Country heterogeneity and long‐run determinants of inflation in the Gulf Arab states†

Abstract

AbstractApplying non‐stationary panel data econometric methods, this paper analyses the major sources and transmission of inflation in the Gulf Cooperation Council (GCC) countries over the 1980–2008 period. We argue that, in GCC countries, money is essentially demand determined, so that the high collinearity between money and aggregate demand indicators such as non‐hydrocarbon output is expected and should be dealt with accordingly. Several important results emerge from the analysis. Firstly, the money supply stands out as a significant determinant of inflation both in short‐run and in long‐run. Both foreign prices and the nominal effective exchange rate are shown to be more successful in explaining inflation in the long‐run than the short‐run. The half‐life of the speed of adjustment reveals that it takes about 2.9 years for 50 per cent of a shock to the long‐run equilibrium to dissipate. An implication of our results is the case it makes for more sovereign monetary policies in GCC countries.