Domestic and External Demand Shocks in Ukraine
Domestic and External Demand Shocks in Ukraine

Summary/Abstract: Persistent budget deficits and extremely high interest rates (while inflation remains relatively low) have been a distinct feature of the 2010–2013 period in Ukraine. By using a statistical technique of the vector autoregressive − vector error correction (VAR/VEC) model, it is established that: a) the budget deficit is a factor behind the exchange rate depreciation and an increase in the interest rate, with a very strong contractionary effect on output; b) a higher interest rate contributes to worsening of the budget balance and a significant decrease in output (both are standard macroeconomic relationships); c) nominal exchange rate depreciation permanently widens the budget deficit, combined with a temporary increase in the interest rate and short-lived output contraction. It is worth noting that upward interest rate pressure is the only statistically significant effect of a positive output shock. According to the variance decomposition, the budget balance determines up to 50% and the interest rate upwards of 40% of changes in the output, respectively. It is confirmed that an increase in output is of marginal importance for the budget balance. On the whole, our findings argue in favour of fiscal discipline in Ukraine as a stabilisation policy tool.

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