The relevancy of the US dollar peg to the economies of the Gulf Cooperation Council countries (GCC)

Al Yahyaei, Qais Issa (2011) The relevancy of the US dollar peg to the economies of the Gulf Cooperation Council countries (GCC). PhD thesis, University of Glasgow.

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Nominal exchange rate stability has long been considered as a policy choice for many oil-exporting economies, including the GCC countries. The main motives for such policy choices include the desire to import credibility to domestic currencies, stabilize oil revenues and in turn government revenues (given their role in fiscal budget of these oil-based economies) and to avoid Dutch disease, particularly for those countries which have been trying to promote their non-oil exports. Recently however, with respect to the GCC countries, the advantages of exchange rate stability/peg have been overshadowed by adverse domestic and global developments. The recent surge in the GCC countries’ inflation rates that coincided with depreciation of the currencies of these countries due to the depreciation of the US dollar, has led to increasing public pressure for an upward revaluation or even a de-peg from the US dollar to an exchange rate regime that will ensure higher price stability.
Accordingly, this thesis was put forth to provide a scientific opinion of the viability of the existing US dollar peg in the GCC countries, by focusing on the link between changes in exchange rate and inflation. To this end, the study attempted to assess the risk to the domestic inflation rates of the GCC countries arising from fluctuations of the US dollar against the currencies of the major trading partners of these economies. Based on a thorough review of the relevant literature, some empirical estimations were carried out using some econometric methods, and it was discovered that the amount of pass-through or impact from changes in exchange rates to inflation rates in the GCC economies is incomplete and moderate, with an average of around 23% in the long-run. Furthermore, an average long-run pass-through of around 23% does not signify a high risk from fluctuations in the foreign exchange market for domestic prices in the GCC countries. In other words, the volatility of exchange rates of the currencies of the GCC countries does not necessitate the adjustment of the money supply in these economies. These findings lent further support to the relevancy of the existing fixed exchange rate regime for maintaining stable inflation in the economies of the GCC countries. The findings were also supported by the performance of the GCC economies over the past two decades, despite some periods of dollar fluctuations. A retrospective analysis indicates that on average, inflation has been stable in the region over the past two decades.
The study provided evidence for the important role of the fiscal policies of the GCC countries in affecting the recent impact from exchange rate to inflation rate in these economies, which suggests that these policies form a key macroeconomic tool in these countries, particularly
given the lost independence of the monetary policy under the existing pegged exchange rate regimes. Moreover, the study suggests lowering the influence of fiscal policies on the link between exchange rate and domestic prices, or inflation in general, in the GCC countries by pursuing gradual steps toward domestic development in the economy, particularly given the limited absorptive capacity of these economies due to the shortage in supply bottleneck.
The study was also extended to identify the potential alternative exchange rate regime if the GCC changed their focus from inflation to other, evolving, national objectives like international competitiveness. Based on the existing literature and the optimum currency theory, the study suggests that the GCC countries should consider moving gradually from their current single peg toward a more flexible exchange rate in order to avoid abrupt change that would disturb the existing market credibility. As an initial step, the study recommends moving toward a basket peg of two currencies, namely the US dollar and the Euro, that account for a large share of the GCC economies’ international trade and non-trade financial transactions.
Finally, the study also concluded that an upward revaluation as a remedy for the recent inflationary development is an unsatisfactory solution, particularly if the same set of circumstances continued into the future. If this was the case, then the process would have to be repeated again, thus triggering the possibility of speculation attack.

Item Type: Thesis (PhD)
Qualification Level: Doctoral
Keywords: Exchange rate regime, inflation rate, nominal effective exchange rate, real exchange rate, fiscal policy, monetary policy,
Subjects: H Social Sciences > HB Economic Theory
H Social Sciences > HG Finance
Colleges/Schools: College of Social Sciences > Adam Smith Business School > Economics
Supervisor's Name: Ronald, Professor MacDonald and Alberto, Dr. Paloni
Date of Award: 2011
Depositing User: Mr. Qais Al Yahyaei
Unique ID: glathesis:2011-2643
Copyright: Copyright of this thesis is held by the author.
Date Deposited: 31 May 2011
Last Modified: 10 Dec 2012 13:58

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