External Inflation Exposure and Fiscal Policy Under the Dollar Peg: Evidence from GCC Economies

Abstract

The six Gulf Cooperation Council (GCC) economies share a dollar peg and heavy hydrocarbon dependence, yet their inflation paths diverge sharply over time. Because the peg imports US monetary policy and forecloses nominal adjustment, GCC inflation plausibly reflects imported price pressure, oil revenue cycles working through fiscal capacity, and domestic real activity. We quantify the associations between these channels and headline inflation in country fixed-effects regressions estimated on an annual panel of the six economies over 1991–2023. Trading partner inflation is associated with domestic inflation with a contemporaneous, within-year coefficient of about 0.46—an association, not an identified causal effect, which strengthens to about 0.65 under country-specific, backward-looking trade weights—while an oil-orthogonal proxy for discretionary fiscal stance is negatively associated with inflation. Both results are stable in leave-one-country-out checks and are robust to lagged inflation; the external association holds under wild cluster bootstrap inference appropriate to six clusters, under Driscoll–Kraay inference robust to cross-sectional dependence, and in first-difference and distributed lag specifications, while two-stage bootstraps propagating the fiscal proxy’s construction uncertainty place the fiscal association at the margin of conventional significance. After the 2014 oil price collapse, the external association weakens and domestic activity and financial volatility carry the largest standardized weights. The cyclically adjusted fiscal residual—our methodological contribution—tracks published IMF non-oil balances more closely than the raw balance does and requires only an overall balance and an oil price.