In the recent past, there has been an unprecedented easing of monetary and fiscal policies in many countries. This has raised widespread concerns that the policies may plunge the world economy into a period of hyperinflation. Already in Saudi Arabia, inflation has been rising. This has been attributed to the government’s recent expansion of fiscal lending, which makes a rise in inflation inevitable. The main factors that drive Saudi’s inflation include food prices, high inflation in trading partner’s economies, and a rise in domestic rent.
In the eighties and nineties, inflation in Saudi Arabia was maintained at a low of 1%. However, since 2003, the inflation rate has risen rapidly and by 2008, it exceeded 11%: a phenomenon that has negatively affected the citizens (Mehran, 2009, p. 3). Although the World financial crisis resulted to a temporary decline in the inflation rate, it again started rising since 2010.
This paper, using the quarterly data from 1980 to 2010, examines the causes behind the inflation in Saudi, its effects, and the effectiveness of the counter-strategies and policies the Saudi government has put in place to curb the rising inflation. The paper will also investigate the solutions provided to the problem of runaway inflation and give recommendations on the same.
The paper utilizes a methodology that incorporates both foreign and domestic factors that affect the inflation rate in the Saudi context. It will examine the external factors as a source of inflation in Saudi, given the open trade nature of the Saudi economy characterized by oil exports and importation of consumer goods from overseas.
The rise in the prices globally will be examined alongside the Saudi domestic prices. Given Saudi’s dependence on exports, fluctuation in the value of the US dollar is a fundamental determinant of the rate of inflation in Saudi both in the short-term and long-term.
Additionally, the rise in the domestic demand fuelled by the sharp increase in oil prices has also accelerated the rate of inflation in Saudi Arabia. By focusing on each factor in turn, this paper aims to find the correlation between inflation in Saudi’s trading partners (OECD countries) and the domestic inflation rate. The paper will also undertake a food price outlook in the wake of rising inflation rate and its effects on Saudi staples such as rice and wheat.
What is Inflation?
Inflation is a common term in economic circles, but its meaning is often misconstrued. Inflation, in simple terms, refers to a continuous increase in prices of goods and services in an economy (Dhakal, & Kandil, 1993, p. 414). More specifically, inflation refers to the continuous increase in prices as measured by consumer indices like the Consumer Price Index (CPI) or a price deflator such as that used for the determination of Gross National Product (GNP) (Juselius, 1992, p. 401).
Inflation can also be described as the loose of the purchasing power of a country’s currency because of too much money in circulation, or rise in consumer demand. Under these circumstances, more cash is needed to purchase goods previously bought at a lower price.
Thus, in defining inflation, two terms must be clarified. First, is the general or aggregate; this implies that the inflation rate constitutes the rise in prices of the entire goods in an economy as opposed to focusing on an isolated increase in the price of a given commodity (Juselius, 1992, p. 402).
Here, the implication is that a rise in prices of a single commodity cannot serve as an indication of inflation in an economy. However, in some circumstances, a rise in the price of a single commodity can lead to a rise in the prices of other products. An example here is oil prices. Nevertheless, such an isolated rise in prices of a given commodity does not indicate inflation, unless the price induces the aggregate price level of an economy to rise.
Second, the increase in the aggregate price level must occur over a given period; that is, it must be sustained for inflation to occur. In other words, the aggregate price level must rise continuously over a given period or period intervals separated by one sharp increase in the price level.
Types of Inflation
The types of inflation are distinguishable based on the magnitude of the rise in annual prices and the period over which it continues to rise. As such, inflation conventionally ranges from mild inflation to severe inflation.
An annual price rise of 1% for several years amounts to mild inflation, which does not warrant much attention given that the price index figures may not be remarkably accurate. For instance, in times of war, quality or quantity of goods may deteriorate resulting to a rise in the real price level, which the price index may not capture.
