The Gulf Cooperation Council countries (GCC) include Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the UAE. Their monetary policy objective is to stabilize the foreign price, i.e., exchange rate instead of the domestic price level, where the nominal interest rate is equalized with the US federal fund rate, but the inflation rates are independent. High oil prices and the depreciating US dollar caused inflation to rise and real interest rates to be persistently negative in the UAE and Qatar. Asset prices bubbles formed then burst creating large loses. They could have moderated the effect of, or avoided, the bubble had they floated the currency and stabilized domestic prices.Inflation, real interest rate, bubbles.

E. M. Bentour

W. A. Razzak

English

Research Papers in Economics

EERI
Economics and Econometrics Research Institute 
EERI Research Paper Series No 03/2010 
ISSN: 2031-4892 
Copyright © 2010 by E. M. Bentour and W. A. Razzak 
Real Interest Rates, Bubbles and Monetary 
Policy in the GCC countries 
E. M. Bentour and W. A. Razzak 
EERI
Economics and Econometrics Research Institute 
Avenue de Beaulieu 
1160 Brussels 
Belgium
Tel: +322 299 3523 
Fax: +322 299 3523 
www.eeri.euReal Interest Rates, Bubbles and Monetary Policy in the GCC countries 
E. M. Bentour 
W A Razzak 
Arab Planning Institute 
2010
Abstract
The Gulf Cooperation Council countries (GCC) include Bahrain, Kuwait, Oman, 
Qatar, Saudi Arabia and the UAE. Their monetary policy objective is to stabilize the 
foreign price, i.e., exchange rate instead of the domestic price level, where the 
nominal interest rate is equalized with the US federal fund rate, but the inflation rates 
are independent.  High oil prices and the depreciating US dollar caused inflation to 
rise and real interest rates to be persistently negative in the UAE  and Qatar.  Asset 
prices bubbles formed then burst creating large loses. They could have moderated the 
effect of, or avoided, the bubble had they floated the currency and stabilized domestic 
prices. 
JEL: Classification  E31, E37, E58. 
Keywords: Inflation, real interest rate, bubbles.1. Introduction 
The fixed exchange rate regime was unsustainable in the US because of balance of 
payments problems.  Friedman (1953) made the case for flexible exchange rates.  The 
US floated the dollar in 1973.  Other Western nations followed suit.  Speculators 
attacked the Bank of England and forced it to exit the European Exchange Rate 
Mechanism in 1992.   
Hong Kong has a currency board vis-à-vis the USD; it feels safe from potential 
attacks, most likely because the Bank of China's massive reserves deter speculators. 
Further, asset price bubbles have higher chances forming under fixed exchange rate 
regimes where 
*
t t i i  , and if 
*
t t    and 0  t r  (see appendix for data and notation). 
Figure 1 illustrates using Hong Kong data (the correlation is -0.75).  During the period 
from the 1990-1999,  0  t r , t  was 6.87 percent and 
*
t  was 3 percent.  High inflation 
is bad, in addition to eroding purchasing powers, increasing the variability of relative 
prices, and distorting real decisions, excess money and credit fuel the asset markets.  
Central banks can stabilize the foreign price (fix the exchange rate) or stabilize the 
domestic prices (e.g., inflation targeting), but not both. 
The GCC adopt a fixed exchange  rate regime to the US dollar (except Kuwait which 
pegs to a basket), where  t i is set equal to 
*
t i , to keep the depreciation rate constant.  
Inflation in the GCC is usually imported, and highly associated with high oil prices 
and loose US monetary policy.   
The IMF article IV consultation 2008 shows that the UAE had negative real interest 
rates persisted for years.  Qatar too had a persistent negative real interest rate. Oman's 
rate became negative in 2007-2008.  The other GCC countries have very low real 
interest rates. The GCC produce about 23 percent of the world's oil and controls 40 
percent of the world's oil reserve. They probably feel safe from speculators because of 
their sizable foreign reserves.  They also seem content with the fixed exchange rate 
regime and oblivious to asset price bubbles. Dubai and Qatar are similar to Hong 
Kong in many aspects. 
