nep-cba New Economics Papers
on Central Banking
Issue of 2022‒06‒13
23 papers chosen by
Sergey E. Pekarski
Higher School of Economics

  1. Managing Monetary Policy Normalization By Gianluca Benigno; Pierpaolo Benigno
  2. Implications for Determinacy with Average Inflation Targeting By Ahmad, Yamin; Murray, James
  3. Government Spending between Active and Passive Monetary Policy By Collin Philipps; Sebastian Laumer
  4. Central bank digital currency and bank intermediation By Adalid, Ramón; Álvarez-Blázquez, Álvaro; Assenmacher, Katrin; Burlon, Lorenzo; Dimou, Maria; López-Quiles, Carolina; Martín Fuentes, Natalia; Meller, Barbara; Muñoz, Manuel A.; Radulova, Petya; Rodriguez d’Acri, Costanza; Shakir, Tamarah; Šílová, Gabriela; Soons, Oscar; Veghazy, Alexia Ventula
  5. Effectiveness and conduct of macroprudential policy in Indonesia in 2003-2020: Evidence from the structural VAR models By Dąbrowski, Marek A.; Widiantoro, Dimas Mukhlas
  6. Central Bank Digital Currencies: The Motivation By Bert Van Roosebeke; Ryan Defina
  7. Monetary and macroprudential policy interactions in a model of the European Union By Richard Dennis; Pelin Ilbas
  8. Why bank money creation? By Gersbach, Hans; Zelzner, Sebastian
  9. Q-Monetary Transmission By Priit Jeenas; Ricardo Lagos
  10. The Fed's International Dollar Liquidity Facilities: New Evidence on Effects By Linda S. Goldberg; Fabiola Ravazzolo
  11. Enhancing Stress Tests by Adding Macroprudential Elements By William F. Bassett; David E. Rappoport
  12. Technological progress and institutional adaptations: the case of the Central Bank Digital Currency (CBDC) By Riccardo De Bonis; Giuseppe Ferrero
  13. The Chronology of Brexit and UK Monetary Policy By Martin Geiger; Jochen Güntner
  14. Exploring the Trade-Off Between Leaning Against Credit and Stabilizing Real Activity By Luca Benati
  15. Normalizing the central bank’s balance sheet: Implications for inflation and debt dynamics By Begoña Domínguez; Pedro Gomis-Porqueras
  16. Output Divergence in Fixed Exchange Rate Regimes: Is the Euro Area Growing Apart? By Yao Chen; Felix Ward
  17. Central Bank Digital Currency: Stability and Information By Todd Keister; Cyril Monnet
  18. Optimal bank capital requirements: What do the macroeconomic models say? By Gulan, Adam; Jokivuolle, Esa; Verona, Fabio
  19. "A GARCH Approach to Modeling Chilean Long-Term Swap Yields" By Tanweer Akram; Khawaja Mamun
  20. Effectiveness of Monetary Policy in Stimulating Economic Growth in Nigeria By Igbafe, Timothy
  21. The digital economy, privacy, and CBDC By Ahnert, Toni; Hoffmann, Peter; Monnet, Cyril
  22. Financial cycles under diagnostic beliefs By Camous, Antoine; Van der Ghote, Alejandro
  23. Sanctions and the Exchange Rate By Oleg Itskhoki; Dmitry Mukhin

  1. By: Gianluca Benigno; Pierpaolo Benigno
    Abstract: We propose a new framework for monetary policy analysis to study monetary policy normalization when exiting a liquidity trap. The optimal combination of reserves and interest rate policy requires an increase in liquidity (reserves) a few quarters after the policy rate is set at the effective lower bound. Removal of accommodation requires that quantitative tightening starts before the liftoff of the policy rate. Moreover, the withdrawal of liquidity takes place at a very slow pace relative to the normalization of the policy rate.
    Keywords: reserve management; central bank balance sheet; quantitative tightening; quantitative easing; interest on reserves
    JEL: E31 E43 E52 E58
    Date: 2022–05–01
  2. By: Ahmad, Yamin; Murray, James
    Abstract: We use a standard New Keynesian model to explore implications of backward- and forward-looking windows for monetary policy with average inflation targeting and investigate the conditions for determinacy. A unique equilibrium rules out sunspot shocks that can lead to self-fulfilling shocks for inflation expectations. We find limitations for the length of the forward window and demonstrate how this depends on other parameters in the model, including parameters governing monetary policy and expectations formation.
