The case study on the monetary union of GCC countries demonstrates various facets of pegging the combined currency to solely US dollar or EURO or a basket of currencies. The implications of pegging the currency to the US dollar (which is the present inclination of the GCC countries) that have weakened vis-à-vis EURO can be manifold (Louis, Balli and Osman 320). First, the difference in the economic cycle between the US economy and that of the GCC countries is significant as it may create an imbalance in the overall economy. Hence, there arises the dilemma of choosing between a fixed and flexible exchange rate system. Under the fixed exchange rate system, monetary policy has to be imported from the US too, which in turn will influence the domestic fiscal policy, inflation, and output trend (Louis, Balli and Osman 320).
The flexible exchange rate system, on the other hand, slows down growth and increases inflation but equips the countries to respond to economic shocks as the monetary policy is controlled by the central bank of the economy (Louis, Balli and Osman 320). Therefore, symmetric shocks that the economy experiences influence the decision to adopt the US dollar, or EURO, or a basket of currencies to peg the unified currency.
Further, most of the GCC countries are dependent on oil trade as their primary economic income. As the oil trade is mostly done in the US dollar in the international market, the economies also move in accordance with the changes of the US dollar (Louis, Balli and Osman 321). The study conducted in the case shows that the EURO should not be adopted as the anchor currency for the GCC countries due to the asymmetrical shock it creates (Louis, Balli and Osman 329). Further, most of the GCC currencies are already pegged to the US dollar. A shift would result in major adjustment costs if GCC adopted the EURO as the new anchor currency (Louis, Balli and Osman 329). The case rejects the option of a basket peg even though the concept may be lucrative due to the current weakening of the US dollar (Louis, Balli and Osman 329).
Regulation of the GCC
After the monetary union of the GCC countries is established, the pricing will change according to two different situations. First, if the US dollar is used as the anchor currency then the demand shocks will be eased which will help in pricing the products based on the economic rule of demand and supply equilibrium (Louis, Balli and Osman 324). Second, if it is pegged to the basket of currencies, including the EURO, asymmetrical shocks will influence the economy and demand for the products sold (Louis, Balli and Osman 324). Therefore, there has to be a regulatory body within the GCC like the European central bank that can control the monetary policy of the union instead of banking on the monetary policy dictated by the fixed currency exchange (Louis, Balli and Osman 320).
Why monetary union is necessary? What are the issues related to it?
As the economic structure of most of the countries in the GCC is the same, forming a unified currency through the formation of the monetary union seems to be a logical step. As most of the countries within the GCC are dependent on oil trade and their economic structures are similar, it is believed that a unified currency will only make their economies stronger as it will reduce the shocks that individual countries face from changes in prices of oil in the international market.
These countries face both aggregate demand and supply shocks, as their economies are dependent on the trade of one product – oil. When there is a fall in the oil prices globally, the economies are adversely affected as this implies the decline in trade revenue. However, the current research shows that there exist similar long term shocks faced by the individual member countries but there is no similarity in the short-term shocks indicating that monetary union may not be a viable solution for the unified GCC (Louis, Balli and Osman 329).
What effect does it have on individual currencies?
Individual currencies react differently to the changes in the pegged currency. The case study shows that Qatar’s and France’s currencies show a symmetrical change while that of UAE and France are asymmetrical. The US and the GCC countries show statistically insignificant results with Bahrain, Qatar, and Saudi Arabia showing positive correlation but Kuwait, Oman, and the UAE show a negative correlation (Louis, Balli and Osman 328).
How does it affect variation in exchange rates and prices of products and what impact does it have on the GCC economies?
The only currency pegged to the US dollar is that of Kuwait. The Kuwaiti currency has faced a shock as the value of the US dollar has declined. Individual currencies will not exist if the monetary units of all countries are unified and they will change symmetrically. This currency, if pegged to the US dollar, will symmetrically rise or fall with changes in the value of the dollar. However, the effect of these changes may be asymmetrical for the economies of the individual countries. With changes in the prices of the products, (the dominant product for GCC countries is oil) all countries face asymmetrical shock.
Louis, Rosmy Jean, Faruk Balli and Mohamed Osman. “On the feasibility of monetary union among Gulf Cooperation Council (GCC) countries: does the symmetry of shocks extend to the non-oil sector?.” Journal of Economic Finance 36 (2012): 319-334. Print.