The three fundamental challenges for Ukraine’s wartime economy are: (1) limited productive capacity and power generation that are constantly under Russian attack; (2) large fiscal deficits; and (3) large external trade deficits. We will cover each of these challenges in turn, but first we would like to present the economic case for European support of Ukraine.
Why help Ukraine?
While many current efforts centre on achieving a ceasefire in Ukraine and thus relieving immediate pressures, broader economic analysis of the costs and benefits of ensuring durable peace in Europe, as well as of alternative scenarios, is sorely lacking. In the interest of space, consider three such costs.
First, the menace of a victorious and aggressive Russia will force European countries to permanently increase defence spending by half or more, which amounts to hundreds of billions of euros in addition spending. In line with this observation, on 3 March 2025, EU President Ursula von der Leyen announced a ReArm Europe package to the tune of €800 billion.
Second, security risks cast a long shadow over economic activity in general and specifically on the cost of capital. If the fear of war grows, European firms, households, and governments will have to pay a premium akin to the ‘Korean discount’. If the cost of capital increases by even one basis point, for example, France will have to spend an extra €1 billion per year on servicing its debts.
Third, a failed Ukraine will be a source of costly instability for Europe and will introduce qualitatively new challenges such as flows of nuclear materials and advanced military technologies. The cost of Ukrainian refugees alone is already immense (cumulatively the EU has spent €125 billion on refugees from the war) and that cost will soar if many more millions – perhaps as many as 10 million – flee a country that is under a permanent threat of Russian aggression.
Clearly, these three costs – and there are potentially many others – dramatically outweigh the costs of supporting Ukraine and avoiding the consequences of its defeat. Furthermore, history (e.g. Ilzetzki 2025) teaches us that investment in European security will create jobs, reduce strategic dependencies, and fund innovation – key objectives outlined in the Draghi Report (European Commission 2024).
In short, the multiplier for investments in defeating Russian aggression may be as high as 10: every euro invested in Ukraine today will save 10 euros for the EU in the future. Decisive support for Ukraine can avert a historical geopolitical disaster in Europe and beyond, but even in narrowly economic terms, it is the best investment the EU can make.
Productive capacity
Ukraine faces shortages of workers, mismatches in the labour market, blackouts, uncertainty, and Russian missile and drone strikes. The National Bank of Ukraine estimates that, given the destruction of productive capacity and occupation of territory to date, output is currently close to potential. If accurate, this means that further demand-side stimulus cannot create much output without inflationary pressures. Hence, economic policy should concentrate on the supply side of the economy. These range from retraining programmes, to de-risking economic activity, to reallocation of business to safer parts of Ukraine (Dombrovskis et al. 2024), to economic reinsertion of refugees back into Ukraine (Gorodnichenko and Gros 2025).
Although Ukraine’s economy faces binding capacity constraints, some sectors could expand even in the short run. Firms in the military defence sector report that their capacity to produce drones is currently only 40% utilised. Although the Ukrainian government may not have resources to contract with these firms to their full capacities, Ukraine’s allies can pay for drone deliveries directly (for example, the Dutch government pledged to spend €700 million on drone production in Ukraine). Apart from addressing the need to replace US military kit and create a ‘drone line’ for Ukraine’s defence, this approach promotes production upscaling and self-reliance in Ukraine, delivers defence capabilities cheaply, and recognises that Ukraine is a critical part of Europe’s defence perimeter.
To enhance allocation of scarce resources, prices should reflect supply and demand conditions. This is particularly important in the context of electric power generation as the country is projected to experience electricity deficits of 5% or more in 2025 and likely beyond (more than 50% of electricity power generation was destroyed by Russian missiles). Although the government increased the price of electricity by 60% in 2024 to bring the price closer to cost recovery levels, planned and unplanned blackouts due to shortages of electricity continue to inhibit economic activity. To balance protection of the population and improvement in efficiency, Ukraine can rely more on nonlinear tariffs, where some amount of electricity is sold at a stable price that corresponds to a moving-average cost of electricity but the marginal kWt of electricity is priced to reflect market conditions.