    Keywords: Average Inflation Targeting, Determinacy, Monetary Policy
    JEL: E50 E52 E58
    Date: 2022–05–13
  3. By: Collin Philipps (Department of Economics and Geosciences, US Air Force Academy); Sebastian Laumer (Department of Economics, University of North Carolina Greensboro)
    Abstract: Theory suggests that the government spending multiplier is larger when monetary policy is passive. We find instead that, regardless of the monetary policy regime at the time of a spending shock, the central bank responds actively towards inflation quickly after the shock. This rapid monetary policy response leaves multipliers ultimately unaffected by whether the initial regime was active or passive. Our analysis highlights the necessity of accounting for the monetary policy reaction to spending shocks. Failure to do so ignores the central bank’s ability to respond to shocks, potentially leading to a misrepresentation of how multipliers depend on monetary policy.
    Keywords: Fiscal Multiplier, Monetary Policy, Nonlinear SVARs
    JEL: C32 E32 E62
    Date: 2022–05
  4. By: Adalid, Ramón; Álvarez-Blázquez, Álvaro; Assenmacher, Katrin; Burlon, Lorenzo; Dimou, Maria; López-Quiles, Carolina; Martín Fuentes, Natalia; Meller, Barbara; Muñoz, Manuel A.; Radulova, Petya; Rodriguez d’Acri, Costanza; Shakir, Tamarah; Šílová, Gabriela; Soons, Oscar; Veghazy, Alexia Ventula
    Abstract: In July 2021 the Eurosystem decided to launch the investigation phase of the digital euro project, which aims to provide euro area citizens with access to central bank money in an increasingly digitalised world. While a digital euro could offer a wide range of benefits, it could prompt changes in the demand for bank deposits and services from private financial entities (ECB, 2020a), with knock-on consequences for bank lending and resilience. By inducing bank disintermediation, a central bank digital currency, or CBDC, could in principle alter the transmission of monetary policy and impact financial stability. To prevent this risk, options to moderate CBDC take-up are being discussed widely.In view of the significant degree of uncertainty surrounding the design of a potential digital euro, its demand and the prevailing environment in which it would be introduced, this paper explores a set of analytical exercises that can offer insights into the consequences it could have for bank intermediation in the euro area.Based on assumptions about the degree of substitution between different forms of money in normal times, several take-up scenarios are calculated to illustrate how the potential demand for a digital euro might shape up. The paper then analyses the mechanisms through which commercial banks and the central bank could react to the introduction of a digital euro. Overall, effects on bank intermediation are found to vary across credit institutions in normal times and to be potentially larger in stressed times. Further, a potential digital euro’s capacity to alter system-wide bank run dynamics appears to depend on a few crucial factors, such as CBDC remuneration and usage limits. JEL Classification: E42, E51, G21
    Keywords: bank intermediation, bank runs, CBDC, digital euro
    Date: 2022–05
  5. By: Dąbrowski, Marek A.; Widiantoro, Dimas Mukhlas
    Abstract: The paper examines the effectiveness of macroprudential policy in Indonesia and policy reactions to economic developments. Using the structural vector autoregression and data on the regulatory LTV ratio, we investigate the policy effectiveness in controlling credit growth and real property prices along with the effects on economic activity. We find that the LTV-based policy in Indonesia is effective in taming credit growth in the medium run. It, however, is not the case with real property prices whose response to policy changes is counterintuitive and resembles the price puzzle found in the studies on monetary policy. Moreover, our results lend moderate support to the effect of LTV policy on economic activity, especially in the non-Covid-19 sample. We also show that the LTV policy in Indonesia is conducted in an active and circumspective way. In a series of robustness checks, we demonstrate that the results hold when the ordering of variables is changed, alternative proxies for macroprudential policy, output gap, and financial conditions are employed, or the sample is limited to the non-Covid-19 period.