GCC housing time series data are not available. Colliers International plots a hump-
shaped housing price index for Dubai, which went from 100 in 2007 to nearly 220 in 
mid 2008 then took a nosedive to 100 in early 2009.
We show that, had the GCC adopted a monetary policy of targeting low domestic 
inflation rate, average nominal interest rate would have been higher than otherwise 
and average real interest rate would have been positive than otherwise, which imply 
that asset price bubbles could have been moderate, if not totally absent.   
Next we simulate a strict and flexible inflation targeting rules. In section 3, we 
conclude.
2. Monetary policy simulations 
The UAE and Qatar's inflation rate are low and stable during 1999-2003.  They are 
high and more variable during 2004-2008.  Oman's inflation increased significantly in2007.  Let's assume that these countries float their currencies. And, they use a "strict" 
and a "flexible" policy formula (Taylor 1993, 1999) to ask, what nominal short term 
interest rate  delivers a positive real interest rate, under a specific inflation target?  
The strict inflation targeting Taylor rule is: 
) ˆ ( 5 . 0 ~ ~ 1        t t t r i ,
and the flexible inflation targeting rule is: 
) ˆ ( 5 . 0 ) ˆ ( 5 . 0 ~ ~ 2 t t t t t y y r i         
We report the results of strict and flexible inflation targeting along with descriptive 
statistics in tables 1 and 2.  Table 1 has 6 columns for each country.  t   is in column 
1.  We assume that the central bank wants to keep average inflation as low as it was 
during the period 1999-2003 for the UAE and Qatar, and 1999-2006 for Oman.  In 
column 2, for the UAE the target is set to 2.5 percent; 1.5 percent for Qatar.  For 
Oman, average inflation during 1999- 2006 is 0.5 percent; we chose  ˆ =1 percent. 
Column 3 includes  t i  (actual) followed by  t i ~ (simulated) in column 4.  In the last two 
columns we have  t r  and r ~ .
On average, to keep inflation low and stable, and the real interest rate is reasonably 
positive, the UAE would have had an average short term nominal interest rate  t i ~  of 
14.2 percent compared with actual  t i  of 3.3 percent; 18.4 compared with actual of 4.7 
percents for Qatar; and 16.2 compared with 2.6 percents in Oman.  Table 2 is similar 
to table 1, with short term nominal interest rate are lower under flexible inflation 
targeting. Over time, when inflation is under control, both the nominal and real 
interest rates would be low.  Most importantly, the variability of real interest rate, 
inflation and output would be significantly lower under inflation targeting.
3. Conclusion
A floating exchange rate regime with an inflation targeting policy could have 
moderated, if not fully prevented, asset price bubbles and stabilized output and 
inflation in the GCC countries UAE, Qatar and Oman.  Targeting asset price bubbles 
by central banks directly is still debatable.Data Appendix 
Data are from IFS.  UAE's interest rate are from IMF staff consultation documents.  
Hong Kong housing price is from HKMA. 
t i denote nominal interest rate; for Hong Kong, money market rate. For the UAE the 
91 CD rate; Repo and Bank rates for Qatar and Oman. 
t  denotes CPI inflation rate. 
t r denotes the real interest rate, t i - 1  t 
t y is log real GDP. 
The output gaps were calculated using the HP filter and data from 1980 - 2008. 
(*) denotes US magnitudes. 
(-) on variables denotes average value. 
(^) on inflation denotes the target; on GDP denotes potential GDP (HP filter with 
100   ).
 (~) denotes simulated value. 
.References 
Colliers International http://www.globalpropertyguide.com/real-estate-house-prices/U
Friedman, M., 1953, The case for Flexible Exchange Rates, in Essays in Positive 
Economics, Friedman, M. (ed.) University of Chicago Press. 
Taylor, J. B., 1993, Discretion versus Policy Rules in Practice, Carnegie – Rochester 
Conference on Public Policy, Cambridge, MA, MIT Press. 
Taylor, J. B., 1999, A Historical Analysis of Monetary Policy Rules, in John B. 
Taylor ed., Monetary Policy Rules, Chicago: University of Chicago Press for NBER, 
319-40.T
a
b
l
e
 
1
:
 
A
c
t
u
a
l
 
a
n
d
 
S
i
m
u
l
a
t
e
d
 
S
t
r
i
c
t
 
I
n
f
l
a
t
i
o
n
 
T
a
r
g
e
t
i
n
g
 
 
 
U
A
E
 
 
Q
a
t
a
r
 
 
 
O
m
a
n
 
 
 
Y
e
a
r
 
 
 
 
 
 
 
 
 
 
 
Y
e
a
r
 
 
 
 
 
 
 