Fiscal deficits
Since the beginning of the full-scale invasion, Ukraine has been running fiscal deficits on the order of 30% of GDP. Although the deficit is projected to stand at 19% of GDP in 2025 and then to decline modestly over time, Ukraine is unlikely to cover it without foreign aid. At the same time, Ukraine can make a number of changes to reduce its dependence on aid. In a nutshell, this would require raising taxes (especially raising taxes on consumption (VAT), making taxes more progressive, and broadening the tax base further) and controlling non-defence spending (especially, making government support more targeted). This is obviously a painful combination in the best of times, but geopolitical developments may force Ukraine to take radical steps.
Limited capacity on the supply side points to the importance of shifting the demand mix from private to government demand. With total available domestic resources roughly fixed, the government has to induce the private sector to cut its spending to free up resources for defence production. This means that (1) taxes must be raised and (2) households and firms should be given incentives (possibly via financial repression) to channel their savings into government bonds. Because the increase in taxes will be matched by a corresponding increase in government spending, any potentially contractionary effects of higher taxes on the economy will be mitigated.
Because the conventional sources of government funding such as banks are largely exhausted, the main focus for internal debt financing should be on direct outreach to savers. In the event of acute financing difficulties, the authorities could opt for more radical solutions, like financial repression. Extending a comprehensive standstill on external debt payments is essential.
With the prospect of a long war, the (high) risk of the economy being ravaged by high inflation outweighs the (minor) benefit of seigniorage revenue. We therefore strongly advise against reliance on seigniorage as a significant source of revenue for the government.
The external trade deficit
Ukraine is running a persistent trade deficit and the war is certainly a prime factor. Hence, economic policies alone cannot eliminate the deficit. But they can mitigate the problem. We suggest three such policies: adjusting the exchange rate, applying capital controls, and removing export bottlenecks.
Specifically, the hryvnia should be allowed to adjust in response to trade imbalances and aid flows. The current regime of managed floating should help absorb shocks and adjustments at least in part. The hryvnia should be allowed depreciate gradually to improve the trade balance and help stimulate the economy.
Given limited reserves and enormous uncertainties, the National Bank of Ukraine has no choice but to retain comprehensive capital outflow controls. The Bank should refrain from any relaxation of existing capital controls. Capital controls should also help the government to borrow at a lower rate.
Reopening of the big Odesa ports unlocked export opportunities. While the government should continue to work on increasing the capacity of seaports, land-based routes are important for diversification and market access reasons.
Concluding remarks
Although the Trump administration has halted military and economic support to Ukraine, the fundamental calculus is largely unchanged. The economic resources of the EU, the UK, Norway, Canada, Japan, and other allies of Ukraine are collectively an order of magnitude greater than Russian resources. There is a growing understanding that the Russian war in Ukraine is a direct and existential threat to the European project, to European security, and to the very ideals of democracy. There is good reason to expect that Europe and others will fill economic and military shortfalls due to US withdrawal. At the same time, the American policy reversal shows that, no matter how deserved assistance to Kyiv may be, Ukraine needs to prepare for all contingencies, including delayed or reduced disbursements of aid from its allies in the face of continued Russian aggression.
References
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 Response Economics 2.
Becker, T, B Eichengreen, Y Gorodnichenko, S Guriev, S Johnson, T Mylovanov, M Obstfeld, K Rogoff and B Weder Di Mauro (2025), “Replacing foreign aid: A macroeconomic plan B for Ukraine (and Europe)”, CEPR Policy Insight 140.
Dombrovskis, V, M Obstfeld, I Sologoub, Y Gorodnichenko, T Becker, A Fedyk, G Roland, and B Weder di Mauro (2024), “Stimulating growth in Ukraine and policies for migrants’ return”, CEPR Policy Insight 132.
Gorodnichenko, Y and D Gros (2025), “Ukraine Refugees: From Temporary Protection to Encouraging Return to Support the Ukrainian Economy”, EconPol Forum 1/2025: 38-40.
European Commission (2024), “The Draghi report on EU competitiveness”.
Ilzetzki, E (2025), Guns and Growth: The Economic Consequences of Defense Buildups, Kiel Report 2.
