Academic journal article Journal of Economics and Finance

On the Feasibility of Monetary Union among Gulf Cooperation Council (GCC) Countries: Does the Symmetry of Shocks Extend to the Non-Oil Sector?

Academic journal article Journal of Economics and Finance

On the Feasibility of Monetary Union among Gulf Cooperation Council (GCC) Countries: Does the Symmetry of Shocks Extend to the Non-Oil Sector?

Article excerpt

Abstract GCC countries' output is heavily dichotomized into oil and non-oil. Oil shocks have similar effects on all member countries but little is known about their responses to non-oil shocks. This paper sets out to determine (1) whether aggregate demand (AD) and non-oil supply shocks (AS) are symmetrical across these countries to justify their suitability for monetary union; and (2) whether there is any commonality of shocks with the United States and the three major European countries, namely France, Germany, and Italy, which can warrant the choice of either the US dollar or the Euro as the anchor for the expected common currency of the bloc. We use bivariate structural vector autoregression models identified with long-run restrictions to extract the shocks. Our results show that (a) AD shocks are unequivocally symmetrical but non-oil AS shocks are weakly symmetrical across GCC countries thereby suggesting a monetary union is feasible, but not overwhelmingly; (b) neither AD nor AS shocks are symmetrical between GCC countries and the selected European countries; (c) GCC's AD shocks are symmetrical with the US but non-oil AS shock are not. Furthermore, there are no significant changes in the results when we aggregate the GCC countries as a bloc. We therefore surmise that the US dollar is a more appropriate anchor for the new currency than the Euro since US monetary policy can at least help smooth demand shocks in GCC countries.

Keywords GCC . Monetary Union . Shocks Symmetry . Currency Anchor

JEL Classification C32 . E52 . F15

(ProQuest: ... denotes formulae omitted.)

1 Introduction

In this paper we address two key empirical questions. First, to what extent do the non-oil sectors of the GCC countries, namely Bahrain, Kuwait, Qatar, Oman, Saudi Arabia, and the United Arab Emirates (UAE), satisfy the prerequisite of common shocks for monetary union?1 Second, does the degree of shocks symmetry or asymmetry between the GCC countries and the United States (US) and/or the three largest European economies (France, Germany, and Italy) warrant the choice of either the US dollar or the Euro or a combination of the two as the anchor for the newly proposed single currency? This paper is motivated by the upcoming signing of a monetary union by GCC countries and the issuance of a single currency, which is to be pegged to the US dollar. Also, since the recent decline in the value of the dollar relative to the Euro and other major currencies has rekindled the debate on the merit of the dollar as a solid anchor; we are particularly interested in determining how suitable of an alternative the Euro or a basket could be for these countries.

There is an abundant literature on the choice of exchange rate regimes and the dollarization of economies. Most notably is the seminal paper of Mundell (1961) on optimum currency areas (OCAs) along with subsequent works by McKinnon (1963), Kenen (1969), and Tower and Willet (1976) that stress the importance of relative economic sizes, labor mobility, degree of openness, trade concentration, and similarity of shocks. These contributions constitute the workhorse for assessing the suitability of fixed, flexible exchange rate regimes, and prospective monetary unions. The determination of the degree of symmetry between shocks across countries has been thus far the most popular criterion used in empirical works to evaluate OCAs. According to this approach, one needs to examine whether AD and AS shocks are correlated across member countries to conclude on the desirability of monetary union, ceteris paribus. In this paper, not only are we interested in the suitability of either the US dollar or the Euro, or an index based on the two currencies as the principal anchor for the new GCC currency, but we also examine the symmetry of shocks both across and between member countries and possible anchor countries.

The debate on whether fixed regimes are better than floating regimes, vice-versa, is a very old one. …

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