Oil Prices and Exchange Rate Dynamics in a Rentier Economy: Institutional Evidence from Libya under a Managed Exchange Rate Regime

Abstract

This study examines the dynamic relationship between crude oil prices and Libya's official exchange rate from 1970 to 2025, using an annual time series dataset of 56 observations from a rentier economy operating under a managed exchange rate regime. The analysis addresses a gap in the empirical literature concerning how institutional arrangements mediate the transmission of oil price shocks to exchange rate dynamics, and incorporates recent policy developments through 2025-2026, including the April 2025 devaluation of the Libyan dinar by the Central Bank of Libya and the persistent gap between the official and parallel exchange rates. The stationarity of the two series is assessed using the Augmented Dickey-Fuller (ADF) and Phillips-Perron (PP) tests, followed by co-integration analysis using both the Engle-Granger and Johansen approaches. A Vector Autoregressive (VAR) model estimated in first differences examines short-run dynamics, complemented by Granger causality testing within a Block Exogeneity Wald framework. The results show that both series are integrated of order one,  but the full sample shows no evidence of co-integration. Short-run VAR estimates reveal strong persistence in exchange rate dynamics, consistent with the managed nature of the official exchange rate. Granger causality tests indicate no statistically significant predictive relationship from crude oil prices to the official exchange rate. In contrast, a statistically significant unidirectional predictive relationship is identified from the official exchange rate to oil prices. These patterns, viewed in the institutional context of the Libyan economy, highlight the importance of institutional and policy mechanisms in shaping official exchange rate dynamics, including Central Bank of Libya intervention and the persistent gap between the official and parallel exchange rates. This supports an institutional interpretation of official exchange rate dynamics and highlights the limited applicability of conventional commodity-currency models under managed exchange rate regimes.