Working Paper: CEPR ID: DP17277
Authors: Oleg Itskhoki; Dmitry Mukhin
Abstract: We show that the exchange rate may appreciate or depreciate depending on the specific mix of sanctions imposed, even if the underlying equilibrium allocation is the same. Sanctions that limit a country's imports tend to appreciate the country’s exchange rate, while sanctions that limit exports and/or freeze net foreign assets tend to depreciate it. Increased precautionary household demand for foreign currency is another force that depreciates the exchange rate, and it can be offset with domestic financial repression of foreign currency savings. The overall effect depends on the balance of currency demand and currency supply forces, where exports and official reserves contribute to currency supply and imports and foreign currency precautionary savings contribute to currency demand. Domestic economic downturn and government fiscal deficits are additional forces that affect the equilibrium exchange rate. The dynamic behavior of the ruble exchange rate following Russia's military invasion of Ukraine in February 2022 and the resulting sanctions is entirely consistent with the combined effects of these mechanisms.
Keywords: sanctions; exchange rate; currency; capital flows; financial repression
JEL Codes: E50; F31; F32; F41; F51
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Sanctions limiting a country's imports (F51) | Appreciate the exchange rate (F31) |
| Sanctions limiting exports or freezing net foreign assets (F38) | Depreciate the exchange rate (F31) |
| Increase in precautionary household demand for foreign currency (F31) | Depreciate the exchange rate (F31) |
| Domestic financial repression (F38) | Mitigate depreciation of the exchange rate (F31) |
| Exports and official reserves (F31) | Supply of currency (E51) |
| Imports and foreign currency savings (F31) | Demand for currency (E41) |
| Domestic economic downturns and government fiscal deficits (H69) | Influence equilibrium exchange rate (F31) |