Can Monetary Policy Undo Asset‐freezing Sanctions?

• Published date: 01 November 2023
• Author: Hengxu Song,Pengfei Wang
• Date: 01 November 2023
• DOI: http://doi.org/10.1111/cwe.12508

©2023 Institute of World Economics and Politics, Chinese Academy of Social Sciences

China & World Economy / 33–55, Vol. 31, No. 6, 202333

*Hengxu Song (corresponding author), Assistant Professor, School of Economics, Jinan University, China.

Email: hengxusong@jnu.edu.cn; Pengfei Wang, Chair Professor, HSBC Business School, Peking University,

China. Email: pfwang@phbs.pku.edu.cn. This research was supported financially by the National Natural

Science Foundation of China (Nos. 72150003 and 72125007).

Can Monetary Policy Undo Asset-freezing

Sanctions?

Hengxu Song, Pengfei Wang*

Abstract

This article investigates the macroeconomic consequences of foreign asset-freezing

sanctions, a tool utilized by several Western nations amid recent geopolitical tensions.

Specifi cally, it examines the repercussions of such sanctions on open economies, fi nding

that they may experience a sharp recession and currency crisis. To quantify the impact,

we develop a new Keynesian dynamic stochastic general equilibrium model with

fi nancial frictions and an asset-freezing channel for an open economy. We also calibrate

our model to capture the unique structures of the Russian economy. The quantitative

analysis of the model demonstrates that an abrupt asset-freezing sanction would lead to

large output losses and high infl ation increases. Our counterfactual examination reveals

that higher elasticity of import substitution and lower elasticity of export substitution

could alleviate the impact of foreign sanctions, whereas more aggressive monetary

policy may have positive but limited stabilization eff ects. Notably, the monetary authority

must navigate a trade-off between stabilizing output and managing infl ation resulting

from the cash-in-advance channel.

Keywords: monetary policy, new Keynesian, reserves freezing, sanctions

JEL codes: E12, E52, F41, F51

I. Introduction

A fundamental role of foreign exchange reserves is to function as an absorber against

international shocks. However, recent asset-freezing sanctions imposed on Russia are

likely to hinder the effi cacy of foreign reserves in this role (Dooley et al., 2022). In this

paper, we do not delve into the geopolitical motivations behind these sanctions. Instead,

our objective is to explore the long-term macroeconomic eff ects of the abrupt freezing of

foreign reserves and their interactions with other sanction shocks. Given the widespread

implementation of asset-freezing sanctions against Russia, we aim to answer three

Hengxu Song, Pengfei Wang / 33–55, Vol. 31, No. 6, 2023

©2023 Institute of World Economics and Politics, Chinese Academy of Social Sciences

34

pivotal macroeconomic questions: (i) What are the macroeconomic effects of asset-

freezing sanctions; (ii) does the impact of these sanctions depend on international trade

conditions, such as the elasticity of import or export substitution; and (iii) can monetary

policy undo asset-freezing sanctions?

Unlike other countries that have encountered foreign sanctions, Russia possesses

distinct characteristics that must be taken into account. First, one of these characteristics is

its determination to regulate fl uctuations in its exchange rates. Since the commencement

of the Russia–Ukraine confl ict on February 24, 2022, and the subsequent imposition of

various sanctions, the value of the Russian ruble has experienced rapid depreciation.

Nonetheless, the exchange rate stabilized within a few weeks (Figure 1). A similar

stabilization of the exchange rate also happened during the 2014 Crimean crisis. Such

stabilization may appear puzzling for many macroeconomists, but it indicates the

independence and ability of the Russian central bank to fi x the nominal exchange rate

of the ruble using conventional or unconventional methods to avert panic and capital

flight.1 Nevertheless, there are macroeconomic costs associated with foreign asset-

freezing sanctions.2

Figure 1. The US dollar to the Russian ruble exchange rate

Source: Data are from the Wind database.

Note: This fi gure depicts the nominal exchange rate of the US dollar to the Russian ruble between January

2022 and April 2022.

1Russia’s central bank head, Nabiullina, announced in March 2022 that the central bank’s key interest rate

would more than double to a record 20 percent to cope with the ruble’s plunging value.

2Itskhoki and Mukhin (2022) demonstrated that the direction of the nominal exchange rate depended on the

particular combination of sanctions imposed, despite the underlying equilibrium allocation being unchanged.

In the meantime, the macro-level quantities will be signifi cantly aff ected by foreign asset-freezing and other

sanction shocks in the long run.