The Exchange Rate Pass-Through into Inflation with Symmetric Oil Price Shocks: An Empirical Analysis for Saudi Arabia: 1970-2015

Abstract

The purpose of this paper is to analyze theoretically and empirically the relationship between inflation as a dependent variable and bilateral exchange rate, output gap and symmetric oil price shocks. The ARDL methodology is employed considering the period of 1970-2015. The exchange rate pass-through to inflation will be thoroughly investigated. Johansen’s testing procedure confirms the existence of long-run relationships between consumer price inflation, exchange rate, symmetric oil price changes and output gap as a proxy for aggregate demand. The estimation results reveal that depreciation of the exchange rate and the symmetric oil price shocks are main factors responsible for long-run domestic consumer price inflation in Saudi Arabia. Although the output gap as a proxy for aggregate demand had the right sign but its contribution is little in explaining the variations in domestic inflation in the long-run. This could be attributed to the sufficient Saudi economic capacity. In economic literature, the findings here are in line and consistent with other researchers’ estimation results.