International Trade and Macroeconomic Dynamics with Sanctions

We study international trade and macroeconomic dynamics triggered by the imposition of sanctions. We begin with a tractable two-country model where Home and Foreign countries have comparative advantages in production of differentiated consumption goods and a commodity (e.g., gas), respectively. Home imposes sanctions on Foreign. Financial sanctions exclude a fraction of Foreign agents from the international bond market. Gas sanctions take the form of a ban on gas trade, equivalent to an appropriate price cap in our model. Differentiated goods trade sanctions exclude a fraction of Foreign and Home exporters from international trade. All sanctions lead to resource reallocation in both economies. Exchange rate movements reflect the direction of reallocation and the type of sanctions imposed rather than the success of the sanctions. Welfare analysis shows that gas sanctions are more costly for Home, while differentiated consumption goods trade sanctions are more costly for Foreign. A third country that refrains from joining the sanctions mitigates welfare losses in Foreign, but refraining from joining the sanctions is beneficial for the third country. These findings highlight the importance and the difficulty of international coordination when imposing sanctions.