DETERMINANTS OF INFLATION IN GCC

Inflationary pressures that had heightened in the oil-rich Gulf Cooperation Council (GCC) since 2003 have moderated in recent times. This paper studies the determinants of inflation in GCC, using an empirical model that includes domestic and external factors. Inflation in major trading partners appears to be the most relevant foreign factor. In addition, oil revenues have reinforced inflationary pressures through higher growth of credit and aggregate spending. In the short-run, binding capacity constraints also explain higher inflation in the face of higher government spending. Nonetheless, by targeting supply-side bottlenecks, the increase in public spending on capital is easing capacity constraints and will ultimately help to moderate price inflation. The results highlight the need to mitigate the pro-cyclical stance of fiscal policy to avoid exacerbating cyclical swings. Moreover, prioritizing fiscal spending to address structural bottlenecks should take priority to avoid inflationary pressures and ease capacity constraints towards reducing overdependence on oil activity.