On the other hand, an aggregate price level that rises at an average of 2 or 3 percent annually cannot be ignored especially if it continues over a prolonged period (Juselius, 1992, p. 404). It may not be serious if it continues for a few years after which the prices decline or stabilize at a lower level. However, if the annual price rise is continuous with no spans of lower prices, then it presents a serious problem even at 2 or 3%.
Inflation can be grouped into four broad categories based on its magnitude; creeping inflation, walking inflation, running inflation and hyperinflation (Juselius, 1992, p. 407).
1. Creeping inflation-is the inflation that occurs when the annual price rise is low. A continuous annual price rise of not more than 3 % per annum is a creeping inflation. It is considered ineffectual and necessary for economic growth. If this inflation continues for a prolonged period, it is referred to as chronic creeping inflation, which can be intermittent or continuous.
2. Walking Inflation- is the inflation that occurs when the annual price rise is moderate. The inflation rate in this case is a single digit usually above 3% but less than 10% per annum. Walking inflation indicates that the government must implement policies to control it before it becomes a galloping or trotting inflation.
3. Running Inflation- is the inflation that occurs when the price rise is rapid and accelerated at a rate of 10 to 20% annually. It is also known as galloping or trotting inflation. Running inflation has profound adverse effects on the middle class and the poor citizenry of a country. It calls for strong fiscal and monetary policies to control it. When it happens, creditors demand protection from anticipated lose of the currency’s purchasing power while debtors get the impression that they will reap from the higher rates.
4. Hyperinflation- is the inflation that occurs when the annual price rise is unusually high with double or triple digit inflation rates. At hyperinflation stage, the inflation rate is immeasurable and uncontrollable. As such, the prices of commodities can rise continuously in a short time resulting to a continuous decline in the currency’s purchasing power.
Causes of Inflation in Saudi Arabia
Previous studies on the reasons behind inflation in most countries identify some domestic and external factors as the causes of inflation. These factors include demand, monetary factors, cost-push, and foreign inflationary trends. Hasan and Alogeel (2008, p. 45), while focusing on Saudi Arabia and Kuwait, established that currency supply and demand affect the inflation rate in the short run while inflation in foreign trade partners influences inflation in the two countries in the long run.
In contrast, Darrat (1985, p. 211) established that inflation in Libya, Saudi Arabia and Nigeria is affected by minimal growth in real income and higher currency supply. He also established that Saudi’s inflationary rate is more affected by prices in international markets than by fiscal or monetary policies.
Another study by Alshathree (2003, p. 12), examined the causes of inflation in the countries that make up the Gulf Cooperation Council (GCC) of which Saudi is a member. He found that internal factors such as GDP growth and currency supply and external factors such as high world prices, import prices and interest rates globally influenced inflation in these countries.
Additionally, Alshathree (2003, p. 17) established that inflation is not a serious threat to Gulf countries at least I the short run. However, it has the potential of causing harm to the economies of these countries in the end. Thus, the world prices and interest rates is a leading cause of inflation in the GCC economies because of their reliance on imports.
However, Kandil and Hanan (2009, p. 4) believe the contrary; that world prices are not the main cause of inflation in GCC economies, rather oil prices are. They contend that oil prices influence the world prices leading to a sharp rise in the prices of imports. Additionally, the increase in oil prices results to increased government spending due to a rise in oil revenues, in these countries. This in turn results to a rise in domestic demand pushing up inflation.
By using a methodology that includes both internal and external factors, this paper will investigate inflation in a Saudi context. The economy of Saudi Arabia is an open trade economy given that the country is a significant exporter of oil products and a net importer of a variety of products.
This means that Saudi is prone to inflation resulting from a rise in the price imports from inflation-affected countries. At the same time, Saudi can transfer inflation to its trading partners via oil exports. Additionally, the domestic price is largely influenced by the cost of non-tradable items that rely on a number of monetary factors.
Normally, the price level, an indicator of inflation, is determined as a weighted mean of the cost of both the tradable and non-tradable goods (Engle, & Granger, 1987, p. 252). Tradable goods rely on external factors such as exchange rates and world prices. The prices of non-tradable goods, on the other hand, depend on the domestic demand, which is a product of the domestic money market conditions.
