On the optimal exchange rate policy for the gcc countries

This chapter extends the new Keynesian small open economy model to evaluate alternative exchange rate arrangements for a small oil-exporting economy. A number of recent stylized facts are incorporated, such as, the increasing counter-cyclicality of oilexporters with the US economy, the increasing volatility of the US dollar vis-à-vis other major currencies, and the increasing trade of oil-exporters with the Euro area, East Asia, and Japan. In addition, by employing a three-country general equilibrium model, we analyze movements of the anchor currency against other major currencies and the consequences for the pegging country. In this respect, the model suggests that a basket peg is more welfare-improving compared to a unilateral peg. Further, the variance of the currency in which oil-price is denominated came as an important determinant in welfare analyses. These conclusions have important policy implication, particularly for the Gulf Cooperation Council (GCC) countries as they consider alternative monetary arrangements.