Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
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# Sanctions and the Exchange Rate

Authors:   
Discussant: None  
Video: https://www.youtube.com/watch?v=zosy3DTjPQU&t=0s


## Talk (00:00:00 – 01:16:14)

[00:00:04] so welcome back everybody uh to another webinar organized by princeton for everyone we're happy to have oligazcotsky with us hi ole good to see you hi marcus thanks okay solik will talk about sanctions and  
[00:00:17] the exchange rate and we are curious to see what he has to tell us how much six sanctions will affect the exchange rate before we go to oleg i just would like to do a little bit of housekeeping  
[00:00:31] and refer to the webinars we had on sanctions before we had sergey guria who talked a lot about the russian economy we had jim hamilton talking about the implications for the oil market and then we had david barcars and ben  
[00:00:44] mol talking about the implications of sanctions or in particular called turkey sanctions on the german economy looking at an aggregate production function then we had elena ribakova talking much more about the details going from pipeline to pipeline and also the  
[00:00:58] financial implications of that and today oleg will talk about implications on the exchange rate and i stole a picture and a figure of olig's paper where he actually analyzes the exchange  
[00:01:12] rate and he shows that you know the ruble was initially uh depreciating and then currently is appreciating again so since the war started uh in the ukraine russia invaded ukraine  
[00:01:25] the ruble first became much weaker because of the sanctions but since then it actually came back and is even stronger than it was initially and i would also like to what's the advantage of having a strong currency  
[00:01:40] and the strong currency if we not very active abroad it's still advantageous to have a strong currency and the reason is that and actually the perception of a strong currency signals also to your own population that actually things are  
[00:01:53] sound uh the probability of bank runs are going down the inflation pressures so the hoarding people's uh panicking essentially is going down so all of this actually helps a domestic policy as well  
[00:02:06] and another sign is that if you look at the policy rate the interest rate the central bank is setting so you saw that you know when in 2014 the interstate was shooting through the roof and was going up and then  
[00:02:20] recently it had to go to stabilize the exchange rate and stabilize the economy it went up dramatically as well but then it came down and in contrast which is the ukrainian uh figure so that's the policy rate for ukraine that's the blue one it went up  
[00:02:34] and it did not come down so the policy rate is actually also very interesting to look at on top of the exchange rate finally i would like to say a few words about the russian strategy and that actually led to this record trade  
[00:02:48] surpluses and that's i took from robin brook's twitter feeds essentially russia is trying to use to export oil at a very high price to the rest of the world in particular to china and here  
[00:03:01] you see how the exporting to over the years how it changed and how it actually increased dramatically to china's expert the oil export in particular to china compared to the previous years  
[00:03:14] and you also see that experts in dollar value actually is going through the roof because the oil prices are going so high is so high inputs went down so you see the red the red area below the zero line  
[00:03:27] these are the imports the inputs went down and total trade surplus for russia went up significantly so you saw [Music] an improvement of the trade surplus russia always as you have heard earlier  
[00:03:40] always had a positive trade surplus but now it is even stronger than before of course inputs because of trade sanctions went down but experts are still doing extremely well so with this i would like to go to olek's poll questions and the answers  
[00:03:55] you gave us for these questions and the first one was you should become a predictor of the exchange rate in the future uh as you as we have seen next exchange but it first depreciated in the beginning of the war and then appreciate  
[00:04:09] it again and do you think it will be stronger at the end of this year was similar what it is now but in 65 and 80 or it would be much weaker where you need 80 rubles to buy one dollar and people said about 20 percent were it  
[00:04:24] will be stronger than that than 65 uh so below 65 so it has you have to need fewer rubles to buy one dollar but it will be similar it's about 55 percent that's the maturity things it will be  
[00:04:37] staying where it is uh between 65 and 80 and weaker that's what the 25 side so it's a little bit like maturity is clearly it will be similar um and then it's a little bit on the weaker side but not much and some on the stronger side  
[00:04:51] so it's fairly stable that's what people think a second question was um the west concentrated sanctions on russia on imports rather than experts will this make it easier  
[00:05:05] or is it then for russia to finance its war or is equally effective or it doesn't really matter because the short-term fiscal deficit is independent of the way where they impose sanctions on imports or experts  
[00:05:19] and the answers are easier people thought 53 percent of maturity thought it would make it easier for russia to fund their the war it's equally effective whether you focus on imports experts that's 21 percent and  
[00:05:32] it didn't matter as it's independent of the short-term fiscal deficits it's mostly funded with rubles and other things as 26 percent so just to get an idea hopefully you will think differently after listening to alex talk  
[00:05:45] or get confirmed what you thought and finally all put forward three statements and which one you assigned to most likely and the first one the west does not have sufficient leverage against russia  
[00:05:59] economic leverage and should not use sanctions only nine percent thought this way and the second statement was the west does not have sufficient leverage against russia and nonetheless should use sanctions  
[00:06:14] that's what 72 percent thought so the majority big majority thought we don't really have leverage over russia but we should do it nevertheless even might hurt us of course it hurts us as well and the final answer the final statement was  
[00:06:28] we have the west has sufficient economic leverage against russia but should not use it that's what the 90 said so it's nine percent 72 and 19 okay with this i pass on the floor to  
[00:06:43] olek and uh we have an interesting perspective and he will tell us how we should think differently and how we should have answered his questions so like the floyd viewers we're looking forward to your presentation uh thanks so much marcus uh  
[00:06:56] i wanna say that uh you know i obviously followed a lot of the webinars at bcf over the pandemic and the recent seminars on sanctions um so i'm you know very pleased uh to be here  
[00:07:10] um you know obviously this war the way i think about it it's a it's an event in scale and sort of like the risks and threats associated with this event to me are actually considerably larger than those  
[00:07:25] associated with the pandemic obviously the uh you know this is the um you know first instance of a full-scale war in europe since the end of the second world war it's a completely unprecedented event uh it has all sorts of  
[00:07:39] unpredictable uh risks involved with it and obviously today even to the extent it has not immediately touched some parts of the world yet but it's definitely an event that there is a lot of focus to  
[00:07:53] and uh you know um hard to stay uh impartial i mean especially in light of the fact of you know this cherished peace uh on the european continent uh over the last 75 years right that this  
[00:08:07] clear you know clearly breaks the you know all sorts of norms in that regard um so i will talk on a fairly narrow um topic here is it's this  
[00:08:21] you know very kind of um scientific positive approach uh to the way sanctions affect the exchange rate and the way shocks affect the exchange rate without going into any kind of normative uh  
[00:08:35] prescriptions in this talk and you know as you will see i think it's fairly easy to reach sort of a consensus you know what happened to the ruble uh and it's much harder uh to reach a consensus what's the right course of  
[00:08:49] actions and policies right uh for the west how to deal with this crisis uh and with the war uh and so this is something i'm gonna leave out for the for the most part of the of the talk but you know maybe it will come up  
[00:09:02] come up in questions and so you know if you google um the best performing currents of 2022 uh right so you're gonna come up with google search outcomes something like this right so you know uh new york times  
[00:09:17] on top gives a rather kind of uh impartial view that it just reaches a seven year high but then you can find a lot of articles that are you know about the best performing currency really stating it in the terms like that is a race  
[00:09:31] and you know there are currencies that do well on currencies that do poorly and so ruble is the best performing currency and you know even uh you know the uh last um um the last uh reference here uh somewhat  
[00:09:45] sensational that it baffles american economist so hopefully i mean it will be clear that actually the behavior of the ruble is quite easy to rationalize within very standard models of exchange rates and that that's going to be the uh you know the purpose of this talk  
[00:09:59] so uh marcus took this uh picture but it was somewhat outdated right so now this is the picture that is extended you know the paper was completed a little while ago basically sometimes in may but um  
[00:10:13] you know since then the ruble has appreciated further and so what's interesting is that in between large crisis episodes the russian central bank has maintained a very stable uh exchange rate right and  
[00:10:26] so since 2014 2015 that was the previous crisis episode the first round of the war in ukraine on a much smaller scale than now than the decline uh in oil prices uh that persisted for many years  
[00:10:39] right uh the russian central bank kind of well so there was a depreciation of the ruble from 35 to 75 and it stayed at 75 over eight years so it was very very stable so if you extend it backwards it  
