Working Papers

Prospects for Arab Monetary Policy in the International Financial System

Publication Number: ECESWP52-E

February, 2001

Author : Mohamed El-Erian and Mahmoud El-Gamal

Type : Working Papers

The monetary/exchange rate policy nexus is in transition in many developing countries. Some of these countries, while recognizing the need for more realistic monetary policy management and related structural reforms, have maintained a fixed exchange rate system; some have adopted explicit inflation targeting frameworks as the nominal anchor for their macro-economic regimes; others are still looking for alternative approaches to the nominal anchor challenge in the context of managed floats. While domestic considerations have played an important role in shaping these transitions, external factors have also been influential in determining the pace, smoothness, and timing of the transitions. As a result, policy management has been called upon to strike that delicate balance among sometimes conflicting domestic and external considerations that, at times, have also been impacted by the vagaries of market technicals. In this context, the paper seeks to analyze recent developments in, and the outlook for monetary policy in select Arab economies. Specifically, after outlines of the prevailing emerging market context and the basic theoretical literature, the paper examines the main determinants of monetary policy in Arab countries in recent years, including the specification of instruments and the growing (albeit still relatively limited) influence of external and technical factors. The paper then discusses some of the medium-term policy issues facing Arab economies, detailing upside and downside risks. Through an econometric analysis, the paper argues that, contrary to widespread perceptions, the management of the exchange/monetary policy nexus has incorporated in several countries systematic “rules” of the Taylor variety. The impact has been notable across countries in terms of inflation reduction; though trade-offs—and, consequently, the level and distribution of costs—have varied among countries reflecting varied domestic considerations. Looking forward, these systematic regimes can provide the basis for policy adaptations that would enable the exchange/monetary policy nexus to play an effective role in these countries’ stated objective to sustain high and well balanced economic growth.