The oil cycle, the Federal Reserve, and the monetary and exchange rate policies of Qatar

Abstract

Supporters of the Arab oil-exporting countries’ decades-long fixed exchange rate regime argue that since, oil is traded in US dollars, pegging to the dollar is optimal. However, the weakening relationship between oil prices and the US economy in terms of the Federal Reserve's expansionary monetary stance amid soaring oil prices for much of the previous decade has raised questions about the viability of the peg. Using Qatar as a case study, this paper empirically analyzes whether the synchronization pattern of business cycles has recently changed between Qatar and the USA. The results of the analysis show a pronounced desynchronization or decoupling of business cycles between Qatar and the USA during 2001–2010. Moreover, the dissimilarly of demand shocks between the two countries suggests that the imported monetary policy stance of the Federal Reserve has not been viable for Qatar in recent years. A natural implication of our findings is the need for a truly independent monetary policy oriented toward domestic goals.

Keywords:

• oil price
• business cycle synchronization
• counter-cyclical monetary policy
• exchange rate regimes

JEL Classification:

• E32
• E61
• F44

Acknowledgements

We are very grateful to Elsayed Elsamadisy for helpful advice and stimulating conversation at an early stage of the paper. We thank two anonymous reviewers and the editor of this journal for very helpful and detailed comments and suggestions. We also thank Megan Foster for very careful proofreading and numerous suggestions. The views in this paper are solely the responsibility of the authors and should not be interpreted as reflecting the views of the affiliated institutions.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1 As discussed in Appendix, Section A.1, in the present context, the importance of the trade, labor and risk-sharing criteria are somewhat weaker than the implications of dissimilar shocks or cycles.

2 See Appendix, Section A.2 for a brief history of the exchange rate system in Qatar.

3 Although hydrocarbons still account for a sizable portion of GDP in Qatar, the share of non-hydrocarbon sector increased from about 45% in 1980 to around 60% by end-2013. Interestingly, by developing large production capacities of natural gas, Qatar has recently reduced its dependence on oil in favor of natural gas (Basher, 2010). Furthermore, although trade with the US has remained relatively stable over the past three decades, Qatar's trade with emerging Asian countries has increased impressively (see Appendix 1 for further details). There is more to Qatar's resilient economy. In the midst of the recent global financial crisis, Qatar's economy was relatively unaffected through trade and financial channels (IMF, 2013).

4 The FFR is an indicator of the US's monetary policy stance and henceforth reflects the monetary stance in Qatar because of the fixed peg of the Qatari riyal to the US dollar.

5 See Neely (2004) for a description of the Fed's reaction to crisis or potential crisis in the financial markets.

6 On 9 and 10 August of 2007, the spread between the three-month London interbank offered rate (LIBOR) and the three-month Overnight Index Swap jumped to unusually high levels and has remained high ever since. This event was dubbed a ‘black swan' in the money market by Taleb (2007) and by Taylor and Williams (2009) due to its unusual appearance. See Cecchetti (2008) for a full discussion of the events leading up to and including the crisis. An event timelines of the US and international policy responses to the global financial crisis is available online at: http://www.newyorkfed.org/research/global_economy/policyresponses.html

7 For the historical journey of the oil industry with a particular focus on the events associated with significant changes in the price of oil, see Hamilton (2013).

8 Authors' calculations using data from EIA (2012).

9 Kilian and Hicks (2013, p. 385) pointed out that ‘the unexpected increase in the demand for oil after 2002 was not driven primarily by unexpectedly high growth in the OECD, but to a large extent by unexpected growth from countries outside of the OECD.’ Furthermore, Smith (2009, p. 155) concluded that ‘some combination of unexpectedly energy-hungry growth from China and elsewhere in the world together with a negative shift in oil supply caused by higher production costs can explain a substantial rise in oil prices after about 2004.’ See also Hamilton (2009).