[00:10:52] was very very stable and before 2014 it was very stable at 35 for the previous something like 12 years right uh you know since the previous crisis in 98 99 right and so this is a completely  
[00:11:04] unusual extent of volatility or you know uh variation and in the ruble exchange rate and indeed right as the war started on february 24 there was a you know massive depreciation of the ruble  
[00:11:18] ruble was taken off from many international exchanges because you know foreign investors could no longer invest in uh assets in russia ruble denominated assets and so on and so this is really the data from the moscow exchange where  
[00:11:31] there is a you know there is a ideal market uh exchange of ruble to many different currencies within the russian economy so it's very important also keep in mind that it's no longer connected very tightly to the world financial  
[00:11:45] market it's really like a local market for the currency in russia with a lot of restrictions on who can invest and hold you know assets and different currencies you know and like sell them and uh  
[00:11:58] extrapolate revenues or incomes from from the trade so in that sense it's a reasonable assumption to think that it's been disconnected from the financial market right and so there was this steep depreciation and then surprisingly some around a  
[00:12:13] month into the war uh ruble started appreciating and at first it looked like central bank just managed to stabilize the value of the ruble but then it became very apparent that it's a you know it's a prominent trend for strengthening of the ruble at  
[00:12:27] first it seemed that maybe the central bank wants to return it uh back to you know 75 to the pre-war level but ruble appreciates it towards you know 55 now so it's at record high indeed in the last couple of weeks which is even  
[00:12:41] further extended here so it's around 55 right and in that sense the poll question was like are you random walk forecasters you know do you believe it will stay at 55 or there are like fundamental forces for it to return to the pre-war level at some point which is  
[00:12:55] here or it will be weaker uh than that right and so it's sort of interesting to think through what are the forces that could you know either keep ruble very appreciated or um lead to a a depreciation and to what extent and so  
[00:13:09] what i'm gonna do here so you know first of all the basic question is like how come ruble depreciated so much initially and appreciated thereafter to levels uh beyond the pre-war levels  
[00:13:24] given that can we conclude that sanctions are not working so this is a typical question posed and you know uh commentaries is like if ruble appreciates so much does it mean that sanctions were wasteful they didn't work they didn't reach uh any results  
[00:13:38] alternatively some people saying well no it's not that sanctions are not working maybe exchange rate is just an irrelevant variable as we as i mentioned you know uh there is lots of financial repression financial restrictions on capital flows on what the foreigners can  
[00:13:51] do on what the domestic uh agents can do and maybe exchange rate is altogether irrelevant you know uh uh somewhat like in soviet union there was an exchange rate of the ruble then the ruble was stronger than a dollar and that nobody really cared about it  
[00:14:06] all that much it was sort of like an artificial variable right and the question is is it kind of the case now or nonetheless exchange rate is an allocative variable and we should pay attention to it right and you know another important question is  
[00:14:20] does it have a relationship with government revenues do the sanctions the movement and exchange rate have consequences for uh revenues of the government budget and the ability of the government to finance different things in particular finance  
[00:14:34] the war but also the domestic expenditure right and so in that sense you know if it does through which mechanism do the sanctions work so these are the questions i would uh address uh in the talk today so  
[00:14:48] is there a black market on the streets in moscow where i can swap rupals for dollars in the first part there was a little emergence of uh alternative exchange rates so it was not quite clear that there was a single exchange rate but to  
[00:15:02] a large extent that was not like in soviet union where you know the exchange rate differed in order of magnitude uh it differed you know maybe 10 percent uh it was unclear what is the you know black market exchange rate and at this point it seems pretty clear that there  
[00:15:16] is no secondary uh secondary market so it all converged to this exchange rate so as soon as there was no more pressure on depreciation there is essentially no shadow secondary market yeah can you do some counterfactuals so  
[00:15:31] somebody asked if if there were cold turkey sanctions on february 25th of 2022 the exchange it would have moved very differently that yes so this is a good question and hopefully like i'll explain the  
[00:15:45] mechanism yeah yeah okay so what how are we gonna approach this question so we have earlier work uh with dema which builds you know fairly rich models for thinking about exchange rates and uh different market kind of conditions different  
[00:16:00] circumstances so here we're going to take those models and really simplify them a lot so we're going to keep only the essential parts that are needed for us to make the points in particular you know we're going to go to a small open economy version of the model completely  
[00:16:14] streamlined uh in all sort of dimensions to only focus really on exchange rate you know real cost of living inflation in the sense of real cost of living and the government revenue so this would be three endogenous outcomes we really  
[00:16:28] focus on and we're gonna take a lot of the other things as exogenously given to the economies in particular the the extent of a recession we're gonna read off sort of the the approach would be to read it off the date right if there is a recession  
[00:16:42] or if there is a decline in experts or there is sort of like some some changes in other circumstances you treat it for example changes in financing conditions the international interest rate availability of foreign funds we're going to treat it as sort of like a  
[00:16:57] stochastic path of shocks that hit the economy and we're going to focus on their implications for these three objects right so that that that's why the model is so simple we don't have to think you know the mechanism behind the recession and model it right with sort  
[00:17:11] of gonna take it as given and see what are the implications uh for for this endogenous variables that we're interested in but on the other hand we're gonna sort of like bring in a very rich set of sanctions and uh policy instruments that were available to the russian government  
[00:17:25] russian central bank and this is where the model will be sort of reach right okay and so the key thing we're going to emphasize is the dual role of the exchange rate that it plays both a role in the goods market and an asset market and this is where our approach is  
[00:17:40] perhaps somewhat different from uh from the rest of the literature and so let me kind of summarize it very uh quickly here sort of the way our approach works is we really want to think about the currency market it's not typical in macro models in macro models we  
[00:17:54] typically state everything in terms of goods flows and sort of the currency flows as a backside of boots flows and we never sort of typically write them explicitly uh we just sort of write everything in terms of value of the goods that cross the border  
[00:18:09] and we do not typically have a separate currency market in in most international macro models even though it's there but it's sort of the back side of the goods market and there is no need to kind of write a separate set of equations that repeat the goods market  
[00:18:23] equations right but here we really want to focus on a currency market where there would be a dual roll of exchange rate and so the idea is that there are two potential uses of currency uh you can you know if you have currency that comes to the economy you can use it  
[00:18:37] to buy imports uh and so soon i will you know have the full set of equations you'll see where you know where this uh where this notation is coming from so so far it's just a shorthand so this is like expenditure and inputs but you know  
[00:18:51] in principle the alternative use of dollars and euros that come into the economy is to use them as vehicles for saving if you lose trust in the domestic currency in domestic stock market uh in the domestic uh you  
[00:19:04] know uh deposits and rubles right the dollars and euros that come into the country could be used as a vehicle for savings right and this is the alternative use of currency and in that sense in the  
[00:19:18] currency market uh you know there is this competition whether you're going to use the euros and dollars that come in to buy imports or you will use them as savings vehicles right in the in the absence of other safe assets inside the  
[00:19:31] economy right so the two sources of currency would be experts and accumulated net foreign assets so you can think of accumulated net foreign assets as the you know the past accumulated net experts trade surpluses  
[00:19:45] that were converted into net foreign assets and this is the supply of currency in the economy and it's it's actually very very simple exchange rate has to balance the supply and demand of currency and so if currency is scarce right if dollars and euros are scarce in  
[00:19:59] the economy from the point of view of trying to buy imports and saving in in those in those vehicles right then the currency will the ruble will depreciate and the foreign currency will appreciate make make this foreign currency more  
[00:20:13] expensive right and by making it more expensive it would discourage imports and would discourage savings to balance out the market right on opposite if uh there is not much desire for this and there is a lot of inflow of you know  
[00:20:27] experts and a big stock of net foreign assets it's it's a abundance of supply of foreign currencies and foreign currency depreciates right and uh uh you know this is sort of the reason why the ruble would uh would appreciate  
[00:20:41] and so you see how different it is from uh kind of like a conventional uh macro model so oftentimes conventional macro models just focus on the flows of goods and they just equalize you know imports and experts uh and so it would be all about  
