Currency Union and Exchange Rate Issues

Currency Union and Exchange Rate Issues

Lessons for the Gulf States

New Horizons in Money and Finance series

Edited by Ronald MacDonald and Abdulrazak Al Faris

This book – written by leading academics and practitioners in the field – brings together cutting edge research on exchange rate regime and monetary union issues. There is a particular focus on the implications for member states of the Gulf Cooperation Council which is itself working towards forming a monetary union for the Gulf States.

Chapter 8: The United Arab Emirates: Exchange Rate Regime Options

Zubair Iqbal

Subjects: economics and finance, financial economics and regulation, international economics, social policy and sociology, migration


* Zubair Iqbal INTRODUCTION This study aims to evaluate the United Arab Emirates’ (UAE) experience with the current exchange arrangement that pegs the dirham to the US dollar at a fixed rate, assess merits of continuing with the arrangement in the period ahead, review exchange rate options that the UAE could consider to address its changing national economic priorities and recommend an alternative regime. The political economy considerations pertaining to the planned GCC monetary union or non-economic reasons for the retention of the existing arrangement are not addressed. The peg to the US dollar, in effect for the last three decades, has provided the UAE economy with a credible nominal anchor. This policy has been consistent with the various criteria for adopting a fixed exchange rate, including labor market and wage flexibility, trade and payments openness, business cycle synchronicity with the US economy and preponderance of real shocks. Wage flexibility and abundant international reserves have allowed an effective mixture of adjustment and financing to address the wide fluctuations in the global oil prices. The exchange arrangement has, until recently, helped maintain inflation at close to that of the UAE’s major trading partners and supported external stability, notwithstanding the real terms-of-trade shocks relating to oil prices. However, this policy has had its limitations. Fiscal policy has had to bear additional burden in the absence of an active monetary policy and a fixed exchange rate to sustain internal stability and growth. Instability of non-oil exports and imports has increased over time, and exchange...

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