Sources of Macroeconomic Fluctuations in the GCC Area : Implications for an Optimum Currency Area

The primary objective of this study is to assess the optimality of a currency area in the six Gulf countries. To evaluate this important strategic it is crucial to investigate the sources of macroeconomic fluctuations in the Gulf Cooperation Council (GCC) area. These countries are Saudi Arabia, Bahrain, Qatar, Kuwait, and United Arab Emirates. These countries share many economic and political characteristics, which are conducive to a monetary union. Moreover, these countries have existing cooperation schemes that make a monetary union feasible. This paper focuses on the symmetry of underling macroeconomic shocks. Using a macroeconomic model and structural VAR models constructed to suit the GCC economies for the 1980-2000 period, we identify terms of trade shocks, trade balance shocks, supply shocks, balance of payments shocks, aggregate demand shocks and monetary shocks. The results show that the macroeconomic structure is largely similar in the GCC economies. In that sense there are potential gains to be obtained from forming a common currency. Moreover, the results show that terms of trade shocks are highly correlated in the region. A single currency would eliminate the transaction costs associated with using different currencies in the GCC countries. One can expect some efficiency gains with enhanced trade capital flows from abandoning a multiplicity of currencies. Moreover, a single currency may promote better policy formulation and coordination and enhances exchange rate credibility