[00:20:55] the force between imports and experts uh so here there is this additional forces that would come into play and i will try to focus on those and so the other thing which is true about conventional models is that well  
[00:21:08] so if you know if private agents want to save in dollars they have a particular preference for it but the financial market is not segmented we think of financial assets as being  
[00:21:21] highly substitutable as long as they pay comparable interest rates or expected interest rates we think of the financial instruments as rather substitutable even taken into countries premier and so on and in that sense if you know you know russians  
[00:21:35] would feel very strongly about saving in dollars and euros and there is access to the foreign financial market right they would just be able to exchange the currencies and this would sort of essentially drop out as a force from determining the exchange rate right uh  
[00:21:48] but in sort of this more decent class of models generation of models with either segmented markets or models with convenience sealed on various assets where like everybody wants to hold money in uh dollars you break the uh  
[00:22:02] this high substitutability between assets and different currencies and this can become a very strong force behind movements you know this becomes a very important force behind movements and currencies and this would be the type of model we're working here  
[00:22:16] so the oleg dual louder has a russian safe asset as well and is it beyond the ruble or is it some you know real estate or gold or something as a safe asset yes i would not be very like it's very easy to spell it out further i will have  
[00:22:30] a ruble bond i will not kind of spell out more acids that are available but this would be a model of convenience field and you know so you'll see in a second exactly how we'll bring it in uh so basically they would we would model  
[00:22:44] it as if russians deem you know dollar savings as safer than alternative assets available in the economy since the beginning of the war and of course if everything is indulgence so things you know whether  
[00:22:58] something is safe or is not safe and if there's a risk premium and indulgence risk premium do you have multiplicity of equilibrium to or we can postpone this yes so this models typically can result in multiplicity of equilibria and the  
[00:23:11] government can try to pick the one with lower volatility of exchange rate and that could be the goal of either monetary policy or foreign exchange interventions so typically those models allow for it it's not going to be something i'm going to analyze  
[00:23:25] but it's true that there could be you know there could be possible equilibria with a lot of volatility of the exchange rate okay yeah so here you assume that the central bank of russia is picking the best one or the least volatile one yes and so what's  
[00:23:40] very interesting about this picture that this picture is uh depicts the trends as opposed to high volatility right so this is using daily data and what strikes you here is that there was a big trend on depreciation and a big trend on  
[00:23:54] appreciation as opposed to a huge increase in you know daily volatility of the exchange rate right and so with the oil and gas price uh so i mean there was no break like that  
[00:24:08] in oil prices no but the daily so if you look at the zig zaggy is whenever the gas price moves up the exchange rate appreciates and or is because the yeah the revenue from the exports are going up now yeah so my guess would be that it doesn't operate at those high  
[00:24:22] frequencies but it's an interesting yeah it's something interesting to check right whether there was a high frequency correlation uh to me again my goal here would be to explain the like slow moving trends as opposed to you know daily or intra-daily uh correlation exchange yeah  
[00:24:37] but it's uh it's a good question um okay so the model is very very simple it's only one slide for the model uh and so yeah so as i mentioned it's going to be the sandalwood small open economy  
[00:24:51] with tradables and non-tradable so the key feature would be that there are tradables and non-tradables and it would be endowment an endowment economy so i don't need to think about you know production disruption and supply chains  
[00:25:03] it will all be taken uh as given and so what the additional ingredient would be this extra demand for foreign currency as a savings vehicle right and the way we're going to capture it is that uh there is the household sector  
[00:25:17] and they want to consume the domestic good and there is an endowment of the domestic goodies period that they consume you know and then there are imports and so they really will be deciding on the quantity of invert so that would be really the you know they decided on  
[00:25:30] quantity of both but this follows endowment and so the truly the endogenous variable which will be determined together with the exchange rate would be the quantity of imparts but there could be sanctions that are imposed on imports which change the you know for example the prices that you  
[00:25:45] face to buy a bundle of imports right uh um and then there is this demand for uh holdings of uh foreign currency so the star will always refer to foreign currency and so this is the holding of foreign currency  
[00:26:00] and so this is in real terms where p star is sort of how much imports you can buy uh for the amount of um foreign currency holdings that we have so basically we model it here as like a hedging device  
[00:26:14] um against like an increase in the cost of leaving on the input side right and so this is the shock and so this shock would you know we will switch it on since the war has started and so this is we think of it as a precautionary  
[00:26:28] savings mechanism right that that's sort of common in the literature you can you can kind of create it in different ways think about ayagata economy uh you know the increase in idiosyncratic risks increase the demand for safe assets and especially if you don't deem anything  
[00:26:41] else as a safe asset anymore right like for example the stock market was put on hold it has not it was not traded since the beginning of the war for a number of weeks uh the bank deposits were frozen to a large extent and so then you know  
[00:26:56] there is this big shift or it's the use of foreign you know foreign currency as a as a safe asset uh right and so that's what the way we're gonna capture it right and so um the the riskiness of the phone  
[00:27:09] bond the b star this exchange within it now so the whole thing is more risky is it reflected in the v functions or the concavity of the v function is this capture test so v is more like marginal utility from holding the real balances but there  
[00:27:24] would be an earlier equation which would reflect the risk of holding it which is inside the exchange rate right so there would be an earlier equation which have which will have a term from here and a term from here and the risk will be captured by it again it will not be the dominant focus for us we're going to  
[00:27:38] focus on interplay between this use of currency and the use of currency to buy imports that would be really where the interesting stuff happens in this paper right and so this would be the utility function you know ces utility over home and foreign good with elasticity data  
[00:27:53] this is really going to be the only elasticity that will play a role in our analysis and this would be the function the way you want to hold foreign currency so that is the ideal level of holdings which is c and so you you're trying to minimize  
[00:28:08] uh sort of the departure of your real balances in foreign currency relative to pc and so if there is a shock to pc you want to change your real real balance as a foreign offering of foreign currency right here right and so then you know in terms of your expenditure you spend it  
[00:28:23] on the home booth and on imports this is the nominal exchange rate so when it goes up it's a depreciation of the ruble so you have to pay more in ruble terms for a unit of inputs even holding the prices uh the foreign  
[00:28:36] currency prices of inputs constant so this returns on the bonds you can hold the home currency bond in rubles with this interest rate or the foreign currency bond and this is the interest rate that the household can receive and it will have an h on it to reflect that  
[00:28:51] this is what the households can get and so this is some type of a wage commitment from the rest of the economy towards the household right so this is the wage bill uh that they expect to receive as the payment so now the second entity in the economy  
[00:29:05] it will be a combined ask a quick question because you have this the subscript t plus one on it can you just explain why so what what is the household choosing in the industry today and you carry it into tomorrow so  
[00:29:19] it's it's really this t plus one is just a time convention that you come into the period with this amount of rubles in terms of your savings and this amount of uh this amount of foreign currency in terms of your savings and in the end of the period you choose the  
[00:29:33] you know your financial positions to go your savings basically to go into that i derived utility from p t plus one dot p t star t plus one yes so this is not this will not be of much consequence you  
[00:29:47] can do you can do the previous period here yeah um and i'll show the earlier equation in a second ah so what's the interesting in terms of our model and we really will think about the government the the production side  
[00:30:00] of the economy and the financial sector is one sector as one union so think about it as guest prom is a part of a government and burbank is the part of the government suppose the financial sector the biggest you know banks are all government-owned the biggest commodity producers are government-owned  
[00:30:15] but in fact you know like a lot of the non-tradeables inside the country are government-owned as well so if you think about transportation to a large extent that's government owned the domestic banking system the you know uh medical services and uh educational  
[00:30:29] services are largely government owned right and even the companies that have a chunk of private ownership oftentimes have some control from the government and oftentimes the government directly controls employment  
[00:30:43] in those places by providing subsidies for example not to fire workers even from private uh enterprises right and so there is this uh this really merger between big business and the government that really makes it justified to model  
