Despite a growing number of sanctions imposed on the Russian economy since its invasion of Ukraine in February 2022, the ruble has appreciated to regain its pre-war level. This column argues that the prevalence of import sanctions over exports and financial repression imposed in Russia, which depressed local demand for foreign currency, drove the appreciation. Despite the opposite effects on the exchange rate, sanctions on imports and exports are equivalent in terms of their impact on consumption, welfare and state budget losses. Nevertheless, the level of the exchange rate remains relevant for imports, savings and monetary policy.
Editor’s note: This column is part of Vox’s debate on the economic consequences of war.
A record number of economic sanctions have been imposed on the Russian economy since the invasion of Ukraine in February 2022. Since the impact of these restrictions on the real economy will be gradual, seen perhaps only after months, if not years, many commentators and policymakers try to infer the effects of sanctions from the short-term dynamics of the ruble exchange rate (see Pestova et al. 2022). Immediately after the invasion and the imposition of sanctions, the Russian ruble rapidly lost nearly half of its value (Chart 1). However, a few weeks later the value of the ruble began to appreciate, and by the beginning of May was higher than before the war.
Figure 1 Daily ruble exchange rate (per US dollar) in 2022
This confusing dynamic leads to several contradictory and misleading interpretations. Some commentators conclude that the sanctions imposed do not work. Similarly, state media in Russia use the reversal of the exchange rate as an indicator of the resilience of the economy and the short-lived effects of sanctions. Other commentators have gone to another extreme, suggesting that given all the policy measures and restrictions imposed to stabilize the exchange rate, it has lost its relevance as an allocative price and has become inconsequential from the point of view well-being.
Exchange rate fluctuations
What explains the confusing swings in the exchange rate in recent months? To answer this question, let us first note that the value of the ruble is determined on the Moscow Stock Exchange, largely disconnected from the international financial markets since the start of the war. Western sanctions prevent foreign banks from trading rubles, and Russian capital controls limit Russian residents’ access to foreign markets. As a result, the local supply of foreign currency comes from export earnings and government reserves, while the local demand is shaped by import expenditures, external liabilities of Russian companies (to the extent that they exist despite 2014 sanctions) and the use of foreign currency. as a store of value. The equilibrium exchange rate balances local currency supply and demand and also adjusts to monetary inflation.
In Itskhoki and Mukhin (2022b), we show that a simple equilibrium model of exchange rate determination can explain the dynamics of the ruble in Figure 1. The overnight freezing of a large fraction of foreign exchange reserves of the government, the exclusion of major banks and corporations from international borrowing markets and a threat of blocking commodity exports led to a sharp depreciation of the rouble. These factors were exacerbated by a surge in precautionary domestic demand for foreign currency, driven by rising inflationary expectations and a collapse in the supply of alternative vehicles for savings.
The exchange rate reversed in mid-March and gradually appreciated over the following month to return to its pre-war level. First, harsher sanctions on Russia’s imports than on its exports during this period led to a large current account surplus and an influx of foreign currency into the economy (see also Lorenzoni and Werning 2022). Second, with limited access to foreign exchange reserves, the central bank resorted to extensive financial repression, which included strict limits on withdrawals of foreign currency deposits, capital outflows, and a 12% tax on currency conversion. local currencies in dollars and euros. This has limited domestic demand for foreign currency. Third, record commodity export earnings have enabled the Russian government to enjoy a sizable budget surplus, thus far obviating the need to monetize its fiscal obligations and induce currency depreciation. These three factors are arguably more important to stabilizing the exchange rate than conventional monetary tools such as raising the policy rate to 20%, which was primarily aimed at stopping a bank run on ruble deposits and preventing monetary inflation. . However, in the future, the prospect of export sanctions and fiscal problems caused by a domestic recession can lead to both inflation and devaluation.
Are the sanctions failing?
