External and Regional Shocks in the GCC Region: Implications for a Common Exchange Rate Regime

Using a structural cointegrated VAR, this study examines the impacts of external shocks originating from the dollar, euro and yen zones as well as the regional shocks on the oil-rich countries of the Gulf Cooperation Council (GCC), viewed as a prospective monetary union. It focuses on the implications of shock impacts for selecting an apposite common exchange rate regime. The SVECM variance decomposition and impulse response analyses strongly underscore the relative impacts of the two external shocks over the regional ones. The findings imply that the world’s three major currencies should figure highly in the GCC’s common basket of currencies. Accordingly, a transitional movement to a more flexible exchange rate may be desirable for these trade-dependent economies in the long run, as argued in the optimal currency literature for developing countries.