Academic journal article Contemporary Economic Policy

Synchronization of Economic Shocks between Gulf Cooperation Council and United States, Europe, Japan, and Oil Market: Choice of Exchange Rate Regime[dagger]

Academic journal article Contemporary Economic Policy

Synchronization of Economic Shocks between Gulf Cooperation Council and United States, Europe, Japan, and Oil Market: Choice of Exchange Rate Regime[dagger]

Article excerpt

I. INTRODUCTION

The six oil-rich Gulf countries--Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and United Arab Emirates (UAE)--formed the Gulf Cooperation Council (GCC) in 1981 as an institutional framework to establish a monetary and currency union that embraces them in a political and economic bloc. Recently, these GCC countries have made serious plans that call for stoking monetary integration among them. They agreed on establishing a GCC central bank that would introduce a single currency in the near future.

The process toward achieving economic integration had however gone slowly, but in 2001 it gained momentum when it culminated in the ratification of a new economic agreement that sets a specified timetable to meet the requirements of the monetary union. Those requirements include the harmonization of all economic policies, particularly monetary policies, the standardization of banking regulations, and the meeting of the convergence criteria. In January 2003, the GCC countries formed a customs union and applied a common external tariff. On the same date, these countries formally pegged their currencies to the U.S. dollar (Al-Hassan 2010).2 They established a common market in 2009 to enhance labor and capital mobility within the GCC members. This step is a significant progress on the road to economic integration because it increases the flexibility of the factor markets to adjust in the face of exogenous shocks. Such a development is needed given the fact that the GCC bloc does not have a common monetary and exchange rate policies, and the national monetary and exchange rate policies of each member are not highly effective (Al-Omran 2010).

The introduction of the GCC single currency will necessitate the creation of a single GCC central bank, a single GCC monetary policy, and the choice of a common GCC exchange rate regime. The choice of the type of the common exchange rate regime prior to the due date is one of the key economic policies pending for action by the GCC countries and also raises several questions. Should these countries allow the new currency to be fixed to the U.S. dollar, the euro, or a basket of the world's major currencies where the dollar, the euro, and/or the yen have the largest proportions? Or should they let the currency float subject to possible exchange market interventions from time to time? Each choice has its own merits and drawbacks. (3)

To shed some light on this issue, we examine the synchronization of global economics shocks of three major world economies and the oil market and those of the GCC countries foreseen as a single bloc to determine the relative importance of those global shocks in the GCC economy. (4) This result should have significant implications for GCC policy makers. The findings should help us make policy recommendations on the sensitivity of the GCC economy to different major sources of economic fluctuations and the best arrangement for having a common exchange rate regime in the GCC region in light of those external and domestic shocks. In view of the recent financial crisis that emanated from major global economic zones, this study takes on an extra dimension at this time.

As a forward-looking study, this anticipatory paper in the absence of actual common GCC bloc data considers the GCC countries as a prospective single monetary union. This is supported by several studies that examined monetary integration among those countries as will be seen from the review of the literature. This study thus constructs historical bloc data for gross domestic product (GDP), exports, and consumer price index (CPI) of the GCC members. The objective is to assess the relative impacts of external shocks: terms-of-trade, zone outputs in the dollar, euro, and yen zones, and the regional output on the GCC GDP, in order to make policy recommendations for the prospective GCC bloc regarding economic growth, exports, inflation, and type of exchange rate regime arrangement that would be suitable for the union. …

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