The appreciation of the ruble to pre-war levels has been widely interpreted as a sign that the sanctions have so far had only a limited effect on the Russian economy. As mentioned above, this argument ignores the fact that most of the restrictions were imposed on imports from Russia, which reduced the demand for foreign currencies, thus creating a force for the appreciation of the ruble. However, this appreciation cannot compensate for the increase in the effective costs of imports, particularly given their limited availability, nor compensate for the associated welfare losses and the increase in the real cost of living.
More generally, there is no direct relationship between the exchange rate and welfare, and therefore the effectiveness of sanctions cannot be inferred from the exchange rate. On the one hand, sanctions on imports and exports are equivalent in terms of their effect on the consumption of foreign goods—the former increase their relative prices, while the latter decrease the amount of resources available to purchase foreign goods— and therefore have the same impact on well-being. On the other hand, the effect on the exchange rate goes in opposite directions in both cases – import sanctions decrease the demand for dollars and appreciate the rouble, while export sanctions reduce the supply of dollars and depreciate the ruble.
It is important to note that the equivalence extends to tax revenues: although import restrictions have no direct effect on government revenues, the associated change in the exchange rate reduces nominal tax revenues and similar to export restrictions (Amiti et al. 2017). The fact that exports are an important source of government revenue does not alter the result and therefore cannot be used as an argument in favor of export sanctions rather than import sanctions. Instead, the use of export restrictions may be justified if the import sanctions are deemed insufficient, are limited by the trade share of the sanctioning countries, or minimize the costs for the sanctioning countries (Sturm 2022 ).
Does the exchange rate not matter?
Equally misleading is the common view that political restrictions make the exchange rate irrelevant to the economy. Despite significant government interventions in the foreign exchange market, including multiple restrictions on the purchase and management of foreign currencies, the value of the ruble affects the economy through two channels. First, exchange rate appreciation increases household purchasing power and stimulates consumption of foreign goods, mitigating the negative effects of import sanctions. Importantly, this comes at the expense of households who wish to hold foreign currency as a safe asset and are therefore subject to the financial repression measures used to strengthen the ruble. In other words, the policy of financial repression creates redistributive effects from savers (who tend to be wealthier households) to consumers of foreign goods (many of whom are “overnight” poorer households).
Second, the nominal exchange rate is a signal about monetary policy, which is particularly valuable in an environment characterized by high uncertainty and low confidence in policymakers. The budget deficit pushes the government to monetize its nominal liabilities. Even before that happens, monetary policy uncertainty can lower demand for local currency deposits, leading to higher inflation and a run on banks. To regain credibility, anchor inflation expectations and stabilize the financial system, the central bank can adopt a nominal anchor to communicate its policy priorities (Athey et al. 2005, Itskhoki and Mukhin 2022a).
In sum, the strong appreciation of the ruble over the past two months has been driven by import sanctions and financial repression, both of which have lowered demand for foreign currencies. This does not mean that sanctions do not work – in fact, there is an important equivalence between import and export restrictions in terms of welfare effects and fiscal losses for the government. The stabilization of the exchange rate allows the Russian government to anchor inflation expectations and support consumption, but comes at the cost of financial repression of national savers.
Amiti, M, E Farhi, G Gopinath and O Itskhoki (2017), “The Border Adjustment Tax”, VoxEU.org, 19 June.
Athey, S, A Atkeson and PJ Kehoe (2005), “The Optimal Degree of Discretion in Monetary Policy”, Econometrics 73(5): 1431-1475.
Itskhoki, O and D Mukhin (2022a), “The Mussa puzzle and the optimal exchange rate policy”, VoxEU.org, 17 January.
Itskhoki, O and D Mukhin (2022b), “Sanctions and the Exchange Rate”, NBER Working Paper No. 30009.
Lorenzoni, G and I Werning (2022), “A minimalist model for the ruble during the Russian invasion of Ukraine”, NBER Working Paper No. 29929.
Pestova, A, M Mamonov and S Ongena (2022), “The Price of War: Macroeconomic Effects of the 2022 Sanctions on Russia”, VoxEU.org, 15 April.
Sturm, J (2022), “The simple economics of a tariff on Russian energy imports”, VoxEU.org, 13 April.