    Keywords: macroprudential policy; loan-to-value policy; structural vector autoregressive models; financial stability
    JEL: E44 E58 F41 G10
    Date: 2022–05–05
  6. By: Bert Van Roosebeke (International Association of Deposit Insurers); Ryan Defina (International Association of Deposit Insurers)
    Abstract: A growing number of central banks are considering the issuance of central bank digital currencies (CBDCs). Upon their introduction and depending on their exact design, CBDCs may have considerable consequences for deposit insurers as well. In the first of a set of papers, this Fintech Brief sets out four of the main motivations for issuing CBDCs. Acknowledging considerable divergences across jurisdictions, we find: CBDCs for the general public (“retail CBDCs†) would constitute a central bank liability and a form of digital cash. To the public, they would be an alternative to central bank issued cash and private money, such as bank deposits. A large and growing share of central banks are experimenting with retail CBDCs. Some 20% of central banks indicate that they are likely to issue a retail CBDC by 2026, 40% indicate this is “possible†. Short-term monetary policy considerations are unlikely to play a significant role in central banks’ motivation for CBDCs. Whereas central banks in emerging markets and developing economies note that CBDCs may contribute to promoting financial inclusion, in advanced economies, CBDCs are not the most straightforward instrument in doing so. The evolution of payments plays a pivotal role in developing CBDCs. Given the declining role of cash in some jurisdictions, CBDCs as a new form of central bank money may contribute to safeguarding trust in the public currency. However, the available CBDC amounts necessary for that purpose may cause conflicts with likely and financial-stability-related limits on the volume of CBDCs that individuals may hold. As CBDCs would offer an alternative payment solution, they would contribute to resilience in future payment markets that may be privately dominated. However, given their digital nature, CBDCs may well be subject to similar cybersecurity and other digital risks that apply to private payment systems. CBDCs may contribute to competition and efficiency in an otherwise oligopolistic market for payment services, dominated by BigTechs. While potentially challenging to implement, a regulatory or competition-law-based response may be possible and would be less intrusive than introducing a CBDC. Central banks face the risk of large-scale use by the public of private or public (i.e. CBDC) digital currencies, not denominated in the domestic currency. These currencies may play a decisive role in the economy, and if foreign-based, largely out of reach of domestic legislation. CBDCs and/or private payment solutions in the domestic currency may assist in mitigating this risk, given sufficient demand for these.
    Keywords: deposit insurance, bank resolution
    JEL: G21 G33
    Date: 2021–11
  7. By: Richard Dennis; Pelin Ilbas
    Abstract: We use the two-country euro-area model developed by Quint and Rabanal (2014) to study policymaking in the European Monetary Union (EMU). We focus on strategic interactions: 1) between an EMU-level monetary authority and an EMU-level macro-prudential authority, and; 2) between an EMU-level monetary authority and regional macro-prudential authorities. In the former, price stability and financial stability are pursued at the EMU level, while in the latter each macro-prudential authority adopts region-specific objectives. We compare cooperative and non-cooperative equilibria in simultaneous-move and leadership environments, each obtained assuming discretionary policymaking. Further, we assess the effects on policy performance of assigning shared objectives across policymakers and of altering the relative importance attached to different policy objectives. In the three-policymaker setting, we find that regional macro-prudential policymakers play an important role in achieving regional stability.
    Keywords: Monetary policy, macro-prudential policy, policy coordination
    JEL: E42 E44 E52 E58 E61
    Date: 2022–04
  8. By: Gersbach, Hans; Zelzner, Sebastian
    Abstract: We provide a rationale for bank money creation in our current monetary system by investigating its merits over a system with banks as intermediaries of loanable funds. The latter system could result when CBDCs are introduced. In the loanable funds system, households limit banks' leverage ratios when providing deposits to make sure they have enough "skin in the game" to opt for loan monitoring. When there is unobservable heterogeneity among banks with regard to their (opportunity) costs from monitoring, aggregate lending to bank-dependent firms is inefficiently low. A monetary system with bank money creation alleviates this problem, as banks can initiate lending by creating bank deposits without relying on household funding. With a suitable regulatory leverage constraint, the gains from higher lending by banks with a high repayment pledgeability outweigh losses from banks which are less diligent in monitoring. Bank-risk assessments, combined with appropriate risksensitive capital requirements, can reduce or even eliminate such losses.
