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On The Road to Monetary Union – Do Arab Gulf Cooperation Council Economies React in the same way to United States' Monetary Policy Shocks?

Louis, Rosmy and Osman, Mohammad and Balli, FAruk (2007): On The Road to Monetary Union – Do Arab Gulf Cooperation Council Economies React in the same way to United States' Monetary Policy Shocks?

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Abstract

This paper empirically estimates the responses of inflation and non-oil output growth from Arab Gulf Cooperation Council (AGCC) Countries to monetary policy shocks from the United States (US) in order to determine whether there is evidence to support the US dollar as the anchor for the proposed unified currency. For this, a structural vector autoregression identified with short-run restrictions was employed for each country with fund rate as US monetary policy instrument, non-oil output growth, and inflation. The main results that are of interest to decision makers suggest that (i) with respect to inflation, AGCC countries show synchronized responses to monetary policy shocks from the US and these responses are similar to US own inflation; (ii) with respect to non-oil output growth, there is no clear indication that US monetary policy can do as good of a job for AGCC countries as it has done at home. Therefore, importing monetary policy from the United States via a dollar peg may guarantee stable inflation for AGCC countries but not necessarily stable non-oil output growth. To the extent that the non-oil output response is taken seriously and there are concerns over the dollar's ability to perform its role as a store of value, a basket peg with both the US dollar and the Euro may be a sound alternative as confirmed by the variance decomposition analysis of our augmented SVAR with a proxy for the European short-term interest rate.

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