10 Dahl and Sterner (1991) and Espey (1998) provide thorough reviews based on hundreds of gasoline demand studies.

11 The process worked almost identically in other GCC countries.

12 See, among others, Bernanke (2004).

13 To find out whether this result was driven by increasing hydrocarbon (i.e. oil and gas) export revenues, we have also examined the extent of interdependence between Qatar's non-hydrocarbon real GDP growth and the US's real GDP growth over the entire sample period. The results are very similar to those shown in Figure 3, supporting the growing growth divergence between the two economies.

14 An anonymous reviewer suggested to test the long-run relationship between FFR and oil prices as an alternative to analyze the decoupling hypothesis. Following this suggestion, we performed cointegration analysis between FFR and real price of oil using monthly data for two samples: full sample (1970–2011) and the pre-decoupling sample (1970–2000). For the pre-decoupling sample, both trace and maximum-eigenvalue statistics suggest a unique cointegrating vector with test statistics 18.24 (p-value: .01) and 15.36 (p-value: .03), respectively. Interestingly, for the full sample, the cointegration relationship does not hold. In this case, the trace and maximum-eigenvalue statistics are 8.15 (p-value: .44) and 6.15 (p-value: .59), respectively. These results suggest that the inclusion of the 2001–2010 data, which coincides with the decoupling episode hypothesized in the paper, leads to a breakdown of the long-run equilibrium relationship between FFR and real oil price. We thank the anonymous reviewer for making this suggestion.

15 Unlike Bayoumi and Eichengreen (1994), who employed a GDP deflator to measure prices, we used the CPI as an indicator of the domestic price level. The GDP deflator is not an appropriate measure of the domestic price level in Qatar due to the high share of oil in aggregate output and the exclusion of imports in the price basket.

16 Alternative choices yield the same results.

17 See Deloitte (2013b) for the projected price impacts of US LNG exports on Qatar and other gas exporters.

18 See Table 7 in EIB (2012) for a geographical breakdown of the GCC's sovereign wealth funds investments. Over 50% of the GCC's sovereign wealth funds are allocated to equity portfolios, followed by fixed income, infrastructure and alternative investment (e.g. private equity, hedge funds, commodities).

19 See Setser (2007), which offers an erudite critique of the dangers associated with a fixed peg to dollar for the GCC states.

20 We thank Stephen Jen for bringing this unique case of Hong Kong to our attention.

21 See Khor, Lee, Robinson, and Supaat (2007) for an assessment of Singapore's experience with the managed floating exchange rate system. Singapore's exchange rate system is characterized by the so-called BBC (Basket, Band and Crawl) principle popularized by Williamson (1998). For a discussion of the applicability of the BBC system to GCC countries, see Basher (2015).

22 This entails enhancing regulation by developing a consistent risk-based micro-prudential framework, expanding macro-prudential oversight, strengthening financial market infrastructure, enhancing consumer and investor protection, promoting regulatory co-operation and building human capital. See QCB (2013) for further discussion.

23 The legend of the Gordian Knot is associated with Alexander the Great. In 333 BC, when Alexander arrived at the town of Gordium in Asia Minor, he attempted to untie an intricate knot tied to an ox cart. In front of a crowd, Alexander struggled to undo the knot and became frustrated. He drew his sword and severed the knot in one stroke. This famous incident is commonly called the ‘Alexandrian Solution.’ Recently, the President of the Federal Reserve Bank of Dallas, described the recent post-crisis evolution of the Fed's ballooning balance sheet as a ‘monetary Gordian Knot,’ a result created from each round of quantitative easing (Fisher, 2013).

¹See Habibi (2011) for an investigation of the market shares of advanced countries and China in the import markets of Arab countries over the past few decades.

²Authors’ calculations are based on statistics from the Qatar Statistical Authority and the International Organization for Migration.

³A 2009 Arab Knowledge Report reported that annually only a limited number of nationals graduated with scientific or technical qualifications across the GCC. See United Nations Development Programme and Mohammed bin Rashid Al Maktoum Foundation (2009) for further details.

⁴This section draws heavily on Elsamadisy and Hamadi (2008).

⁵Over the period March 1976 until June 1980, the QR was revalued twelve times – adding up to 8.5% – against the US dollar, compensating for the depreciation of 13.4% in the dollar's value against the SDRs.