    Keywords: monetary system,banking,money creation,loanable funds,capitalrequirements,leverage constraint,asymmetric information,moral hazard,CBDC
    JEL: E42 E44 E51 G21 G28
    Date: 2022
  9. By: Priit Jeenas; Ricardo Lagos
    Abstract: We study the effects of monetary-policy-induced changes in Tobin's q on corporate investment and capital structure. We develop a theory of the mechanism, provide empirical evidence, evaluate the ability of the quantitative theory to match the evidence, and quantify the relevance for monetary transmission to aggregate investment.
    Keywords: Monetary transmission, stock prices, Tobin's q, investment, capital structure
    JEL: D83 E22 E44 E52 G12 G31 G32
    Date: 2022–05
  10. By: Linda S. Goldberg; Fabiola Ravazzolo
    Abstract: In March 2020, the Federal Reserve eased the terms on its standing swap lines in collaboration with other central banks, reactivated temporary swap agreements, and then introduced the new Foreign and International Monetary Authorities (FIMA) repo facility. We provide new evidence on how the central bank swap lines and FIMA repo facility reduce strains in global dollar funding markets and US Treasury markets during extreme stress events. These facilities are found to contribute to the narrowing of foreign exchange swap basis spreads and to reduce the sensitivity of global funding strain metrics to risk sentiment deterioration. Cross border flows through banks for excess liquidity support purposes are reduced in the near term, and the risk sensitivity of equity and bond fund flows declines. However, access to these facilities leave longer-term patterns of liquidity and capital flows across borders broadly unchanged. While official sector liquidity hoarding and “dash for cash” type of activity is expected to be lower with access to these facilities, initial evidence does not show general differential changes in foreign exchange reserve holdings by foreign central banks in line with the type of liquidity access.
    JEL: F31 F33 F42 G01 G15
    Date: 2022–04
  11. By: William F. Bassett; David E. Rappoport
    Abstract: The use of stress testing for macroprudential objectives is advanced by modeling spillovers within the financial sector or between the real and financial sectors. In this chapter, we discuss several macroprudential elements that capture these spillovers and how they might be added to stress test frameworks. We show how funding spillovers can be modeled as an add-on, using a reduced-form relation between banks' funding cost, bank capital and economic activity. Using a calibration to US data, we project very modest funding spillovers conditional on the DFAST 2018 severely adverse scenario. We describe the pros and cons of modeling different types of spillovers using this approach.
    Keywords: Bank capital; Funding shocks; Macroprudential policy; Stress testing
    JEL: E58 G28
    Date: 2022–05–06
  12. By: Riccardo De Bonis (Bank of Italy); Giuseppe Ferrero (Bank of Italy)
    Abstract: The paper summarizes the debate about the proposed introduction of a Central Bank Digital Currency (CBDC). We place the CBDC in the wider context of the different types of money used in market economies. We explore the most important ideas on why economic agents use money, on the history of money and on the distinction between public and private money. We then discuss the digitalization of the payment system and the main characteristics of cryptoassets. We conclude the paper by explaining the reasons for introducing a CBDC as well as the associated risks.
    Keywords: central bank digital currency, history of money, payment system, digitalization, digital euro
    JEL: E42 E58
    Date: 2022–04
  13. By: Martin Geiger (Liechtenstein Institute); Jochen Güntner
    Abstract: The outcome of the referendum on the UK’s membership of the European Union in June 2016 was largely unanticipated by politicians and pundits alike. Even after the “Leave†vote, the uncertainty surrounding the withdrawal process might have affected the UK economy. We draw on an official list of political events published by the House of Commons Library and daily data on UK stock prices, exchange rates, and economic policy uncertainty to construct a novel instrument for Brexit shocks. Including a monthly aggregate of this time series into a vector-autoregressive model of the UK economy, we find that Brexit shocks were quantitatively important drivers of the business cycle in the aftermath of the referendum that lowered gross domestic product, consumer confidence, and monetary policy rates while raising CPI inflation. A counterfactual experiment, in which we shut down the endogenous response of UK monetary policy to Brexit shocks, reveals that the Bank of England fended off a stronger contraction of output in 2016 and 2018.