[00:30:56] this one sector of the economy right and so uh then if i look at the government so e f will be the net foreign assets of the country and b are the privately held uh  
[00:31:10] foreign assets and so the difference between the two f minus b other reserves of the government so the in the beginning of the period the government starts it with this amount of reserves these are the total net foreign assets of the country in the beginning of the  
[00:31:24] period and this is privately held part of it and so you know government reserves is one of the instruments that the government can use and obviously sanctions can cover a target net foreign assets or government reserves right and so this is the international interest  
[00:31:38] rate on foreign uh foreign savings uh which may or may not available uh to the country dependent on the financial sanctions right and this is the household interest rate on foreign currency savings and there  
[00:31:52] could be a wedge between the two and the wedge between the two reflects financial repression so what the government could do is depress the expected return on foreign currency savings domestically by making it very difficult to withdraw or impossible to withdraw or withdraw  
[00:32:06] with the tax or there could be a tax to convert from one currency to another and all of this has been used right and so this we're gonna capture it as a gap between these two possible uh interest rates and so these are measures of financial uh depression so this is the  
[00:32:21] savings side of you know this government firms and financial sector and so on the right hand side this is the income and so this is the endowment of the domestic non-tradable good this is the price level and so we're going to think of inflation as this pt  
[00:32:35] so if there is inflation in the country it's the change in the price level of the domestic goods right the cost of living depends on both this price and this price which is the import price component uh but the way we're going to sort of think of inflation is is there truly an  
[00:32:50] increase in the domestic price level of the domestic goods right or this is just reflection of uh import sanctions that raise the prices right so we're gonna separate these two types of inflation one from kind of monetary side of the economy and the other one is an increase  
[00:33:05] in the real cost of living because imports have become uh less available right so this is the endowment of um commodities that are sold and so this isn't foreign currency right so it's already expressed as  
[00:33:18] revenues that you can get uh given the world prices of commodities if world prices of commodities go up why star goes up if there are sanctions on purchases on the quantity uh why star can go down right and so then you know  
[00:33:33] this is the revenues in foreign currency and this is the exchange rate you converted back uh into rubles and this is the ruble revenue of the of of the country of the government sector and then uh there are two sources of expenditure so you have this wage  
[00:33:47] commitment to the household sector you promise to pay a sequence of wages to the household sector and this is promised the nominal terms right and so if there are fiscal problems you might face a problem of pain at the nominal terms then you can  
[00:34:01] either default on those promises or you can have inflation which would basically shrink this in real terms so this is kind of like a choice that could be available to the government and this i just i will set it to zero because it's  
[00:34:15] of no with no loss of generality but imagine that there is a some commitment to pay nominal wages to the household and then there are some government expenditure for example government expenditure on the war right and so the government then we can solve  
[00:34:28] a kind of like a pareto problem for the government right like holding this fixed what's the best wage promise that you can sustain or like if if you need to sustain the wage promise here uh what is the maximum amount of expenditure you  
[00:34:41] can afford on the war and so just to point out that these are complete competing uses of the of the revenues right and so going forward i'm just going to normalize this to zero think of it as some constant it's not gonna it's really not gonna change the  
[00:34:54] analysis i'm gonna just think that there is some commitment and you have to honor that commitment in some ways right okay so this is the full setup of the model from now on this would be just the analysis um and the oligox they're part of the household sector or the government  
[00:35:09] sector no no so oligarchs and firms and government are all in here and the financial sector so yes yeah and so in particular this whole discussion of whether it will be the gas chrome that will get revenues from  
[00:35:22] experts or the central bank is of no consequence in this model because they are really part of the same sector right it's just relocating from one pocket of the government to another pocket of the government which i think is a realistic description okay and so now this is the equation  
[00:35:36] that uh marcos was looking forward to uh so first of all there is this market clearing that the endowment of non-tradables domestically has to be consumed and i'm just going to assume that the domestic savings vehicle and in zero net supply and again it's of no  
[00:35:51] consequence here the government would provide supply of you know you know government bonds for example in rubles they're not in very high demand uh and it's not of much consequence how we model it here right and in fact the  
[00:36:05] government has we think of this as the government monetary policy tool so this is what marcus brought up in his introduction that they hiked the interest rate to 20 at first and the beginning of the war and then reduced it to eight percent i  
[00:36:18] think now or maybe even lower uh and so this is how they can we think you know the way we're going to model it there will be an earlier equation which i'm not going to show you for this bonds which allows you to directly control with this interest rate the amount of domestic inflation so i'm just going to  
[00:36:32] think that the government has a direct control over domestic inflation by setting the policy rate it's a simplification but you know like the assumption here would be that the government can control the inflation rate and i'm going to show you the constraints  
[00:36:46] on the inflation right and so of course there is another hurdle is that you know if there is problems with the financial sector with the domestic financial sector this transmission from the interest rate here to control the inflation could be lost by the  
[00:37:00] government indeed the first couple of weeks looked like a banking panic but it was stopped and after that the government regained control of you know domestic monetary policy essentially via the domestic banking system so i think uh-huh just to understand the model better so  
[00:37:15] what's the time period here is it like a week or is it a quarter do you want to explain the whole the the rise and the fall or the fall or so one thing we don't do here is a particular quantification with numbers  
[00:37:29] it will be a qualitative model which will rationalize the qualitative trends and in this sense we can think of it as a month or a quarter well the trends like the trends to depreciation what lasted for a month and then it revert and there was a quarter of appreciation  
[00:37:43] so i think a month would be a reasonable model uh interval here but if you want to make the model quantitative it's actually fairly straightforward uh you would probably want to uh spell out a few more things you probably want to you know depart from  
[00:37:57] the endowment assumption and think a little uh through how to sort of model substitutability more also maybe not make this a perishable endowment but really think through the temporal decisions of when you extract oil again i'm just going to take it all  
[00:38:11] as sort of given is this correct period so the shocks would be this yeah so it comes here uh uh oh no i didn't spell out the shocks let me tell you the shocks on  
[00:38:26] this slide endowment of like oil revenues is a shock and it's subject to both international oil prices and sanctions domestic endowment is a shock in the sense that it could be a domestic recession which will read it as a shock  
[00:38:39] to the economy uh import sanctions which will affect this and the increase in the demand for safe safe safe assets so these are the four shocks that we really are going to focus on and then the policy instruments i spell out here so the government  
[00:38:54] controls inflation financial repression and reserves so this would be the main and i didn't i didn't put here the domestic interest rate but implicitly this is what allows you to control the inflation so these are the three instruments i'm going to give the  
[00:39:08] government and then the endogenous variables would be imports exchange rate and the extent of foreign currency savings by the households right so we're going to read all the shocks the policies and study  
[00:39:21] the effect on this this vector so solivar landman would like to know whether does the model help to answer why russia would like to be paid in rubles instead of dollars yeah so this is very interesting so uh this is really the reason we started  
[00:39:35] working on it because the appreciation seemed intuitive to us that it should happen but like this idea of pain and rubles seem to be outside of economics right and so what we can confirm is what i mentioned is like really what it does it relocates the euros from the pocket  
[00:39:50] of gas chrome to the pocket of central bank and from the point of our model it makes no difference and we believe in the real world that really makes no difference there are two sort of reasons uh and so also the payments and rubles of the foreign debt which was discussed this  
[00:40:05] week right so it feels like a political position in political gesture in the sense that if i tell you to pay in rubles you'll pay in rubles and if i tell you to dance when you receive the gas you'll dance and you know germans and italians and you know hungarians  
[00:40:19] will gladly dance to receive russian oil and gas and pain rubles right and so like i think largely that's the biggest part of the story uh but uh the other part of the story could be that it somehow makes it easier to hide the  
[00:40:33] transactions and the payment systems i you know i don't i cannot kind of provide any support for that uh but this is only either possible or maybe it's like a first step and some longer kind of idea of how to hide the transactions  
