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Introduction, Background, and Rationale

This paper aims to analyze monetary policy tools’ effectiveness under a fixed exchange system during economic shocks. Focusing on the GCC countries, the report illustrates how monetary policy strategies are ineffective under the fixed exchange system since a pegged exchange rate implies a country has no domestic monetary autonomy.

In many ways, the exchange rate regime choice is fundamental to economic stability and prosperity of a nation. Under the fixed exchange regime, economies anchor their monetary policy to another economy (Arratibel & Michaelis, 2014). All the GCC countries namely, Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and UAE, except for Kuwait, which has pegged its currency on a basket of currencies, have pegged their currency to the US dollar (Cevik & Teksoz, 2012). Indeed, the choice for a fixed exchange regime in GCC economies is grounded on these countries’ structural characteristics, specifically on the importance of the oil sector to these economies’ GDP, exports, and government revenue.

However, the recent global financial crisis has illustrated monetary policy tools are virtually ineffective during economic shocks (Ellis & Gyoerk, 2019), (Tevdovski, Petrevski, & Bogoev, 2019). Analysis of the usefulness of monetary policy strategies during economic shocks is vital. This is particularly so in the case of GCC countries since the conclusions of this research will influence GCC countries’ future decisions when it comes to the choice of exchange rate regime. Undeniably, the ever-increasing inflationary pressures, proliferation in the integration of global markets, in addition to different economic cycles and policy needs of the anchor country, the USA, continue to raise questions on the validity of pegging (Pinto, 2018).

Over the past half a decade, since the work of Mundell (1963) and Fleming (1962), much research has been dedicated to investigating the effectiveness of monetary policy strategies under the fixed exchange regime. However, many studies have not focused on the CGC countries exclusively (Terra, 2015). The CGC economies are among the most homogenous groups of counties among other unions. Specifically, these countries share a common history, language, and culture. Moreover, they are mainly oil exporters, except for Bahrain (Merza & Cader, 2009). Therefore, an analysis of the effectiveness of monetary policies in these economies is likely to provide a unique perspective necessary for informed decision-making as society continues to pursue the integration of markets. Moreover, most of these studies were published before the 2008 financial crisis and fail to provide a complete picture of how monetary policy tools function during economic crises (Gali & Monacelli, 2005), (Shambaugh, 2004).

Research Questions

Are monetary policy tools effective under the fixed exchange regime? To what extent are they useful?

These two research questions intend to explore the monetary policy tools’ functioning under a fixed exchange regime and, subsequently, their shortcoming in addressing economic shocks. The paper provides a unique perspective by focusing exclusively on the GCC economies.

Literature Review

There are quite a number of theoretical approaches that investigate the effects of monetary policy on the economy. The neoclassical model suggests that money is neutral, asserting that tightening or expansionary monetary policy and a decrease or increase in money supply affects nominal variables but has no effect on real variables (Khan, 2009). However, Keynesian IS/LM argues expansionary monetary policies cause a decrease in the short-term interest rate, which causes a reduction in the long-term interest rate since the long-term interest rate is the average of the short-term interest rate. A decline in interest rate induces investments and increases consumption expenditure, which boosts aggregate demand (Melvin & Norrbin, 2017). There has been relatively scarce research on monetary policy in any GCC economies (Prasad & Espinoza, 2012). For instance, Darrat (1985) investigated the impact of money on price level fluctuation in Libya, Nigeria, and Saudi Arabia before Saudi Arabia pegged their exchange rate to the US dollar and concluded high money supply is directly linked to higher inflation in these countries.

A theoretical perspective of the fixed exchange regime implies since the GCC exchange rates are pegged to the USA dollar, then it is deductive the GCC countries monetary policies and interest rate should concede with the US Federal Reserve Policies (Ziaei, 2013), (Hinic & Miletic, 2013) (Mosteanu, 2017). However, different business and economic cycles between the USA and GCC countries raises questions on the effectiveness of monetary policy strategies in GCC countries.


The research paper applies various macroeconomics variables data, including interest rate, inflation, aggregate demand, GDP, among others from the six GCC countries and the US, to establish varying business and economic situations between the two regions. Data from all these countries will be collected from official publications, including the ministry of finance, central banks, and the Federal Reserve. Special attention is dedicated to the period prior to and after the financial crisis in 2008. The research applies the recently developed Bayesian VAR to analyze monetary policy tools’ effectiveness in GCC countries that operate under the fixed exchange regime.


Arratibel, O., & Michaelis, H. (2014). The impact of monetary policy and exchange rate shocks in Poland. ECB.

Cevik, S., & Teksoz, K. (2012). Lost in Transmission? The Effectiveness of Monetary Policy Transmission Channels in the GCC Countries. Econometric Modeling.

Darrat, A. F. (1985). The monetary explanation of inflation: The experience of three major OPEC economies. Journal of Economics and Business, 37, 209-221.

Ellis, C., & Gyoerk, E. (2019). Investigating the economic and financial damage around currency peg fails. Journal of Risk and Financial Management, 12(92), 1-16.

Fleming, J. (1962). Domestic financial policies under fixed and floating exchange rates. International Monetary Fund Staff Papers, 369-379.

Gali, J., & Monacelli, T. (2005). Monetary policy and exchange rate volatility in a small open economy. The Review of Economic Studies, 72(3), 707-734.

Hinic, B., & Miletic, M. (2013). The efficiency of the fiscal and monetary stimuli: the case of Serbia.

Khan, M. S. (2009). The GCC monetary union: Choice of exchange rate regime. 1-19.

Melvin, M., & Norrbin, S. (2017). The IS-LM-BP approach. International Money and Finance.

Merza, I., & Cader, H. (2009). Determining the exchange rate of the common GCC currency under a fixed exchange rate regime. International Review of Business Research Papers, 192-199.

Mosteanu, N. R. (2017). Currency pegged to a foreign currency- GCC and Europe models. The Business and Management Review, 9(1), 52-76.

Mundell, R. A. (1962). Capital mobility and stabilization policy under fixed and flexible exchange rates. Canadian Journal of Economics and Political Sciences, 29(4), 475-485.

Pinto, L. (2018). Sustaining the GCC currency pegs: The need of collaboration. Brookings.

Prasad, A., & Espinoza, R. (2012). Monetary policy transmission in the GCC countries. IMF Library.

Shambaugh, J. (2004). The effect of fixed exchange rates on monetary policy. Quarterly Journal of Economics, 300-351.

Terra, C. (2015). Exchange rate regimes. Principles of International Finance and Open-Economy Macroeconomics.

Tevdovski, D., Petrevski, G., & Bogoev, J. (2019). The effects of macroeconomic policies under fixed exchange rates: A Bayesian VAR analysis. Journal of Economic Research, 32(1), 2138-2160.

Ziaei, S. M. (2013). Evaluating the effects of monetary policy shocks on GCC countries. Economic Analysis and Policy, 43(2), 195-216.

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