    Keywords: Brexit, business cycle, economic policy uncertainty, high-frequency identification, monetary policy
    JEL: E02 E31 E32 E44 E58 F15
    Date: 2022–05
  14. By: Luca Benati
    Abstract: Evidence from monetary VARs for ten countries points towards an unfavorable trade-off between leaning against credit fluctuations and stabilizing real economic activity. Results are robust both across countries, and based on two alternative approaches, i.e. either (i) focusing on the impact of monetary policy shocks, which I identify based on a combination of zero and sign restrictions, or (ii) analyzing ‘modest’ policy interventions in which the central bank reacts weakly, but systematically, to credit fluctuations. In particular, a modest intervention suggests that in the U.S. during the years leading up to the financial crisis a 1% shortfall in real GDP would have been associated with a decrease in credit leverage by 2.5 percentage points.
    Keywords: Credit; structural VARs; sign restrictions; zero restrictions; Lucas critique
    Date: 2022–05
  15. By: Begoña Domínguez; Pedro Gomis-Porqueras
    Abstract: We explore the effects of reducing the overall size of the central bank’s balance sheet and lowering its maturity structure. To do so, we consider an environment where fiscal policy is traditionally passive and the central bank follows the Taylor principle. In addition, the monetary authority has also explicit size and compositional rules regarding its balance sheet. Agents in this economy face limited commitment in some markets and government bonds can be used as collateral. When short and long-term public debt exhibit premia, changes in the central bank’s balance sheet have implications for long-run inflation and real allocations. To ensure a unique locally stable steady state, the central bank should target a low enough maturity composition of its balance sheet. In our numerical exercise, calibrated to the United States, we find that long-term debt holdings by the central bank should be less than 0.5 times of their short-term positions. Moreover, the process of balance sheet normalization should aggressively respond to the total debt issued in the economy relative to its target. These findings depend on the degree of liquidity of long-term bonds. The more liquid long-term bonds are, the lower is the value of the composition threshold and the parameter space consistent with unique and stable equilibria is smaller. In addition, we consider a modified Taylor rule that takes into account the premium. Such rule increases the prevalence of multiplicity of steady states and delivers lower welfare. Thus, we argue that the traditional Taylor rule is appropriate for managing interest rates in the presence of premia.
    Keywords: Inflation, Government Bonds, Liquidity, Spreads, Maturity, Balance Sheet.
    JEL: E40 E61 E62 H21
    Date: 2022–05
  16. By: Yao Chen (Erasmus University Rotterdam); Felix Ward (Erasmus University Rotterdam)
    Abstract: Can fixed exchange rate regimes cause output divergence among member states? We show that such divergence is a long-run equilibrium characteristic of a two-region model with fixed exchange rates, heterogeneous labor markets, and endogenous growth. Under flexible exchange rates, monetary policy closes output gaps and realizes the associated maximum TFP growth in both regions. Upon fixing exchange rates, the region with higher structural wage inflation falls into a low-growth trap. When calibrated to the euro area, the model implies a slowdown in the TFP growth rate of the euro areaÕs periphery relative to its core. An empirical analysis confirms that the peripheryÕs higher structural wage inflation rate contributed to its lower TFP growth in the aftermath of joining the euro.
    Keywords: Exchange rate, growth, monetary policy
    JEL: E50 F31 O40
    Date: 2022–04–28
  17. By: Todd Keister (Rutgers University); Cyril Monnet (University of Bern, Study Center Gerzensee, Swiss National Bank)
    Abstract: We study how the introduction of a central bank digital currency (CBDC) would affect the stability of the banking system. We present a model that captures a concern commonly raised in policy discussions: the option to hold CBDC can increase the in- centive for depositors to run on weak banks. Our model highlights two countervailing effects. First, banks do less maturity transformation when depositors have access to CBDC, which leaves them less exposed to depositor runs. Second, monitoring the flow of funds into CBDC allows policymakers to more quickly identify weak banks and take appropriate action, which also decreases the incentive for depositors to run. Our results suggest that a well-designed CBDC may decrease rather than increase financial fragility.
    Date: 2022–05
  18. By: Gulan, Adam; Jokivuolle, Esa; Verona, Fabio
    Abstract: The optimal level of banks' capital requirements has been a key research topic since at least the introduction of the Basel rules in the late 1980s. In this paper, we review the literature, focusing on recent findings from quantitative structural macroeconomic models. While dynamic stochastic general equilibrium models capture second-round (general equilibrium) effects such as the feedback effects from macroeconomic outcomes back to financial intermediation and the dynamic evolution of the economy following regulatory changes, they suffer from tractability issues, including treatment of nonlinear effects, that typically force modeling simplifications. Additionally, studies tend to be concerned with determining the optimal level of fixed capital requirements. Only a handful offer estimates of the optimal size of the dynamic buffers. Since optimal dynamic macroprudential policies depend heavily on the nature of the underlying shocks, questions arise regarding the robustness and potential side effects of such plicies. Despite progress, the optimal level of bank capital requirements - in either fixed or dynamic form - remains largely an open research question.
