Petroleum products - Prices ; Inflation (Finance) ; Dollar, American

Carlos Garriga

Michelle T. Armesto

English

Research Papers in Economics

February 2008 InternationalEconomicTrends
Views expressed do not necessarily reflect official positions of the Federal Reserve System.
S
ince the early 1980s, oil-rich Gulf states such as
Qatar, Saudi Arabia, Bahrain, Kuwait, and the
United Arab Emirates have pegged their currencies
to the U.S. dollar, benefiting from the relative stability of
U.S. monetary policy. After 2006, however, the weakening
U.S. dollar and rising oil prices have increased inflation
in these economies.1
A falling dollar contributes to inflation in dollar-pegged
economies by raising the domestic-currency prices of
tradable goods (such as manufactured goods and many
types of food). Rising oil prices make individuals wealthier
and encourage them to buy more tradable goods as well
as nontradable goods (such as houses and land), increas-
ing the relative prices of goods and services produced
within the country.
These Gulf states are now considering whether a dollar
peg is in their best interest. In May 2007, Kuwait broke
the dollar peg in favor of tracking an undisclosed basket
of currencies, albeit one in which the dollar is believed
to be heavily weighted. In mid-November, the governor
of the United Arab Emirates’ central bank stated that the
dollar peg has “served the economy…very well in the past.
However, we have reached a crossroads.”2 But are the oil-
rich Gulf states at a crossroads or merely revisiting the
same intersection?
The chart shows the evolution of the dollar’s relative
value and oil prices starting in 1980, when most currencies
were pegged to the dollar; the table shows the inflation
rates of these five economies averaged over three distinct
time horizons: 1980-81, the last period of persistently high
inflation; 1986-2003, which featured low but volatile
inflation; and 2006-07, the current inflationary period.
In the first period, a weak U.S. dollar and high oil
prices both accompanied high Gulf-state inflation; whereas,
in the second period, the more modest levels of exchange
rates and oil prices accompanied low inflation. Over the
past decade, the openness to international labor move-
ments in some Gulf states might have helped keep infla-
tion lower than it would have been otherwise: Notably,
Qatar, which has 12 percent fewer migrant workers today
than in the early 1980s, has seen much worse inflation
recently.3
In sum, oil prices will not continue to rise and the
dollar will not continue to fall forever. This recent spike
in Gulf-state inflation, therefore, is very likely transitory
and will probably not translate into persistent inflation.
—Carlos Garriga and Michelle T. Armesto
1 Two major causes of the weakening dollar are (i) the low domestic savings
rate and consequently large current account deficit and (ii) subprime market
turmoil and recession concerns.
2 “Wealthy Nations in Gulf Rethink Peg to the Dollar,” Wall Street Journal,
November 20, 2007.
3 RPP 2005 Bangladesh country report.
A Falling Dollar Raises Inflation in the Gulf
research.stlouisfed.org
Oil Price Euro/U.S. Dollar
Oil Price (Real)
Euro/U.S. Dollar
0
10
20
30
40
50
60
1980
1983
1986
1989
1992
1995
1998
2001
2004
2007
0
0.5
1
1.5
2
2.5
Inflation rates 1980-81 1986-2003 2006-07*
Qatar 7.63 2.61 11.92
Saudi Arabia 3.490 . 492 . 6 4
Bahrain 7.62 0.27 2.80
Kuwait 7.22 2.412 . 7 0
UAE 9.00 3.59 8.65
NOTE: *2007 data are International Monetary fund estimates.

A falling dollar raises inflation in the Gulf

http://research.stlouisfed.org/publications/iet/20080201/cover.pdf

A falling dollar raises inflation in the Gulf

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