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The Economics of War Sanctions

Paper Session

Saturday, Jan. 7, 2023 8:00 AM - 10:00 AM (CST)

Hilton Riverside, Grand Salon D Sec 21 & 24
Hosted By: American Economic Association
  • Chair: Pierre-Olivier Gourinchas, University of California-Berkeley

A Minimalist Model for the Ruble During the Russian Invasion of Ukraine

Guido Lorenzoni
,
Northewestern University
Ivan Werning
,
Massachusetts Institute of Technology

Abstract

This note isolates an overlooked economic force for the Ruble to appreciate in response to
international sanctions limiting exports to Russia. The economic intuition is that when Russians
are unable to buy the mix of foreign goods they wish, then foreign goods becomes less attractive,
increasing the demand for domestic goods; to reestablish an equilibrium a real appreciation is
needed to raise the relative price of domestic goods and incentivizing the accumulation of foreign
assets and the import from non-sanctioning countries. We also review well-known forces for a
depreciation (e.g. Russian export reduction). Our analysis emphasizes that the exchange rate is an
inadequate signal of welfare impacts and the effectiveness of sanctions.

On Wars, Sanctions and Sovereign Default

Javier Bianchi
,
Federal Reserve Bank of Minneapolis
Cesar Sosa-Padilla
,
University of Notre Dame

Abstract

This note provides a simple conceptual model to account for this set of events. The model has
two countries, a debtor country, Russia (the sanctionee), which can default on its debt and chooses
external borrowing and international reserves, and a creditor country, the US (the sanctioner), which can impose restrictions on the use of reserves by Russia. During the wartime (the  1st period in our model), the sanctioner's utility is decreasing in the resources available to the sanctionee (i.e., the US dislikes Russia having resources to pay for the war) but at the same time it holds sovereign bonds issued by the sanctionee (i.e., the US is a net lender to Russia). The latter implies that imposing sanctions may have a boomerang effect by triggering a default and losses for the sanctioner. In this environment, we examine the Nash equilibrium in a strategic game in which the sanctioner moves  1st and decides whether to impose sanctions and how strong these would be, the sanctionee moves second and, given the sanctions, decides whether to repay or default.
The key results we obtain are as follows. Soft restrictions on the use of reserves on the sanctionee
come at no cost for the sanctioner. Hard restrictions, however, can precipitate a default and this imposes costs on the sanctioner. If the disutility that the US suffers from Russian resources (to  nance the war) is low, the optimal restriction involves squeezing the resources up to the point in which Russia is indifferent between repaying and defaulting. However, if this disutility is high enough, the optimal sanction is a total freezing of reserves and this triggers a default.

Sanctions and the Exchange Rate

Oleg Itskhoki
,
University of California-Los Angeles
Dmitry Mukhin
,
London School of Economics

Abstract

Trade wars and financial sanctions are again becoming an increasingly common part of the international economic landscape, and the dynamics of the exchange rate are often used in real-time to evaluate the effectiveness of sanctions and policy responses. We show that sanctions limiting a country's exports or freezing its assets depreciate the exchange rate, while sanctions limiting imports appreciate it, even when both types of policies have exactly the same effect on real allocations, including household welfare and government fiscal revenues. Beyond the direct effect from sanctions, increased precautionary savings in foreign currency also depreciate the exchange rate, when they cannot be offset by the sale of official reserves or financial repression of foreign-currency savings. Furthermore, the government may choose to compensate sanctions-induced fiscal deficits with an exchange rate depreciation using either monetary loosening or FX accumulation; the former solution comes at a cost of higher inflation, while the latter policy provides only a temporary relief. The overall effect on the exchange rate depends on the balance of foreign currency demand and supply forces. We show that the dynamics of the ruble exchange rate following Russia’s invasion of Ukraine in February 2022 are quantitatively consistent with the combined effects of these forces calibrated to the observed sanctions and government policies.

A Theory of Economic Sanctions as Terms-of-Trade Manipulation

John Sturm
,
Massachusetts Institute of Technology

Abstract

How can a country design economic sanctions to maximize their economic cost to the sanctioned country at the lowest cost to the sanctioner? I consider this problem from the perspective of international trade and draw a close connection between trade restrictions as economic sanctions and trade restrictions as terms-of-trade manipulation. This connection has several useful implications for sanction design: Small sanctions increase welfare in the sanctioning country. Sanctions target the same goods as terms-of-trade manipulation. Sanctions ignore elasticities of demand and supply in the sanctioning country. Sanctions treat imports and exports asymmetrically.

Market Integration and Supply Disruptions: Sharing the Pain from a Russian Gas Shut-off to the EU

Silvia Albrizio
,
International Monetary Fund
John Bluedorn
,
International Monetary Fund
Christoffer Koch
,
International Monetary Fund
Andrea Pescatori
,
International Monetary Fund
Martin Stuermer
,
International Monetary Fund

Abstract

How does market size affect the economic propagation of supply shocks? We examine this question at the example of a Russian gas shut-off to the European Union (EU). An open-economy, multi-sector general equilibrium model suggests that the adverse economic impact on the EU shrinks five-fold if integration with the global LNG market is considered. Greater integration provides a buffer for the EU through trade. The flip side of integration is that other LNG importers around the world see adverse effects from higher prices. Still, the combined total economic damage for the EU and other LNG importers is less than half in the case of integration than in the counterfactual case without. As a larger market scope provides more margins of adjustment, governments should foster more integration to make economies resilient to supply shocks
JEL Classifications
  • F3 - International Finance
  • E0 - General