Cash outside the banking system

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Reference no: EM133985628

Question

The America, the EU and other allies have put in place unprecedented sanctions on Russia over its invasion of Ukraine, and hundreds of international companies have pulled out of Russia. However, most of the Western sanctions were perceived not to have significant impact on Russia's economy, especially since energy transactions were exempted from sanctions.

The new measures targeting Russia's central bank and its financial system, announced by the America and its allies on February 26th, changed that.

The new measures target Russia's central bank and may lead to freezing of its $630 billion of reserves (38% of its GDP) held in foreign banks. As the central bank's assets were frozen, it has damaged the public confidence in Russia central bank and the banking system, triggering a bank run in Russia. Reports show Russians lining up at ATMs to withdraw their cash from banks2.

1. Suppose the depositors do not believe that any bank is safe and hold their cash outside the banking system. Explain how the bank run would affect money supply. With an aid of the money demand and money supply diagram, illustrate the impact of the bank run on the money market and interest rate.

2. Explain how it would affect Russia's economy in the short run.

Reference no: EM133985628

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