Determining Real Exchange Rate Fluctuations in the Oil-Based GCC Economies

Abstract

This paper attempts to empirically determine the relationship between oil price fluctuations and movements in the dollar-pegged Gulf Cooperation Council (GCC) countries’ exchange rates. Panel unit root tests are applied, followed by the estimation of a panel co-integration model to identify the long-run equilibrium relationship. Built on the co-integration test results, a Vector Error Correction Model (VECM) is then estimated to determine causality relationships and investigate the short run dynamics. A panel of annual data of real exchange rates, oil prices and three other variables are utilized, which were selected in reference to the literature. The time series cover the 32-year period of 1980 to 2012. Test results indicate that the series are integrated of order one and evidence is found that oil prices and GDP per capita have a long run co-integration relationship with real exchange rates. The estimated VECM confirms the long run relationship and identifies a short run causality running from oil prices to exchange rates. The model also shows that exchange rates correct for short run disequilibria slowly, at the speed of 4% annually. The results confirm the findings of past researchers and recommend reviewing the existing exchange rate regimes to mitigate the impact of oil price fluctuations on these economies.