Can Monetary Policy Undo Asset-freezing Sanctions?

Abstract

This article investigates the macroeconomic consequences of foreign asset-freezing sanctions, a tool utilized by several Western nations amid recent geopolitical tensions. Specifically, it examines the repercussions of such sanctions on open economies, finding 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 financial 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 inflation 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 effects. Notably, the monetary authority must navigate a trade-off between stabilizing output and managing inflation resulting from the cash-in-advance channel.