Essays on macroeconomic and real exchange rate fluctuations in Kuwait

This dissertation consists of two essays investigating the sources of macroeconomic fluctuations on the Kuwaiti economy and the sources of real exchange rate fluctuations of the Kuwaiti dinar, preceded by a chapter about the historical and economic background of Kuwait. The dissertation adopts the Structural Vector Autoregression (SVAR) approach and uses the longest annual data available, spanning 41 years, from 1962 to 2002.; The objective of chapter two is twofold. First is to investigate the main shocks that cause the movement in the real exchange rate of the Kuwaiti dinar in order to get a better picture for exchange rate policy. The second objective is to study the correlation of supply disturbances (shocks) and correlation of demand disturbances between those of Kuwait and those of the United States of America (home of the dollar) as well as with those of Germany as proxy for the European Union (home of the Euro) to determine the proper anchor currency, if any, on which to peg the Kuwaiti dinar. The empirical results show that the a dominant proportion of the fluctuations in the real exchange rate of the Kuwaiti dinar are real shocks which indicate that the exchange rate policy of a special basket of currencies for the Kuwaiti dinar, which was in effect until the end of year 2002, should be readopted instead of the single currency peg policy that has been used since January 2003 as part of future exchange rate policy arrangements for the Gulf region (GCC States). In addition, the empirical findings of the correlations of the supply shocks and correlations of demand shocks of the concerned countries do not support pegging the Kuwaiti dinar with the US dollar nor with the Euro. Therefore, Kuwait should adopt a multilateral currency basket exchange rate policy consistent with the results of the first investigation of this essay. These interesting results regarding Kuwait may provide incentives for the GCC states to consider their optimum currency area arrangement to determine the optimal exchange rate for the region.; The objective of the third chapter is to investigate the sources of macroeconomic fluctuations to determine main shocks and their relative importance, which would provide insight into the economy. The empirical results show that the oil prices, aggregate supply, and trade balance have important influence in explaining the fluctuations in the Kuwaiti economy. Based on the findings of the underlying model adopted in the study, the Kuwaiti government ought to lessen its degree of dependency on oil by diversifying the production side of the economy to minimize the adverse effects of the shocks overall. The government should adopt a diversification plan that widen non-oil sectors of the economy through investment projects using oil sales revenues in conjunction with the private sector to provide value-added to the economy and lessen the dependence on foreign workers. Kuwait ought to coordinate with other members of OPEC to stabilize oil prices in the world oil market to avoid any harmful effects of oil price crises. The monetary authority should adopt exchange policy that takes into consideration the structure and openness of the Kuwaiti economy.