Thus, in a Saudi context, the external factors are the principal causes of inflation, which arises from the fact that the Saudi economy is an open economy with high import volumes from oversea markets. As a result, a rise in world prices and the fluctuation in exchange rates i.e. the Riyal against the Dollar stimulate inflation in both the short run and long run. Additionally, a rise in domestic demand in Saudi resulting from a sharp rise in oil prices, has also led to a rise of the inflation rate.
Effects of Inflation in Saudi Arabia
A small inflation rate or creeping inflation is a praiseworthy thing in any economy. In contrast, deflation tends to reduce domestic consumption as it makes households postpone expenditure by expecting a further drop in prices.
This, in turn, influences firms to reduce their investment as the consumption rate declines. Subsequently, the national output begins to shrink resulting to unemployment and slow economic growth. Additionally, the real interest rates increase resulting to a credit crunch and massive defaults. Nevertheless, high inflation is problematic.
It distorts prices of commodities adversely affecting savings and the value of earnings, which discourages investment. It also stimulates capital flow into foreign assets and unprofitable real estate thereby affecting economic planning. Hyperinflation can trigger political and social unrest. Thus, an average, predictable and sustainable inflation rate is the ultimate goal of any monetary policy as it protects producers and consumers and encourages saving.
Saudi’s experience with rising inflation has had profound effects on its economy
Given the rise in inflation, the cost of living index (CLI) Saudi rose by an average of 9.9 % in 2008 indicating a rise in prices of consumer goods (Hasan, & Alogeel, 2008, p. 34). The wholesale price index also increased by 9% over the same period, which indicates a further pressure on consumers. In particular, the inflationary pressures were felt in the food and beverage index that rose by an average of 14% in 2008.
Large increase were evident in the cereal sector with rice, a key staple food for Saudi citizens, cooking oil and dairy products; all of which are imported from other countries. The trend reflected the global oil prices, which rose by an average of 38% during in 2007/2008 period, consequently raising transportation costs for food products.
Furthermore, there has been a general rise in consumer inflation in Saudi’s main trading partners in 2008 occasioned by the global financial crisis.
Indeed, the majority of Saudi’s main import markets have experienced a rise in the inflation rate with the inflation rate in the US (the utmost import market of Saudi Arabia Kingdom) rising from 2.9% in 2007 to 3.8% in 2008. The inflation rate also rose in other import markets including Germany (from 2.3% to 2.8% in 2008), India (6.4% to 8.3%), Korea (2.5% to 4.7%), and China from 4.8% to 5.9% (Dhakal, & Kandil, 1993, p. 419).
This general rise in the inflation rate in Saudi’s leading import markets triggered a price increase involving a broad range of imports including chemicals (rose by 14% in 2008), manufactured products (increased by 14%) and machinery and other equipment (rose by 6.2%). The Saudi inflation resulted to weakening of the exchange rates with leading currencies including the US Dollar against the Saudi’s Riyal.
The current economic growth in Saudi began in 2003, but this did not translate to higher rents as much of the labor comprised of expatriates. However, in 2008, the rents began to rise because of the higher inflation rate. In particular, real estate and commercial establishments, which are in high demand, have registered increased rents occasioned by inflation.
Inflation in Saudi Arabia from 1980 to 2010
The inflation rate in the Saudi economy has been low for the period 1980 to 2003 largely because of the oil boom experienced in the seventies. During this duration, the Saudi’s inflation rate fluctuated between a deflation and a small inflation with the average rate being less than 1% (Dhakal, & Kandil, 1993, p. 421).
However, since 2003, the rate of inflation has increased rapidly reaching a maximum of 11% in 2008. Then, between the last quarter of 2008 and the year 2009, it slowed down to an average of 4% in the aftermath of the global financial crisis. Nevertheless, the inflation rate began rising beginning in 2010 to about 6% currently. Thus, Saudi Arabia has a history of fluctuating inflation.