[00:40:46] from the you know european regulators or something like that but in this model there is no room for this to make a difference it's really of no consequence yeah okay very good so now back to the equations  
[00:41:00] uh and marcos do i have about 15 minutes or a little longer a little longer okay good okay very good so there will be three equations so three variables that we need to determine three equations so one is a crucial  
[00:41:15] equation and these types of models on the good side it's the expenditure switch and condition or input demand and the idea is that you choose between consumption of imports and consumption of the domestic good which needs to equal to endowment and equilibrium as a function of the relative price of the  
[00:41:30] two and so if imports become expensive relative to the domestic goods right you will want to shift away from imparts and this is the form that equilibrates on the sort of demand side for goods right and so this is the elasticity of demand  
[00:41:44] and so this condition must be satisfied right and so you know movements and exchange rate are needed to in particular clear this market right the goods market the expenditure switching between domestic consumption and input consumption and so  
[00:41:58] import sanctions will also target this market the second equation also what gamma is oh and the gamma is just uh the weight that you put on inputs it's just a normalization right like typically we  
[00:42:11] think of economists as rather close to international trade in the sense that they have a lot of home bias and so small gamma reflects the fact that you disproportionately consume domestic goods but there is a chunk of your consumption that goes to expenditure  
[00:42:25] that goes to impacts yeah so this is one equation the second equation is even simpler it's the temporal budget constraint of the country so we consolidate the government and the household so essentially we just sound the government and business  
[00:42:40] uh budget constraint with the household budget constraint cancel a bunch of terms like the w uh domestic bond which isn't zero net supply cancels out and so what's left is this and the temporal budget constraint for the country where this is the net foreign asset position  
[00:42:54] of the country and this is essentially the terms of savings internationally right the international interest rate and so this is the accumulation of net foreign assets on this side and the right-hand side is net experts so these are revenues in foreign currency from commodity experts because we you know  
[00:43:09] simplify that it's only commodity experts and this is the expenditure in inputs given the price of imports and it's all written in terms of foreign so there is no not even an exchange rate in this equation but this equation needs to be satisfied right and so this would be  
[00:43:23] the crucial discipline would be the budget constraint right you have to satisfy the potential budget constraint um and finally that is the earlier equation and for a part of our analysis i'm going to ignore earlier equation because we're  
[00:43:37] going to be in steady state and like take it as a one-time permanent shock and uh do a competitive static between steady states and then you just assume that in steady state you know everything is stabilized so early equation is about dynamics so it's not a binding condition you just check that  
[00:43:51] it's satisfied but the earlier equation is really this desire to save and so what is the desire to say there are two reasons for it you want to smooth your import consumption and that's why you save important currency and the the benefit of saving is that  
[00:44:06] you get an interest rate as a household you can get an interest rate on your foreign currency savings it doesn't have to be the same interest rate as the international one if there are financial depression in the domestic market that obviously you discount future right  
[00:44:19] and so this is how much dollars lose their value over time if you can buy less goods that is like sort of like less purchasing power ability right and finally this is the piece which tells you that you do want to hold foreign  
[00:44:33] currency as a saver even if it pays a really bad return here so even even if there is a lot of financial repression and really low interest rate expected interest rate your ability to withdraw the dollar in deposits and so  
[00:44:46] on this compels you to hold some of it right and so this is the force that you know this is this convenience yield thing that you are willing to hold dollar savings because you deem them a safe even if uh they are associated with very low return with low interest rates  
[00:45:00] and that right and so this is how we going to capture this idea that there is a demand for saving which will play a competent role with demand for imports and this is where sort of the interesting stuff will happen so now kappa tilde is related to the  
[00:45:14] kappa of the v function before now correct yeah it's some uh some transformation of this couple with some other parameters yeah yeah and so this is there are two elasticities that play a role this data which you will see and this kappa which is in one preposition  
[00:45:28] that i will not show you but uh i will tell you where it matters we kind of completely you see streamlined and did not have any other elasticities as i mentioned of how you can you know for example use oil in the domestic economy to enhance domestic production it's not  
[00:45:43] there or how you can inter temporarily instead of selling oil today keep it in the ground and sell it in the future or sell oil on the ground for example to china and receive dollars now for oil in the ground all of this is not there we  
[00:45:57] kind of capture it in terms of like cash flows right today's cash flow right and so there could be a future cash flow it's it's a whole path of this white stars so it's allowed in that way okay very good so with this we can go to the analysis  
[00:46:11] right and so you know we mentioned a bunch of sanctions so sanctions could be on experts or if oil prices go up this can go up uh they can be on imports you can either be rationed or there could be like a tax  
[00:46:24] right either you cannot buy same imports at the same price anymore you have to pay more or you just some some inputs are not are just not available as varieties anymore right so both is allowed here uh you know like the domestic recession will be captured this  
[00:46:38] way so if there is like a uh problems with intermediate uh supply intermediate good supply or exit of foreign multinationals from the economy this can trigger a domestic recession so this could be captured with a change like that there could be a freeze of foreign  
[00:46:52] assets which actually happened in the first week of the war there was a freeze on network on the reserves of the government so it's essentially this shock uh there could be exclusions from international financial markets and very interesting you don't have to change  
[00:47:06] equations you just say you don't get an interest rate right you can only save now you cannot have borrowing internationally and you don't get any interest rate on saving you just heard foreign currency if you run trade surpluses and so in  
[00:47:20] that sense set of equations doesn't change and the households also cannot you know if the households want to hold currency it has to come from the domestic reserve from domestic net foreign and then this is the shock and so the policy instruments we've uh  
[00:47:34] already discussed right that that the government has so we can uh we can go straight to the analysis now uh i have a little less than 15 minutes so i think i should be able to show you all the results now  
[00:47:47] okay so first just to get started it's a little bit of a warm-up exercise i'm gonna go to a cop douglas utility which just makes equations easy uh but you know obviously more generally i don't want to be there because scope  
[00:48:02] douglas is quite quite peculiar and so given that uh if i will be in steady state so i don't need to really check this equation because it will be somehow satisfied in steady state there is no dynamics right so all of this will be constant and so just that this  
[00:48:16] interest rate need to observe this demand uh but so this would be the interplay of these two equations of the demand for imports and then in the temporal budget constraint which both become static now so in the long run sense  
[00:48:30] these are imports like some average imports or steady state imports these are steady state experts and this is the annuity flow on net foreign assets  
[00:48:43] right and this is the demand for imports where instead of you know the consumption of domestic good is just why and so the idea here is that the import sanctions will be reflected in the increase if if you are  
[00:48:58] russian like initially you wanted to consume a range of varieties gamma of imports and now the range of varieties delta became unavailable in this model there would be an increase  
[00:49:10] in the effective price that you face and the demand schedule will just look like this so it still will be moving together with the price of imports right but it's like the input rationing is like a shift in that demand schedule and i'm gonna  
[00:49:23] tell you uh the intuition sort of where it's uh where it's coming from okay and so here just putting these two equations together again the logic is very simple you just need to satisfy the budget constraint and you need to be on your demand for input  
[00:49:38] schedule that's the only two equations that we're using you can solve for uh equilibrium exchange rate and so here are the forces for equilibrium exchange right and this is sort of essentially spells out all the mechanisms so check it out  
[00:49:51] if sanctions aren't experts so they reduce y star or on net what in essence this shrinks this side of the budget constraint resources become unavailable you cannot afford the  
[00:50:04] same quantity of imports so the way the market would adjust to that is by depreciating the exchange so this shrinks which means that this goes up which is a ruble depreciation so sanctions that are focused either on net foreign assets or  
[00:50:18] on experts will depreciate the exchange rate and the idea is you cannot afford imports so exchange rate from this equation needs to move in such a way that in equilibrium you don't want to buy those imports and so basically weak  