    Date: 2022
  19. By: Tanweer Akram; Khawaja Mamun
    Abstract: This paper econometrically models the dynamics of the Chilean interbank swap yields based on macroeconomic factors. It examines whether the month-over-month change in the short-term interest rate has a decisive influence on the long-term swap yield after controlling for other factors, such as the change in inflation, change in the growth of industrial production, change in the log of the equity price index, and change in the log of the exchange rate. It applies the generalized autoregressive conditional heteroskedasticity (GARCH) approach to model the dynamics of the long-term swap yield. The change in the short-term interest rate has an economically meaningful and statistically significant effect on the change of the interbank swap yield. This means that the Banco Central de Chile's (BCCH) monetary policy exerts an important influence on interbank swap yields in Chile.
    Keywords: Interest Rate Swaps; Swap Yield; Short-Term Interest Rate; Banco Central de Chile (BCCH); Chile
    JEL: E43 E50 E58 E60 G10 G12
    Date: 2022–05
  20. By: Igbafe, Timothy
    Abstract: This study examined the effectiveness of monetary policy in stimulating economic growth in Nigeria between 1990 and 2019. Secondary data were sourced mainly from CBN publications. The theoretical framework was based on the Keynesian transmission mechanism. In the cause of empirical investigation, various advanced econometric techniques like Augmented Dickey Fuller Unit Root Test, ARDL Bounds Test and Error Correction Mechanism (ECM) were employed and the result revealed that all the variables were stationary at first difference except monetary policy rate that was stationary at level, meaning that the variables were integrated of different order justifying ARDL Bounds Test and error correction mechanism test. The ARDL Bounds Test result indicated that there is long run relationship among the variables with the lower bound and upper bound less than the calculated at 5% level of significant. The result of the error correction mechanism (ECM) test indicates an 88% adjustment back to equilibrium. It is therefore recommended that since economic growth in Nigeria is greatly influenced in the long-run by interest rate and reserve requirement making monetary policy an effective tool in stimulating economic growth. Nigerian government through its monetary authorities should unveil other policies that will stimulate economic growth not only in the long run but also, in the short run period.
    Keywords: Monetary policy Economic Growth Time Series Dat Error Correction Model.
    JEL: G00
    Date: 2022–01
  21. By: Ahnert, Toni; Hoffmann, Peter; Monnet, Cyril
    Abstract: We study a model of financial intermediation, payment choice, and privacy in the digital economy. Cash preserves anonymity but cannot be used for more efficient online transactions. By contrast, bank deposits can be used online but do not preserve anonymity. Banks use the information contained in deposit flows to extract rents from merchants in need of financing. Payment tokens issued by digital platforms allow merchants to hide from banks but enable platforms to stifle competition. An independent digital payment instrument (a CBDC) that allows agents to share their payment data with selected parties can overcome all frictions and achieves the efficient allocation. JEL Classification: D82, E42, E58, G21
    Keywords: central bank digital currency, digital platforms, financial intermediation, payments, privacy
    Date: 2022–05
  22. By: Camous, Antoine; Van der Ghote, Alejandro
    Abstract: Swift changes in investors' sentiment, such as the one triggered by COVID-19 global outbreak in March 2020, lead to financial tensions and asset price volatility. We study the interactions of behavioral and financial frictions in an environment with endogenous risk-taking and capital accumulation. Agents form diagnostic expectations about future stochastic outcomes: recent realizations of aggregate shocks are expected to persist. This behavioral friction gives rise to sentiment cycles with excessive investment and occasional safety traps. The interactions with financial frictions lead to an endogenous amplification of financial instability. We discuss implications for policy interventions. JEL Classification: E32, E44, E71
    Keywords: diagnostic beliefs, financial cycles, macro-prudential policy
    Date: 2022–05
  23. By: 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.
    JEL: E50 F31 F32 F41 F51
    Date: 2022–04

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