In particular, the consumer price index in most of Saudi’s history has been low. In the period between 1990 and 1999, the consumer price index rose by an average of only 1.3% while from 2000 to 2006, it increased by just 0.1%.
The slow inflation rate indicated several factors including the availability of low-cost imports, average economic growth, capital mobility and high flexibility of the labor market. Additionally, the fixed exchange contributed significantly to a lower inflationary rate.
Serious inflation only started in the year 2007. In this year, the average consumer-price inflation rose to an average of 4% annually in the first quarter (from 2.4% reported in 2006) to a high of 6.5% in the last quarter of 2008. The consumer prices gathered pace in this year, resulting to an inflation peak of 11.1%. This weakened the exchange rates. Nevertheless, lending by commercial banks was expanding, and by the second quarter of 2008, it stood at 35% just like in all other GCC countries.
Global Financial Crisis and the Saudi Inflation
The global financial crisis in 2007/2008 resulted to a decline in the inflation rate in most economies including Saudi Arabia because it resulted to a decline in liquidity and demand. However, there are indications that the inflation rate will not return to a low of 1% as experienced in the 1980s. Already, the inflation rate started rising in 2010 despite government intervention policies eliminating any hopes that it will come down further.
The Inflationary Spike in the 2007/2008 period (Government expenditure 2004-2009 as a percentage of GDP
As shown in the graph, in the 2007/2008 period, Saudi experienced the highest inflation in the country’s history. The IMF identified various factors as responsible for this unprecedented inflationary spike. The rise in food prices by an average of 7% during this period resulted to a pronounced Cost of Living Index of 4%. The food products that experienced sharp rises in prices included; vegetable (rose by 12%), cereals (by 7%), fish (by 12%), legumes (by 30%) and meat products, which rose by 6% (Hasan, & Alogeel, 2008, p. 38).
The inflation in other countries (trading partners) is also considered responsible for this inflationary spike. Since it is not easy to disentangle the inflation involving the global food prices, it is a leading cause of inflation in Saudi Arabia. In 2007/2008, inflation was also felt in many countries including Germany, China, the US, which form the principal import markets of Saudi Arabia. The trends increased in the 2007/2008 period with the CLI standing at 9.9%.
The Computation of Inflation in Saudi Arabia
In Saudi Arabia, inflation is computed by the Central Department of Statistics and Information, a government department that operates independent of the Saudis central bank, the Saudi Arabia Monetary Agency (SAMA).
This department uses two different indices in computing inflation: the Whole Sale Price Index and the Cost of Living Index (CLI), both of which are surveyed regularly by this department. However, the inflationary trends and the labor productivity are not regularly surveyed (Mehran, 2009, p. 3). Historically, Saudi has had a low and stable inflation.
The CLI, in the context of Saudi, incorporates the prices of a broad range of products. The CLI relies on a 1999 index (Hasan, & Alogeel, 2008, p. 41) whereby approximately 44% of the CLI comprises of rental and food costs. About 10% of the goods or services included in the CLI are the goods subsidized by the government such as electricity and petroleum products. In Saudi, the prices of these subsidized goods are set, and as a result, they have no impact on the CLI.
In Saudi Arabia, the central bank, SAMA, is responsible for stabilizing the prices and the exchange rates. In theory, the maintenance of exchange rates is given a priority by SAMA to price stability. For a long period, this has been the case in Saudi’s economy. The consumer prices only rose by an average of 1.3% in the 1990-1999 periods and only 0.1% during the 2000-2007 periods (Wang, & Wen, 2007, p. 204).
During these periods, the exchange rate remained relatively stable. The inflation rate during these periods was low attributable to cheap imports from import markets, flexibility in capital and labor markets and a moderate economic growth. Evidently, the fixed exchange rate lowered the inflationary rate.
How Does Inflation Affect the Society, Firms and the Government?
