For over 160 days, Ukraine has been resisting Russian aggression. The economic cost has been staggering: GDP is projected to decline by more than 30% in 2022 and the unemployment rate is at 35% (Constantinescu et al. 2022, Blinov and Djankov 2022, National Bank of Ukraine 2022). A prolonged war is increasingly likely, a prospect that calls for a recalibration of the country’s macroeconomic strategy. Specifically, the current policy mix, which relies on running down foreign reserves and other temporary measures, is progressively untenable. Unless altered, this course will result in a major economic crisis that will cripple Ukraine’s ability to sustain its war effort over an extended period.
In CEPR Rapid Policy Response #2 (Becker et al. 2022), we outline macroeconomic policies to put the economy on a sustainable trajectory for the duration of the war. We emphasise at the outset that Ukraine’s crisis is not a setting for a typical macroeconomic adjustment programme. The country’s very survival – and Europe’s future – Is at stake. This key constraint should condition the design of any programme. Extraordinary challenges must be matched by extraordinary policies and extraordinary support from Ukraine’s international partners.
Our recommendations build on four key elements.
First, the government must mobilise more resources to improve its fiscal position (the fiscal deficit is running at about $5 billion per month, which is approximately 30% of pre-war monthly GDP) so that the country can fund huge military expenditures and maintain basic public services in an economy ravaged by the war. The aim should be to increase the collection of tax revenues (e.g. close loopholes, introduce new taxes, raise tax rates, make taxes more progressive). Remaining shortfalls should be financed primarily through nonmonetary means: preferably through external aid, but if not, through domestic debt issuance (the Ministry of Finance should offer bonds across the whole range of the yield curve at rates closer to the market), with much less reliance on seigniorage (printing money). Controlling and raising the effectiveness of nonmilitary spending is critical for keeping public finances sustainable.
We emphasise that foreign military aid remains vital, of course, but Ukraine’s allies should radically increase economic aid and accelerate its disbursement to relax Ukraine’s budget constraints and provide a short-term solution to internal and external economic imbalances. The current level of support is ‘too little, too late’. For example, the EU had proposed an urgent macro-financial assistance programme of €9 billion in May but has only managed to mobilise €1 billion by July, with the remaining €8 billion still locked in discussions. To avert economic calamity, Ukraine’s allies should transfer larger amounts immediately. Furthermore, the base of donors should be broadened to include not only governments but also the corporate sector and non-government organisations. Perhaps businesses that provide meaningful help to Ukraine can receive ‘points’ that they will be able to cash in at the reconstruction stage.
Second, there is an urgent need for a durable nominal anchor. Heavy reliance on money printing to finance government deficits has been unavoidable in the first months of the war, but if the current reliance on money finance is sustained, inflation, already over 20%, could easily drift much higher. The aim should be for relatively low inflation. In a time of national mobilisation, the main responsibility for attaining price stability falls on the fiscal authority (Sargent and Wallace 1981), which can strongly influence inflation through the tools it chooses to raise resources from the domestic private sector. The government should aim to enhance national saving rather than rely on monetary financing from the central bank. In coordination with fiscal authorities, the central bank should implement a flexible framework to support macroeconomic stability. A managed float of the exchange rate is consistent with this goal.
Third, external imbalances should be addressed through a combination of strict capital outflow controls, restrictions on imports (such as higher import taxes and a binding list of critical imports), and some flexibility in the exchange rate to avoid jeopardising internal macroeconomic stability in the face of huge fiscal needs. By radically constraining choices for potential investment, tighter capital controls will also help the government to mobilise more resources at a cheaper price from the internal capital market. A comprehensive standstill on external debt payments is essential.
Fourth, although wartime governments usually take over the allocation of resources, Ukrainian circumstances call for more market-based allocation mechanisms to ensure cost-effective solutions that do not overburden the state capacity, exacerbate existing problems (such as corruption), or encourage (untaxed) black market activities. This element is critical because the war is a massive reallocation shock. The economy of Eastern Ukraine is largely destroyed (some of the largest steel mills were in Mariupol), while Western Ukraine is more lightly damaged. There is also major differentiation across production sectors. For example, Russian missiles have destroyed all major oil refineries, but the IT sector remains strong. As a result of the Russian invasion, some sectors and locations in Ukraine have little to no economic activity currently. The released resources must be employed elsewhere, and government policies should facilitate this large-scale reallocation of resources. To this end, the aim should be to pursue extensive radical deregulation of economic activity, avoid price controls, facilitate matching of labour and capital, and enhance the management of seized Russian and other sanctioned assets.
In summary, the wartime experience of many countries – including Ukraine’s in 2014-2015 – suggests that the government has to make a number of tough choices. The budget constraints are particularly painful and call for many sacrifices shared by every Ukrainian. The country will have to mobilise more resources to pay for enormous military expenditures as well as to help the population affected by the war. The marathon of this war requires prudence and caution in public finances, a durable nominal anchor, a resilient financial system, a careful management of external balances, and flexibility and efficiency in the allocation of scarce resources. Various branches of the government must coordinate their efforts to this end.
The current situation in the country is most challenging but Ukraine is not alone in this war. The support from Ukraine’s allies is absolutely critical not only for the existence of the country but also for the future of the global order and security. Economic and military aid to Ukraine is the best investment in peace. We call on the global community to support Ukraine in every possible way.
Becker, T, B Eichengreen, Y Gorodnichenko, S Guriev, S Johnson, T Mylovanov, M Obstfeld, K Rogoff and B Weder di Mauro (2022), Macroeconomic policies for wartime Ukraine, CEPR Rapid Policy Response #2.
Blinov, O and S Djankov (2022), “Ukraine’s recovery challenge”, VoxEU.org, 31 May.
Constantinescu, M, K Kappner, and N Szumilo (2022), “Estimating the short-term impact of war on economic activity in Ukraine”, VoxEU.org, 21 June.
National Bank of Ukraine (2022), Inflation Report: July 2022.
Sargent, T and N Wallace (1981), “Some Unpleasant Monetarist Arithmetic”, Federal Reserve Bank of Minneapolis Quarterly Review, Fall.