In recent weeks, commentators around the world have become increasingly concerned about the menace of inflation. As pointed out in an Economist cover story, “inflation’s back” and is particularly damaging in emerging markets most sensitive to commodity prices and the cost of foodstuffs. The Economist rightly points out that at least half the Gulf states are grappling with double-digit inflation. In the Gulf context, however, it’s worth noting that policy makers have a unique toolkit for managing inflation which differs significantly from the tools available elsewhere.
In general, two types of tools are used for managing inflation: monetary policy and fiscal policy. OECD observers are most familiar with the use of monetary measures — namely, the raising and lowering of interest rates — as the first line of defense against inflation or recession. Fiscal measures relate to government spending and resource allocation.
All GCC member states, with the exception of Kuwait, peg their currency to the dollar and therefore have limited flexibility in the realm of monetary policy. While many have blamed the peg for “importing inflation,” it is telling that even Kuwait — without a dollar peg — is facing double-digit inflation. Due to a number of trade-related concerns, it appears the dollar peg is here to stay for at least the short-term future.
It is in the realm of fiscal policy where GCC economies have more flexibility. On almost a daily basis, governments make choices about how much oil and gas to produce and — perhaps more importantly — how to allocate the revenue from energy exports. Much of the region’s growth has been spurred by investing more of the energy surpluses at home, as part of overall economic development and diversification strategies. Allocating the surplus is therefore a key instrument in the trade-off between growth and inflation.
The Gulf’s toolkit for managing inflation is thus a unique one. Monetary policy is relatively constrained, while the flexibility of fiscal policy — and particularly the allocation of energy surpluses — is substantial and potentially more potent than in states without such surpluses.
One key factor driving Gulf inflation is the rising prices of imports, upon which the GCC economies rely. Since many of these imports come from the EU and other non-dollar economies, their prices in relative terms have soared as the dollar has lost value. While policy makers are taking steps to reduce import-dependence, the economies and natural endowments of the Gulf are such that imports are simply indispensable.
In this environment of unprecedented energy prices, Gulf policy makers are choosing to stimulate their local economies as never before. Inflation is a natural consequence of this choice. The challenge will be for Gulf decision makers to grow household incomes at least as fast as inflation — and to do so using their unique toolkit.
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