The effects of inflation in an economy are everywhere. It affects people, various firms or government economic agents in different ways. In any society, there are two broad economic groups: the flexible income group and the fixed income group (Keran, & Al Malik, 1979, p. 11). During periods of inflation, individuals in the flexible income group gain while those belonging to the fixed income group lose.
This arises because the price or cost of various goods and services is not uniform. Usually, during inflation, although the aggregate price level rises, the rate at which the cost of individual goods increase differs. In other words, the prices of some goods or services may rise while that of other goods remains relatively unchanged.
The middle class and the poor, whose salaries are largely fixed even as the prices of consumer goods continue to increase. By contrast, people in the flexible income group including the industrialists, traders, speculators, businesspersons, and real estate developers, gain from the rise in prices of goods. Thus, the second category becomes rich at the expense of the first group.
This means there is a net movement of wealth and income from the poor in the society to the wealthy individuals. In general, the income group in the society that loses or reaps from high inflation is largely dependent on anticipatory practice of individuals. The individuals who anticipate inflation accurately, can change their buying, lending or borrowing practices to avoid either lose of income or gain wealth from inflation (Engle, & Granger, 1987, p. 253).
The effect of inflation on individuals is different, and as such, it is vital to discuss the effect on various groups separately
a) Debtors and Creditors- In times of inflation, the creditors, in general, are adversely affected. The real value that they can get from money lent out is pegged on the inflation rate. On the other hand, the debtors benefit during periods of inflation as they pay significantly less than the amount they had borrowed in real value (Engle, & Granger, 1987, p. 253). As such, inflation affects the creditors while favoring the debtors.
b) Wage Earners – This group may lose or gain during inflation based on how their wages respond to increases in prices. If the wages appropriately respond to the rising prices of goods, then their wages may be pegged on the Cost of Living Index. If this happens, then the wage earners get protection from the adverse effects of inflation. However, more often, there is a delay between the rise in prices and the increase in the employee’s wages by employers, which exposes the wage earners to the negative effects of inflation.
c) The Salaried individuals- Normally, white-collar jobs adjust to inflation slowly than other jobs, as they are performance-based and contractual. Thus, during inflation, individuals with white-collar jobs lose as their salaries are fixed.
d) Fixed Income group of individuals- This group comprises of pensioners, persons under social security, and unemployment benefits among others. Additionally, the recipients of rent also fall under this category. They lose because the payment they receive is fixed, while the prices of goods continue to rise and the value of money deteriorates.
e) The Investors- The investors fall under the flexible income category; they gain from increased demand. During inflation, the rising prices mean that the company reaps more and more profits. Consequently, the value of the shares or equities held continues to increase as does the dividends. However, investors in bonds and debentures, which have a fixed interest rate, do not gain during inflation as they receive a fixed income even as the value of money declines.
f) Businessmen and other Traders- This group comprises of real estate developers, producers and businesspersons. They gain during inflation as the prices of the goods or property they are trading in rises. At the same time, the cost of production does not increase in line with the prices.
Thus, when the price of the trader’s products rises, the income also rises by the same proportion especially in the short run. For real estate developers, the prices of land and property rise at a faster rate during inflation and hence they make a profit. However, prolonged instability in prices hampers accurate business decision-making. Thus, in the end, wages may rise and subsequently reduce the profits, which in turn would affect future investments.
g) Agriculturalists and Peasant Farmers- This group include peasant farmers, property owners and agriculturalists with no land ownership. The property owners receive fixed rents despite the increase in prices; thus, they loose. In contrast, the peasant farmers gain, as they own land and cultivate goods whose prices keep on rising during inflation.
In times of inflation, though the cost of production increases, the prices of agricultural products increase at a much faster rate (Nelson, & Plosser, 1982, p. 141). In other words, the cost of farm inputs and land rates do not increase at the same rate as the increase in the prices of agricultural products. Thus, peasant farmers who own and cultivate crops gain during inflation as the general prices of food crops rise.