[00:50:33] exchange rate makes imports expensive and you substitute the expenditure away from imports and that ensures that you're satisfied in the temporal budget constantly right so sanctions on this side of the economy on on basically the income side  
[00:50:47] of the temporal budget constraint uh uh will uh depreciate the exchange rate now this is the domestic part of the economy so either domestic inflation  
[00:51:01] right monetary inflation or domestic uh so this going up this will depreciate the exchange rate domestic recession when y goes down will actually push this down and  
[00:51:14] appreciate the exchange rate so what's the intuition here so this is interesting so if there is domestic recession you actually cannot afford you know if this is the only shock that happened you cannot really buy the domestic goods anymore that you like  
[00:51:29] and so in this model if you cannot buy the domestic goods you also want to reduce your expenditure and imports right but the imports must satisfy the budget constraint so you need to buy the same quantity of them so the only way you're going to sustain  
[00:51:43] the same amount of imports during the domestic recession if exchange rate appreciates so the first force if if the sanctions their effect on the domestic output are stronger than on experts in some ways that could lead to an appreciation of  
[00:51:57] the currency again because you know things are bad in the domestic economy and you don't want to consume inputs in parallel with that but you have to be convinced by lower prices of imports right so this is how it works this is peculiar to particular  
[00:52:11] elasticities that we assumed here so this effect happens under this particular cop douglas utility that that we've assumed with other utilities you can get effects going in other directions here right uh the other effects that i'm talking about are robust and finally  
[00:52:26] what is the effect on of import sanctions and this is something i'm going to focus more on so remember that input sanctions kind of raise the effective price of whimpers that you face right they don't change the actual price that you pay  
[00:52:39] right but you're just being told you're not allowed to get a bunch of varieties anymore right and so here um uh basically what happens if you cannot get a bunch of varieties anymore uh  
[00:52:52] then you know you still need to spend your intertemporal budget right on the varieties that you like less and so this is uh so there is a paper by uh without any and which really focuses on this part of the mechanism is that you know you need  
[00:53:07] to you still need to allocate expenditure to imports that you do not like and how will you be compelled to buy those imparts right if you cannot buy italian shoes you have to switch to chinese shoes previously you didn't want  
[00:53:20] to buy them at the prices that you faced right you wanted the italian shoes italian shoes and learning are available you have to switch to the available ones and the only way to compel you to spend your resources on those shoes that you actually did not want is if they become cheaper  
[00:53:34] and they become cheaper by means of an exchange rate adjustment and it's an exchange it's a ruble appreciation in that case right and so this is from the point this is the equilibrium from the point of view of the goods market uh in a way it's much easier to think about it from the point of view of the  
[00:53:48] currency market imagine you know europe says you cannot buy our goods but you still have plenty of revenues from sailing experts from sailing uh natural resources you have this inflow of currency into the country  
[00:54:03] which you cannot really spend on the uh previously available uh imports then some of them are no longer available so you have an abundance of currency in the domestic economy and this is the force to the depreciation  
[00:54:16] uh to the appreciation of the ruble depreciation of the foreign currency against the ruble right and so this will be a very robust intuition that once you bring in the financial marketing as a competing use of currency this would be the persistent contribution that will  
[00:54:30] stay it's really all going to be about the inflow of currency and the alternative uses of it okay very good i i'm not doing great on time so let me go very quickly uh  
[00:54:44] yes so let me go very quickly here so the last condition that we need to satisfy is the government budget right so the government receives this and it needs to pay for its wage commitment and exchange rate is an  
[00:54:57] endogenous variable here and so the ques and so it's written in ruble terms the wage commitment is in rural terms and the question is what does this change in the exchange rate due to the tightness of the budget constraint and so you plug in the exchange rate and basically you can see that the government would need  
[00:55:12] to inflate if this constraint is tight if this constraint is not tight the government budget is slack essentially right it can even increase the payments but if this constraint is tied the only way to deal  
[00:55:25] is either default on the promises or increase inflation and reduce the promises in real terms and sort of not surprisingly the key force here is well if you promised a lot it's hard to pay for it or if you have a domestic recession it's hard to pay for it but  
[00:55:40] what's interesting is that you know you have both expert sanctions and input sanctions that also affect your budget constraint through the exchange rate through the essentially you have to convert your oil revenues back into rubles  
[00:55:54] and it can tighten the change rate and so this is something i'm going to focus on in a minute okay so this is the summary of the results that i already mentioned right so of how different sanctions work and so now i want to show you a very general  
[00:56:08] result actually which is really behind uh this paper and so this result is based on a completely fascinating result by abba lerner from many years ago almost 100 years ago so this is a learner symmetry result  
[00:56:23] and it's completely fascinating it states that the effect of an impact tariff is equivalent to an effect of an expert tax and in that sense as soon as somebody tells you that you can use imperterif  
[00:56:37] uh to deal with current account deficit it should ring a bell it's sort of it seems weird right like how can importative deal in the same way with current account deficit as an expert tax it seems that they operate in completely opposite directions right and so the  
[00:56:51] idea behind this is that it's again it's a temporal budget constraint both of these policies will reduce the total amount of trade but you have to be subjected to temporal budget constraints so you put a wedge in your ability to trade you will trade  
[00:57:06] less but in the temporal budget constraint says that the effect of both wedges should be comparable right you will reduce both imports and experts as a result of it and how does the adjustment happen well it turns out that relative  
[00:57:19] wages and exchange rates have to adjust to support it as an equilibrium so it could be either relative wages between countries or the exchange rate typically we think of exchange rate as doing the adjustment in flexible exchange rate environments and basically exchange rate  
[00:57:33] needs to move in opposite directions depending on whether you do an importative or an expert tax you're going to get the same allocation supported by a differential movement and exchange rate right uh if you have an importative  
[00:57:47] you know uh you cannot really buy imports and you export too much how can you have the adjustment well you need the domestic wage to go up so you export less you know and given the terry if want to import a little more so it's equivalent  
[00:58:00] to an exchange rate appreciation if you have an expert tax then you don't export sufficiently you need you import too much and the only way to adjust is for your wages to come down or exchange rate to depreciate and that's literally what's going to be behind this result  
[00:58:15] and it's remarkable how robust learner symmetry is right and so something that we can prove and it's interesting that our model does not have ricardian equivalence so there is an issue between the government budget and the household budget right there is a tension between  
[00:58:30] the two uh but uh in through the asset market but it turns out that learner symmetry works and models without recording equivalents that actually kind of satisfy equivalence of allocation budgets said by budget set that's why it doesn't require recorded equivalence and  
[00:58:44] one result is kind of uh very interesting here okay so what what is the result the result is that if you do expert sanctions combined with the initial network and asset fees that's exactly equivalent to input  
[00:58:58] sanctions whether you rush on imports or increase the price of inputs with the tax but like if you do it by 10 and you do this by 10 they're gonna result in exactly the same allocation and so how do you prove it well you go  
[00:59:12] back to the budget constraint to the temporal budget constraint and you can sort of see that you can you know this is the expert revenues divided by the price of inputs to the extent you make this guy move down by the same amount as long as you  
[00:59:26] do the right adjustment to net foreign assets in the beginning right you actually make feasible literally the same allocation and then the exchange rate becomes just the side equation exchange rate will adjust in a way to support it as an  
[00:59:40] allocation so if sanctions happened on this side right well you have to reduce your impact consumption imports uh you cannot buy as much imports if there were expert sanctions and the adjustment will happen through only this term  
[00:59:54] and so exchange rate will have to depreciate if it's expert sanctions but if sanctions came on the input side then again you know you increase this this whole object goes down you can afford less inputs because inputs have  
[01:00:08] become more expensive but you have all these experts right and so the only way to kind of go back to an equilibrium that this is partially offset by movement here and if this elasticity is greater than one which is a typical assumption that you can substitute between the domestic and  
[01:00:23] foreign goods right we think of this lsd as bigger than one then you would need to have an appreciation right in order to satisfy the same budget constraint right uh you know again the intuition is you have inflow of currency from experts  