1
9
9
9
 
2
.
1
 
 
1
.
7
 
 
1
9
9
9
 
0
.
5
 
2
0
0
0
 
1
.
4
 
 
6
.
5
 
 
4
.
4
 
 
1
.
7
 
 
6
.
6
 
 
4
.
9
 
 
2
0
0
0
 
-
1
.
2
 
 
7
.
3
 
 
6
.
8
 
2
0
0
1
 
2
.
8
 
 
3
.
2
 
 
1
.
8
 
 
1
.
4
 
 
2
.
5
 
 
0
.
8
 
 
2
0
0
1
 
-
0
.
8
 
 
7
.
5
 
 
8
.
7
 
2
0
0
2
 
2
.
9
 
 
1
.
7
 
 
-
1
.
1
 
 
0
.
2
 
 
1
.
7
 
 
0
.
3
 
 
2
0
0
2
 
-
0
.
3
 
 
7
.
5
 
 
8
.
3
 
2
0
0
3
 
3
.
1
 
 
1
.
0
 
 
-
1
.
9
 
 
2
.
3
 
 
1
.
3
 
 
1
.
1
 
 
2
0
0
3
 
0
.
2
 
 
7
.
5
 
 
7
.
8
 
A
v
e
r
a
g
e
 
2
.
5
 
 
3
.
1
 
 
0
.
8
 
 
1
.
5
 
 
3
.
0
 
 
1
.
8
 
2
0
0
4
 
0
.
7
 
 
0
.
7
 
0
.
5
 
S
t
d
 
0
.
7
 
 
2
.
4
 
 
2
.
9
 
 
0
.
7
 
 
2
.
4
 
 
2
.
1
 
2
0
0
5
 
1
.
9
 
 
3
.
1
 
2
.
4
 
2
0
0
4
 
5
 
2
.
5
 
1
.
7
 
9
 
-
1
.
4
 
2
.
8
 
6
.
8
 
1
.
5
 
2
.
6
 
1
2
 
0
.
3
 
2
.
6
 
2
0
0
6
 
3
.
2
 
 
3
.
6
 
1
.
8
 
2
0
0
5
 
6
.
2
 
2
.
5
 
3
.
9
 
1
1
 
-
1
.
1
 
3
.
0
 
8
.
8
 
1
.
5
 
4
.
5
 
1
5
 
-
2
.
3
 
2
.
5
 
A
v
e
r
a
g
e
 
0
.
5
 
 
7
.
5
 
 
5
.
2
 
2
0
0
6
 
9
.
3
 
2
.
5
 
5
.
2
 
1
5
 
-
1
 
2
.
3
 
1
1
.
8
 
1
.
5
 
5
.
5
 
1
9
 
-
3
.
3
 
2
.
0
 
S
t
d
 
1
.
4
 
 
0
.
1
 
 
0
.
8
 
2
0
0
7
 
1
1
.
1
 
2
.
5
 
4
.
5
 
1
8
 
-
4
.
8
 
2
.
6
 
1
3
.
8
 
1
.
5
 
5
.
5
 
2
2
 
-
6
.
3
 
2
.
1
 
2
0
0
7
 
6
.
1
 
1
.
0
 
2
.
0
 
1
1
 
-
1
.
2
 
2
.
3
 
2
0
0
8
 
1
1
.
5
 
2
.
5
 
1
.
4
 
1
8
 
-
9
.
7
 
2
.
0
 
1
5
.
0
 
1
.
5
 
5
.
5
 
2
4
 
-
8
.
3
 
2
.
2
 
2
0
0
8
 
1
2
.
6
 
1
.
0
 
0
.
9
 
2
1
 
-
5
.
2
 
2
.
6
 
A
v
e
r
a
g
e
 
8
.
6
 
2
.
5
 
3
.
3
 
1
4
.
2
 
-
3
.
6
 
2
.
5
 
1
1
.
3
 
1
.
5
 
4
.
7
 
1
8
.
4
 
-
4
.
0
 
2
.
3
 
A
v
e
r
a
g
e
 
3
.
8
 
1
.
0
 
2
.
6
 
1
6
.
0
 
-
3
.
2
 
2
.
4
 
S
t
d
 
2
.
9
 
 
1
.
7
 
4
.
1
 
3
.
8
 
0
.
4
 
3
.
4
 
 
1
.
3
 
4
.
9
 
3
.
4
 
0
.
3
 
S
t
d
 
4
.
6
 
 
0
.
8
 
7
.
1
 
2
.
8
 
0
.
2
 
-
t

ˆ
i
s
 
a
v
e
r
a
g
e
 
f
r
o
m
 
1
9
9
9
-
2
0
0
3
 
f
o
r
 
U
A
E
 
a
n
d
 
Q
a
t
a
r
.
 