On the other hand, agricultural workers who are landless and rely on wages paid by the owners of farms lose during inflation, as their wages remain the same even as the prices of consumer goods increase. Additionally, since they often lack trade unions to lobby for wage increment, they are losers during inflation.
h) The Government- The government loses and gains during inflation as inflation affects the government both positively and negatively. As a debtor, the government gains from inflation through high interest paid by creditors, usually households.
This arises from the fact that, “during inflation, the interest rates on debentures and government bonds remain fixed” (Engle, & Granger, 1987, p. 254); they are not raised to offset the corresponding increase in prices. Additionally, the government through the tax levied can pay off its domestic debt. Inflationary finance obtained from the tax can help the government to fund its activities.
As the level of income of employees in response to inflation increase, the government gains through taxation and levies on the incomes and goods. As a result, the government revenue increases as prices rise during inflation. However, the government can also lose through the rise in the salaries of public servants and the rise in the cost of financing public projects including infrastructure, healthcare and schools or educational facilities.
Policies taken by the Saudi Government to Curb Inflation
The decline in Saudi’s inflation during the 2007 world financial crisis was attributed to several reasons. Among them is the fall in prices of commodities in Saudi’s import markets, a reduction of oil prices, a reduction in domestic demand, and the rise in the Dollar value against leading currencies globally.
However, the outlook of Saudi’s inflation indicates that inflation is likely to increase again despite the government policies to curb it. The expected rise in oil prices, which will result to increased public spending, prolonged dollar weakness, expected increases in world prices of agricultural products and the rise in public expenditure are among the factors that would lead to the rise in inflation again.
The government policies in response to inflation have not been effective as indicated by the rise of the inflation rate since 2010. The SAMA tightened the monetary and fiscal policies during the inflationary spike. These included an increase in the value of reserve requirements for commercial banks and tightening of the treasury bills issues.
However, the ineffectiveness of these measures prompted SAMA to change focus to exchange rate control especially the pegging of the Saudi riyal to the US dollar. Commentators made two observations; first, the pegging of the riyal on the dollar created imported inflation as indicated by the sharp rise in inflation during the weakening of the US dollar relative to leading world currencies (Kandil, & Hanan, 2009, p. 7).
In 2007, the US dollar’s Nominal Effective Exchange Rate i.e. its value against weighted value of principal currencies depreciated by 4.3% in 2007 compared to only 1.5% the previous year. This resulted to increase in import prices and subsequently on Saudi’s retail prices.
The second observation regarded the monetary policy. The pegging of the riyal on the dollar limited SAMA’s policy options especially with regard to reducing credit and interest rates. If SAMA increased or lowered the interest rates without consideration of the US rates, then this will attract capital inflows, which in turn would result to a rise in the exchange rate.
The 2007 financial crisis did little to dampen lending by commercial banks, which stood at 35%: an indicator that, Saudi’s economy was growing remarkably fast (Kandil, & Hanan, 2009, p. 9). However, the rate cutting by the US during the same period meant that SAMA had limited options of redeeming liquidity growth to curb inflation.
In particular, many policy options are available to the Saudi government to curb inflation. The first policy option involved government’s intervention in the determination of the prices of essential goods. The mechanism here involved price control of commodities especially food products.
However, this presented a problem; it affected investment and affected the privatization program in a market economy. The second policy involved government intervention to prevent the rise of rents and real estate rates through the determination of the annual rent increases.
However, this had the potential of affecting the real estate sector, reducing investments into the sector and encouraging capital outflow into other investment destinations abroad. Ultimately, this would create a shortage of real estate in the country. A third policy option involves delinking the evaluation of the riyal on the US dollar or raising its value to a higher level. However, this would enhance speculation on the riyal, which would hamper investment and the riyal’s stability.
Other policies available include reducing the export of agricultural goods whose prices are high especially agricultural products. The mechanism here involves taxation to reduce the export volumes.
However, this affects investments in production and agricultural sectors. Another policy option involves increasing the interest rates to discourage borrowing and encourage saving and reduce liquidity. However, this again affects investment as the cost of borrowing increases. The other policy option involves the reduction of the government expenditure especially in public projects. However, this hampers economic growth rate and recovery as distinguished projects are delayed.
