energy needed to cover demand, therefore, perhaps counterintuitively, a small decrease in production or an insignificant increase in demand can generate large price variations. For example, in Europe, the merit order system operates, which stipulates that energy is produced in order of cost. Thus, in order to meet demand, power plants generating the cheapest energy are used first-namely hydro, wind, solar, and nuclear; and if these do not cover total consumption, more expensive generation – based on coal and gas-fired power plants- is used. The final price of energy is given by the last unit needed to cover demand, which is also the most expensive. In this mechanism of price formation at marginal cost, the distinction between baseload and intermittent production becomes critical. Renewable units (wind, solar) have a marginal cost close to zero, but their volatile nature does not allow them to ensure system stability on their own. Thus, the current market paradox is that, although the installed capacities of “green” energy are increasing, the final price remains captive to the marginal cost of gas or coal, which are necessary to cover peak periods or periods of absence of the renewable resource. In Romania’s case, it has become essential to develop its energy capacities and try to produce not only more and cheaper, but also to make investments in storage and demand flexibility that would remove infrastructure limitations that lead to increased energy prices, in order to decouple consumer prices from the dictates of fossil fuels in times of imbalance.

Regarding geopolitics and the impact on energy prices, I would like to emphasize that the situation in the Middle East is one with a high degree of uncertainty. Negotiations are announced, then military hostilities continue, and in the meantime the Strait of Hormuz continues to remain closed. This strait is not only an oil distribution route, but a vital factor for the functioning of the Gulf economies. As I mentioned in a recent article, the question that naturally arises is whether, in the current circumstances, the Middle Eastern states will again resort to cartel-like policies as in the 1970s, which would result in consistently high oil and natural gas prices.

In geopolitics, unlike macroeconomics, but similar to the field of financial stability, the circumstances associated with stress scenarios are considered and analyzed. The oil crises of the 1970s led to persistent inflation, and the disinflationary process of the Volcker era came with very high economic costs, as a result of the aggressive increase in interest rates. A recent article in The Economist mentioned the idea that, in the circumstances of the current conflict in the Middle East, even a best-case scenario is disastrous for energy markets.

Regarding the new economic normality, I will briefly highlight three main ideas. In general, in colloquial language, risk and uncertainty are used as equivalents. If risk refers to the fact that we do not know exactly what will happen, but we know the scenarios, as well as the associated probabilities with which they can occur, uncertainty refers rather to the fact that we do not know many details about the scenario that will eventually become reality and, implicitly, about the probability of its materialization. In my opinion, at this moment we are faced with a high level of uncertainty. It is known and documented in the specialized literature that the effects of uncertainty on the macro-financial framework are more pronounced in a negative sense than those generated by an increase in risk. In conditions of uncertainty, markets tend to “freeze” and the current uncertainty transforms the investment horizon from one based on the calculation of probabilities to one dominated by extreme caution, which partly explains the stagnation of private investment in leading technology sectors in Europe.

Then, referring to the AI ​​era we have transitioned into, it is obvious that Europe is not very competitive compared to the United States of America and China. And if we look at European statistics, we note that, unfortunately, Romania is ranked last in the EU, with a share of only 5.2% of enterprises that used AI technologies in 2025, well below the European average. This share increased from 3.1% in 2024, recording an annual advance of 2.1 percentage points, more than three times lower than the European growth rate. The transition to the AI ​​era should not be viewed in isolation, as a simple indicator of modernization, but as the common denominator of national resilience, as AI becomes the bridge between labor productivity, energy security, and even military security. Romania’s delay in adopting these technologies generates a multidimensional vulnerability: in energy, the lack of “smart grid” algorithms prevents us from optimizing the “merit order” system, keeping us dependent on expensive production units and amplifying price shocks; in the economy, low labor productivity limits the fiscal resources necessary to support the defense budget; in security, technological superiority and the capacity to process data quickly are as important as gross budgetary allocations in a modern conflict. Thus, digitalization is no longer a business option, but a national security imperative, being the only way to compensate for the accelerated increase in the price of the previously mentioned pillars of stability.

Last but not least, the fiscal-budgetary situation in our country is extremely complicated. We are the first country in the European Union that will have to manage a level of public debt of over 60% of GDP, with a sovereign rating of BBB- according to FITCH (i.e. the last level before entering the category of non-investment or junk), simultaneously with a high level of budget deficit, but also of the current account deficit, with a level of interest costs of approximately 3% of GDP (what the entire deficit should be according to the Maastricht Treaty). At the same time, we cannot lose sight of the increasingly pessimistic macroeconomic prospects as a result of the tensions generated by the current conflict in the Middle East.

Given this complicated picture, with some risks even of a systemic nature, in my view, in the short term, the macroeconomic policy mix should be oriented towards widening the room for maneuver, as much as possible, of course. I will paraphrase in this sense Paul Krugman, who introduced the concept of the “Panglossian” decision-maker into the economic literature, this name coming from classical literature, more precisely from the character of Dr. Pangloss in Voltaire’s novel Candide. In Candide, Dr. Pangloss was a caricatured philosopher who supported the idea that “we live in the best of all possible worlds”, regardless of how dire the circumstances were. Thus, in a world full of uncertainty, a non-Panglossian approach would indicate facilitating a room for maneuver to be used only when truly needed. I will conclude by referring to an important hypothesis from the theory of consumption, permanent income and precautionary saving, promoted by economists such as Milton Friedman, Franco Modigliani, or John Campbell: saving for a rainy day. With the current debt and rating metrics, our fiscal “umbrella” is largely worn out, and in a non-Panglossian world, fiscal consolidation is not an exercise in austerity, but a necessity to rebuild reserves for times when geopolitical shocks may materialize in unsustainable financing costs.

In the context of the new normal, energy becomes, in my opinion, the main channel through which geopolitical tensions are transmitted into the economy, influencing inflation, economic growth, and the macroeconomic policy mix. Essentially, the economy of the geopolitical era forces us to a triple adaptation: a robust defense policy, a smart energy policy supported by AI, and a responsible fiscal policy, the only one able to protect us against the unpredictable.