Economic Integration in the Six Middle Eastern Gulf Countries: A Look from the Perspective of Money Demand

Abstract

The six Middle Eastern Gulf countries, comprising Bahrain, the Kingdom of Saudi Arabia, Kuwait, Oman, Qatar and the United Arab Emirates (UAE) are contemplating, and experimenting with, many varieties of economic integration. The question arises whether they form an optimum currency area. The traditional approach deals with the real side of the economy, such as factor mobility, wage and price flexibility, the size and concentration of intraregional trade, the presence of different inflation/unemployment trade-offs, the elimination of transaction costs and better informational content of prices. The approach in this article is different and dwells upon the financial and monetary sides. The article studies whether there are long-run empirical, stable and parsimonious money demand functions (MDF) within each of these six countries. In addition, a panel long-run MDF is estimated. The results will determine whether the loss of an important tool of economic stabilisation in a monetary union, which is monetary policy, is compensated by a more effective fiscal policy. The article concludes that a monetary union is not commendable, unless fiscal restraints are applied thoroughly on all the six countries involved.