F
o
r
 
O
m
a
n
 
(
1
9
9
9
-
2
0
0
6
)
 
w
e
 
c
h
o
s
e
 
1
 
p
e
r
c
e
n
t
 
a
s
 
a
 
t
a
r
g
e
t
.
 
-
S
t
d
 
i
s
 
s
t
a
n
d
a
r
d
 
d
e
v
i
a
t
i
o
n
.
t

t

ˆ
t
i
t
i
~
t
r
r
~
t

t

ˆ
t
i
t
i
~
t
r
r
~
t

t

ˆ
t
i
t
i
~
t
r
r
~T
a
b
l
e
 
2
:
 
A
c
t
u
a
l
 
a
n
d
 
S
i
m
u
l
a
t
e
d
 
F
l
e
x
i
b
l
e
 
I
n
f
l
a
t
i
o
n
 
T
a
r
g
e
t
i
n
g
 
 
 
 
U
A
E
 
 
Q
a
t
a
r
 
 
 
O
m
a
n
 
 
 
Y
e
a
r
 
 
 
 
 
 
 
 
 
 
Y
e
a
r
1
9
9
9
 
2
.
1
1
.
7
 
1
9
9
9
 
0
.
5
 
2
0
0
0
 
1
.
4
 
 
2
.
1
 
6
.
5
 
 
4
.
4
 
1
.
7
 
 
6
.
5
 
6
.
6
 
 
4
.
9
 
2
0
0
0
 
-
1
.
2
 
 
-
2
.
1
 
7
.
3
 
 
6
.
8
 
2
0
0
1
 
2
.
8
 
 
-
2
.
4
 
3
.
2
 
 
1
.
8
 
1
.
4
 
 
3
.
3
 
2
.
5
 
 
0
.
8
 
2
0
0
1
 
-
0
.
8
 
 
1
.
0
 
7
.
5
 
 
8
.
7
 
2
0
0
2
 
2
.
9
 
 
-
6
.
3
 
1
.
7
 
 
-
1
.
1
 
0
.
2
 
 
-
3
.
2
 
1
.
7
 
 
0
.
3
 
2
0
0
2
 
-
0
.
3
 
 
-
0
.
7
 
7
.
5
 
 
8
.
3
 
2
0
0
3
 
3
.
1
 
 
-
1
.
8
 
1
.
0
 
 
-
1
.
9
 
2
.
3
 
 
-
7
.
1
 
1
.
3
 
 
1
.
1
 
2
0
0
3
 
0
.
2
 
 
-
3
.
1
 
7
.
5
 
 
7
.
8
 
A
v
e
r
a
g
e
 
2
.
5
 
 
-
2
.
1
 
3
.
1
 
 
0
.
8
 
1
.
5
 
 
-
0
.
1
 
3
.
0
 
 
1
.
8
 
2
0
0
4
 
0
.
7
 
 
-
2
.
5
 
0
.
7
 
 
0
.
5
 
S
t
d
 
0
.
7
 
 
3
.
4
 
2
.
4
 
 
2
.
9
 
 
0
.
7
 
6
.
2
 
2
.
4
 
 
2
.
1
 
2
0
0
5
 
1
.
9
 
 
-
1
.
3
 
3
.
1
 
 
2
.
4
 
2
0
0
4
 
5
.
0
 
2
.
5
 
0
.
4
 
1
.
7
 
9
 
-
1
.
4
 
2
.
5
 
6
.
8
 
1
.
5
 
-
1
.
2
 
2
.
6
 
5
0
.
3
 
1
.
8
 
2
0
0
6
 
3
.
2
 
 
0
.
4
 
3
.
6
 
 
1
.
8
 
2
0
0
5
 
6
.
2
 
2
.
5
 
1
.
1
 
3
.
9
 
1
1
 
-
1
.
1
 
2
.
4
 
8
.
8
 
1
.
5
 
-
3
.
1
 
4
.
5
 
7
-
2
.
3
 
1
.
8
 
A
v
e
r
a
g
e
0
.
5
 
 
-
1
.
2
 
5
.
3
 
 
5
.
2
 
2
0
0
6
 
9
.
3
 
2
.
5
 
2
.
8
 
5
.
2
 
1
7
 
-
1
.
0
 
2
.
9
 
1
1
.
8
 
1
.
5
 
-
0
.
1
 
5
.
5
 
8
-
3
.
3
 
2
.
8
 
S
t