[01:00:37] but you cannot afford the imports and the only way to make consumers happy with that is if the if the exchange rate is stronger basically right so you you know you still buy a little more of the imports that than the  
[01:00:50] one that has rationed right but uh but in the end of the day you end up with less imports and a partially appreciated exchange rate and we can quantitatively put this all the this movements here depend on the extent of sanctions and this elasticity and this is something  
[01:01:05] that could be contrasted directly with the data so one thing that i'm going to show you very quickly and this is one of the surprising impressions what you're saying is that the west by imposing that sanction or the other sanction is just determining the  
[01:01:19] exchange rate correct so the exchange rate is like a size equation the goal of both sanctions is to really tighten stuff here and tighten the fiscal constraint of the like if you want to hurt the economy  
[01:01:33] it's you want to do the effect here and the effect is literally the same whether you do one set of sanctions or the other the second goal could be and this is also reflected in the real cost of living and the spectacular result here is well it's not surprising  
[01:01:47] that real cost of living will increase in proportion to input share in gdp this is like a halton result and that elasticity of substitution that will play a role here but the amazing thing is it doesn't matter whether you do sanctions on imports or experts you're going to impose the same  
[01:02:02] real cost of living increase for the economy right so while it's the input sharing gdp that matters for the magnitude of the effect it really doesn't matter whether you use input impact or export sanctions so now another interesting object is the  
[01:02:15] government fiscal revenues and not surprisingly the effect on government fiscal revenues will be proportional to the share of revenues from experts in total government revenues right so if the government receives a lot of revenues from experts which is the case  
[01:02:30] in the russian economy the recent budgets show that about 60 of government revenues uh comes from experts of natural resources so this is a very large number right and so then it's the theta minus one that's the ls60 that's  
[01:02:44] relevant here so this is the effect on the budget uh on the budget balance in rubles right and the fascinating thing is it really doesn't matter whether you do expert or input sanctions and what's the intuition here well the  
[01:02:57] intuition in the end of the day is if you convert expert revenues back into rubles the effect will be the same under expert and imperceptions it will work differentially in this in under expert sanctions it would be the shrinkage in y  
[01:03:12] star and a depreciation of the currency that undoes part of that effect here with import sanctions it would be fully the effect of appreciation of the ruble which will put strain on the government on on the government fiscal  
[01:03:25] deficit in that sense the second question that we asked in the beginning of the talk does it make it easier for russia to finance the war this model gives the answer that there is some sense of equivalence uh i mean obviously you these two sets  
[01:03:39] of sanctions they magnify each other if you do one you can do the other on top of it and the effects will be magnified but if you really achieved all you wanted with import sanctions right there is no uh like if already inputs are at the minimum  
[01:03:54] which obviously is a case you cannot make but if inputs were the minimum then there is no residual role of expert sanctions even from the point of view of the government budget constraint it's a little weird because you know the russian government receives  
[01:04:08] you know this uh tens of uh billions of euros and revenues but the exchange rate appreciates and makes the euro revenues less valuable in rubles harder to satisfy the ruble wage commitment of course to the extent that  
[01:04:21] a big part of government expenditures in euros itself are in dollars then this logic doesn't work anymore this logic only works from the point of view of the government balance in rubles  
[01:04:34] so can i can i ask one quick question so there's this equivalence i was wondering when it breaks down so let's suppose i enlarge the model and the exchange rate movement is also used as a signal even sure it shouldn't be used as a signal how strong the  
[01:04:48] economy is and it didn't use bank runs and other things then it wouldn't work yes uh so we should actually post facilitate such a way to make the russian economy look weak even if it is not weaker de facto if if exchange rate for some reason shows up  
[01:05:03] in some objective function or is used as a signal then it has differential effect on the exchange rate absolutely but from the point of view of real cost of living of the actual inflation that people should see in the supermarket  
[01:05:16] uh it doesn't matter it turns out right but if it's high if this is not observable easily and exchange rate is used as a signal then yes then exchange should become a goal in itself that's correct okay and so i will take just a few more  
[01:05:31] minutes and so there is this interesting last result about the financial shock which i think is sort of like what really happened as well in the russian economy uh there was both financial authority imposed on russia and a financial shock that people did  
[01:05:45] not trust the domestic financial system in the beginning and really wanted to switch to foreign currency right so here's here's a couple of possibilities right so imagine that there is the shock in this earlier equation so we're now finally using the earlier equation so  
[01:06:00] imagine there is a shock and so there are three ways the government can respond to it uh so one way would be to provide this so that if the government has reserves it really can provide it to the  
[01:06:13] households if they want to hold dollars the government has reserves and this is what's been done in typical normal times there is a shock that triggers bigger demand for foreign currency this is how the reserves they reserve their use the  
[01:06:25] government really can change the uh currency of its balance sheet provide this liquidity to the private sector and there is no other change right so all of the effect of it will stay in this bracket it will not affect imports  
[01:06:39] or exchange rates or anything else of course if foreign reserves are no longer available and so this were the sanctions on foreign reserves this is no longer an option for the government right then you have to choose between two one is just let things happen  
[01:06:52] or do financial repression and so let's see what happens in those times i want to come back to so this just to understand it it's a a preference shift that is the society it's not an increase in volatility  
[01:07:07] no no it's just a one-time shift that you want to hold more foreign currency because you are concerned about the future and you think foreign currency provides a better you know way of saving just coming back to my subscript t plus one was b start subscript t plus one  
[01:07:22] it's known at time t when i make my choice so it's only known at t plus one yes it's a choice made of t yeah so i know it so it's measurable at time t not yes yes and so the government can accommodate it uh without any uncertainty  
[01:07:35] yeah and so here here are the answers what the government can do right so i mentioned that uh there could be foreign exchange rate policy with full accommodation so they can basically sell reserves and provide foreign currency liquidity to the private sector and this  
[01:07:50] was fully insulate imports and exchange rates so there would be no movements and imports are exchanged right now and this is what typically a lot of countries do uh due to normal times this is a very important policy instrument to smooth exchange rate fluctuations right in  
[01:08:05] response to the shifts and capital inflows and outflows and so the previous paper that we wrote with demo was literally studying the optimal policy under this regime right but we assume that this regime is not feasible and then there are two options one option is a passive government when  
[01:08:20] the government does nothing does not do financial repression does not do effects interventions and then here's where the competing use of currencies comes into play if people really want to save in foreign currency they have to cut on imports  
[01:08:34] and so this will be associated with an exchange rate depreciation this is driven by the earlier equations like you shift into not consuming but into saving uh and this is sustained by a fallen imports  
[01:08:47] and associated depreciation as you accumulate foreign currency from under consuming import space right and so this is the effect uh that would happen when the economy is hit by the savings shock by by like a  
[01:09:00] strong demand either for capital outflows from the country or for precautionary savings and foreign currency right this is kind of the same in the model and so the big exchange rate depreciation initially in the first week we think was triggered by the shock right  
[01:09:14] but then the government has this third policy tool which is financial repression and so you see what the government can do in response to a big demand for foreign currency it can really reduce the expected return it can make it very difficult to withdraw foreign  
[01:09:29] currency it can impose a big tax on holding foreign currency or or changing foreign currency or there could be bans on uh on ex on exporting foreign currency and sending it abroad and all of this was  
[01:09:43] done in the first couple of weeks of the recession and so you know we think that the initial response looked like this in the first week which triggered the devaluation but then it was replaced by very steep financial repression of various sorts and this stabilized the  
[01:09:57] currency and so what's interesting that the government can achieve a stable exchange rate with this policy or whatever exchange rate it really wants by choosing the uh extent of financial repression here but it's not without cost it's really by the represent the  
[01:10:11] domestic savers so the cost comes not for consumers of goods it comes for the domestic savers because they face financial repression can you give us explicit examples how did i do it i cannot hold dollar assets anymore i have  
