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JEL Classification System

E32, E37, E44, E50, E52, E61

Abstract

This research aims to present a DSGE model that can investigate the effect of utility changes due to the financial sanctions imposed on the dominant economy by defining different utility functions for households. The link between the real economy and financial markets stems from the countries’ need for external finance to engage in investment opportunities in each country. Each and every economy often needs foreign funding; however, restrictions can limit the access of the given country to international financial markets. The existence of a crisis in international financial markets such as international sanctions can aggravate the adverse shocks and their destructive effects on an open economy. These restrictions can lead to a sudden stop of financial inflows, which in turn blocks economic activity, accelerating the initial downturn. Further, the resulting deterioration of their ability to finance from an external country produces a negative impact on their investment, which might lead to a decrease in economic activity and exacerbates poor financing conditions and further reduces the economic activities. In fact, starting a small sanction on financial markets naturally produces a large change in any country’s economic condition. Given the importance of the role of sanctions in the utility functions for the household and their effects on economic models, this paper seeks to investigate the role of the sanctions in the economic models by designing a dynamic stochastic general equilibrium model and compare the impact of such costs on the behavior of macroeconomic variables and household. Comparison of the results of the impulse-response functions of the variables showed that adding sanctions into the model led to a sharp reduction of the impact of shocks on the study variables. Therefore, the existence of sanctions changes the behavior of variables and prevents a sharp increase in the effects of shocks.

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