d
 
1
.
4
 
 
1
.
5
 
2
.
8
 
 
3
.
5
 
2
0
0
7
 
1
1
 
2
.
5
 
1
.
6
 
4
.
5
 
1
9
 
-
4
.
8
 
2
.
6
 
1
3
.
8
 
1
.
5
 
3
5
.
5
 
7
-
6
.
3
 
2
.
3
5
2
0
0
7
 
6
.
1
 
1
.
0
 
1
.
7
 
2
.
0
 
1
2
 
-
1
.
2
 
2
.
4
 
2
0
0
8
 
1
2
 
2
.
5
 
1
.
4
 
1
.
4
 
1
9
 
-
9
.
7
 
2
.
3
 
1
5
.
0
 
1
.
5
 
7
5
.
5
 
6
-
8
.
3
 
2
.
7
5
2
0
0
8
 
1
2
.
6
 
1
.
0
 
2
.
7
 
0
.
9
 
2
2
 
-
5
.
2
 
2
.
2
 
A
v
e
r
a
g
e
 
8
.
6
 
2
.
5
 
1
.
5
 
3
.
3
 
1
5
.
0
 
-
3
.
6
 
2
.
5
 
1
1
.
3
 
1
.
5
 
1
.
1
 
4
.
7
 
6
.
6
 
-
4
.
0
 
2
.
3
 
A
v
e
r
a
g
e
9
.
4
 
1
.
0
 
2
.
2
 
2
.
6
 
1
7
.
0
 
-
3
.
2
 
2
.
3
 
S
t
d
 
2
.
9
 
 
0
.
9
 
1
.
7
 
4
.
7
 
3
.
8
 
0
.
2
 
3
.
4
 
4
.
0
 
1
.
3
 
1
.
1
4
 
3
.
4
 
0
.
5
 
S
t
d
 
4
.
6
 
 
0
.
8
 
0
.
8
 
7
.
1
 
2
.
8
 
0
.
2
 
-
t

ˆ
i
s
 
a
v
e
r
a
g
e
 
f
r
o
m
 
1
9
9
9
-
2
0
0
3
 
f
o
r
 
U
A
E
 
a
n
d
 
Q
a
t
a
r
.
 
F
o
r
 
O
m
a
n
 
(
1
9
9
9
-
2
0
0
6
)
 
w
e
 
c
h
o
s
e
 
1
 
p
e
r
c
e
n
t
 
a
s
 
a
 
t
a
r
g
e
t
.
 
-
S
t
d
 
i
s
 
s
t
a
n
d
a
r
d
 
d
e
v
i
a
t
i
o
n
.
 
t

t

ˆ
t
t
y
y
~

t
i
t
i
~
t
r
r
~
t

t

ˆ
t
t
y
y
~

t
i
t
i
~
t
r
r
~
t

t

ˆ
t
t
y
y
~

t
i
t
i
~
t
r
r
~F
i
g
u
r
e
 
1
:
 
H
o
n
g
 
K
o
n
g
 
R
e
a
l
 
I
n
t
e
r
e
s
t
 
R
a
t
e
 
a
n
d
 
C
h
a
n
g
e
 
i
n
 
H
o
u
s
i
n
g
 
P
r
i
c
e
 
I
n
d
e
x
-
4
0
-
3
0
-
2
0
-
1
0
0
1
0
2
0
3
0
4
0
5
0
1
9
9
0
1
9
9
1
1
9
9
2
1
9
9
3
1
9
9
4
1
9
9
5
1
9
9
6
1
9
9
7
1
9
9
8
1
9
9
9
H
o
u
s
e
 
P
r
i
c
e
 
C
h
a
n
g
e
-
8
-
6
-
4
-
2
0
2
4
R
e
a
l
 
I
n
t
e
r
e
s
t
 
R
a
t
e
H
o
u
s
i
n
g
 
p
r
i
c
e
s
 
I
n
d
e
x
 
R
e
a
l
 
M
o
n
e
y
 
M
a
r
k
e
t
 
R
a
t
e

Real Interest Rates, Bubbles and Monetary Policy in the GCC countries

Abstract

Similar works

Full text

Available Versions

Research Papers in Economics