[01:10:24] to pay attack so what did they do there were many different things and so in particular when things got better so at first all the exporters had to sell almost essentially all of their expert revenues and foreign currency to the central bank 80  
[01:10:38] now it's been reduced to 50 because you don't need as much financial repression anymore right so with the idea that the exporters could keep currency away from the country and this the central bank made them bring the currency in right and now it does not require as much  
[01:10:52] currency to be brought in also you could only uh you could only send five thousand dollars abroad uh for an extended period of time and now they increase the 250. so basically what happens and so i'm gonna go back to the picture and kind of study those  
[01:11:06] different parts right is uh uh is when different policies had a bite right so i i i will take one more minute one thing i was going to show you there was something very interesting uh what you're asking there was a 12 tax on buying dollars  
[01:11:21] finally enough you had to pay the same tax on euros and pounds but not on swiss franc and so to show that this is really a market price of currency it's very interesting we can look at swiss exchange rate against the dollar in russia relative to  
[01:11:35] foreign markets and so as you can see it's always like this relative exchange rate is always at one in logs it's at zero but during the period of that tax the relative exchange rate in the russian economy really moved with the  
[01:11:48] tax so economy is very responsive to this taxes imposed on it right and so this is where this is the relative turnovers everybody switched to trade in swiss francs a lot of i mean this is an increase in turnover of swiss francs during this period and then people went  
[01:12:02] back to dollars when this tax was uh you know was was taken out uh so the last thing i was going to say i think this is just a very important result swiss decided to join the sanctions that i forgot they didn't join initially  
[01:12:15] somehow they kept swiss franc as a small it's a very small currency in terms of turnover so even that increase in turnover you know it didn't make it a big currency in the market the turnover increased you know three or four-fold but it still kept it as a fairly small  
[01:12:29] currency from the point of view of households it's not the currency in which they were making savings anyways right but some agents in the financial market really wonder so we're going to make a conclusion soon yes so this will be my conclusion  
[01:12:42] one thing i was going to say uh is do you ever want to use financial repression so one thing that we can show is that in a representative agent economy financial repressions are unambiguously bad they reduce welfare  
[01:12:56] but once you go in a heterogeneous agent model and you have agents that save and agents that consume like hand to mouse consumers and savers what financial repression does it really hurts the savers but it benefits the consumers because it  
[01:13:09] smoothes out exchange rate movements right with the idea that imports are more affordable right so the problem is that in the economy is heterogeneous agents if you have rich agents that really want to herd dollars for savings reasons it takes away foreign currency  
[01:13:23] from the other part of the economy that would have used it to buy imports and so if your goal is to kind of like really uh do something with the welfare of the poor hand to mouse agents financial depression actually becomes welfare and proven by hurt and you know welfare improvement  
[01:13:38] and some utilitarian maybe sense by hurting savers and trying to smooth out you know reduce the costs to consumers reduce the extent of increasing the consumer cost of living right and then financial depression becomes interesting and i  
[01:13:51] think many countries potentially use financial depression for that reason so here's my conclusion so let's just go back to this graph what happened trees of network in assets a highly unanticipated move by europe to freeze that foreign assets  
[01:14:06] and that's the sanction that works to depreciate the currency a run on the banks fc shock people really want to take out the deposits and keep them in foreign currency and this then financial repression was switched on so the initial month  
[01:14:21] is the tension between the in the financial market between sanction on the reserves um precautionary savings shock and financial depression financial repression stabilize it and then this is when realization comes that  
[01:14:35] uh you know the export revenues are so much bigger than import expenditure russia is running the spectacular trade surplus and so this is the force for a long-term appreciation of the ruble you know once the there is no financial  
[01:14:50] panic and kind of bubble solution with you know bubbling exchange rate once that's stabilized then we have this fundamental forces coming from the inter-temporal budget constraint which really pushed the ruble stronger than it was before and it's not surprising  
[01:15:04] because experts are so much bigger than imports now and so now we are in the area where the central bank really wants to reduce financial repression they have a too much they don't want such a strong ruble because it puts so much pressure on the fiscal balance of the of the  
[01:15:18] ministry of finance now so the central bank is trying to reduce financial repression reduction of the home interest rate as part of it as well in order to not have the stiff appreciation of the ruble because it makes the life of minister of  
[01:15:33] finance very difficult and so here's a big difference between expert and import sanctions right so expert sanctions would probably be associated with a much more devalued exchange rate while import sanctions they you know put the central bank in the position that the only thing that  
[01:15:48] they need to do is avoid uh excessive appreciation of the ruble they do not need to do any inflation to resolve the budget constraint they only need to avoid excessive appreciation and that would be  
[01:16:01] fine to relax uh the budget constraint right and so what we study in the paper to what also to what extent it's possible without inflation to relax the budget constraint by means of election financial repression here and the answer is under certain circumstances that  

## Q&A (01:16:14 – 01:20:20)

[01:16:14] actually can relax the budget uh budget constraint of the government without inflation let me stop here thanks thanks a lot alex so let me just ask you your first question where do you think the ruble will be at the end of the year  
[01:16:27] yes so i mean uh we're uh all of our fears say that in a random walk forecasts are the best forecast so you take the value today which is 55 business without sanctions i guess correct right so but here's the big  
[01:16:41] consideration that i think we have to keep in mind so first of all uh if we look at the budget deficit they really cannot afford such a strong ruble so they really have a huge incentive to weaken the ruble right now to relax the pressure on the budget constraint of the  
[01:16:54] government and so this would be i think the primary force which will lead to depreciation from now because the government really central bank really wants to relax uh financial depression and do it almost completely and let ruble kind of somewhat mean revert back  
[01:17:09] to relax the uh pressure on the budget the other thing is we're gonna see more and more imports coming in through some shadow channels right so russia will figure out a way to buy imports and this is the force that will depreciate the currency right like once sanctions are  
[01:17:24] really stiff on imports the ruble is strong but as soon as there is this ways of buying alternative goods from other countries this would be a force for depreciation of the ruble finally europe promised not to buy  
[01:17:39] russian oil started in december uh which would be another shock uh and already now on the expert side so if i think about fundamental forces i see a lot of forces for uh ruble depreciation going forward but  
[01:17:52] obviously the market must be somewhat forward-looking to some extent and so some of it is already priced in perhaps and so in that sense you really always like my prediction will be somewhere between where ruble is now and somewhat weaker so if i had to choose that one answer i  
[01:18:07] would say it will revert back to 75 basically and the government will try to keep it there and and you would say that it should be clear but the exchange rate or should we not care about the exchange rate  
[01:18:21] uh it's it's very interesting i think in the end of the day it's a allocative relevant variable i think what happens to exchange rate right now is very clearly not a situation of strength but of  
[01:18:34] shocks to the economy completely unusual unprecedented shocks which happen to be much heavier on the input side and so in that sense i think what you can read off from the data is that sanctions are actually working  
[01:18:48] uh you know it's just the composition of sanctions were such that they create this force for this completely unprecedented appreciation of the ruble and then everything that concerns financial depression right i think the government really has this tool of  
[01:19:02] choosing uh what to do like of what are the agents and the economy that it wants to suppress others the consumers or the savers and in that sense exchange rate is also an allocative variable and so like all the actions of the central bank now i think they're driven by this two  
[01:19:16] considerations right one is send the correct signal about the value of the exchange that the economy is strongest as you pointed out but two is actually uh relax the situation of one important agent for for for the government is the  
[01:19:29] government budget constraint so a lot of what happens with the change right now we can uh read it off as the ability to as the attempt to relax the constraints on the fiscal fiscal budget constraint  
[01:19:43] thanks a lot oleg for bringing back our learners insights from 1936 um to the real world and helping us to understand much better how much emphasis we should have put on the exchange rate movements in order to interpret whether  
[01:19:57] scientists work or not i appreciate it i think it's very useful to understand this and shows the value of economics and we stay in touch and keep talking and keep following what's going on in the real world and thanks to all the listeners and hope  
[01:20:11] to see you soon again with for the next webinar series thanks a lot marcus thanks bye