The Solution Provided for these Problems
The policies implemented by the Saudi government were largely ineffective as the inflation rate, which declined to 4% in 2009 rose to 5% in 2010 (Kandil, & Hanan, 2009, p. 4) The solution provided here is to implement policies that curb inflation but do not affect the national economy or conflict with market mechanisms.
The policies need to be comprehensive with fewer impacts on the market economy. In particular, maintaining the stability of the Saudi currency is paramount in curbing inflation. However, this does not mean fixing its value at a higher rate relative to other currencies. Instead, it implies not pegging the Saudi Riyal entirely on the US dollar as this affects the monetary policy especially when the value of the dollar, relative to capital currencies, declines.
By not pegging the riyal on US dollar, agricultural goods will attract other investors dealing in other leading currencies, which would raise the world food prices. Additionally, this would result to increased domestic investment especially in the housing sector and ultimately raise the rent rates.
However, the mortgage law, which has been proposed, could serve to alleviate the rental pressures by discouraging investments in real estate and commercial buildings by encouraging investments in middle-level residential housing. Thus, the solution is two pronged: not pegging the riyal on the US dollar alone and the proposed mortgage law.
This paper involved a study of the causes and effects of inflation in Saudi Arabia between 1980 and 2010. This period showed a significant fluctuation of inflation due to both external and domestic factors. Evidence from the 2008 inflationary spike indicates that, external factors are the prime determinants of Saudi’s inflation; a finding that agrees with the fact that Saudi’s economy is an open trade economy with oil exports and import of many commodities from abroad.
The rise in world prices, accompanied by the decline in the value of the US dollar relative to the world main currencies, helped trigger inflation in Saudi during the 2000-2006 period. Additionally, domestic factors such as the rise in demand occasioned by a rapid rise in oil prices also contributed to the high inflation in Saudi. Nevertheless, the high inflation appears unrelated to money supply in Saudi’s economy.
This could be explained by the observation that the riyal is pegged on the US dollar and, therefore, Saudi interest rate is consistent with the fed interest rates. As a result, the low interest rate involving the US dollar has led to low interest-rate effect on Saudi inflation. On the other hand, the low interest rate has presented challenges to Saudi’s monetary policy.
Thus, in order to curb inflation in Saudi, monetary policies have to be formulated in a way that diversify the Saudi economy and encourage local output to cut down on imports. Also, reviewing the exchange rate policy by avoiding the pegging of the Riyal on the US dollar can be helpful in combating the high rate of inflation in Saudi.
To control inflation rate in Saudi in light of external factors, this paper proposes the following recommendations:
1. The adoption of a monetary policy that targets the inflation rate. The fiscal and monetary policies should be based on the inflation rate framework so that the exchange rates and wages are adjusted in line with the prices.
2. For this monetary policy to become successful, the government must reveal the inflation target to all citizens, investors and business community when presenting the national budget so that the interest rate of their savings is adjusted in this regard. Additionally, the Saudi Arabian Monetary Agency (SAMA) should show commitment in achieving target inflation rate by enhancing transparency in the computation of inflation. Period publications, which show the inflation rates and the deviation from the target inflation rates, can also be useful.
3. The government must also illustrate the approaches of dealing with inflation and strategies of mitigating the effects of inflation, in order to cushion investors and savers from unpredictable interest rates and prices.
4. In controlling inflation or its effects, the government must not rely on policies that in any way affect the market mechanisms and force as this will affect liquidity.
5. The government must undertake to increase the national output, especially of agricultural and food products to cut down on imports. The findings in this paper indicate that import inflation is largely responsible for the current high inflation in Saudi. Thus, by reducing increasing production, imports from inflation-prone economies will be reduced.
6. Lastly, the Saudi government must seek a solution for the high rents for real estate and housing sector through the mortgage law. Otherwise, inflation and its effects will continue to affect the national economy.
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