An analysis of macroeconomic fluctuations for a small open oil-based economy: The case of Saudi Arabia

The increasing fluctuations in the oil prices through the last decades have been transferred to the oil exporting countries. Thus, many oil exporting countries experienced significant changes in the economic activity due to changes in the oil markets. In light of this, oil exporting countries have attempted to implement a policy that would stabilize the fluctuations in the oil markets recognizing the adverse effects of such behavior on oil exporting countries, as well as oil importing countries.;Saudi Arabia, as the largest oil-exporting country and a member of OPEC, takes the role of oil-markets stabilizer by behaving as the swing producer. This role has caused the global economic fluctuations to transfer into the domestic economy. In addition, Saudi Arabian government has adopted a fixed exchange rate currency regime. Although it has contributed to domestic price stabilizations, this policy has also exposed the country to global economic disturbances.;The purpose of the study is to empirically investigate these aspects for Saudi Arabia. First, the effects of shocks originated in the international markets on the Saudi Arabian economy. Second, how the fixed exchange rate regimes influences the domestic macroeconomic variables. Third, to what extent the oil sector contributes to the non-oil domestic fluctuations. Finally, how the findings from the study can be explained by economic theory. In pursuing this, there are four economic theories that are considered to explain the causes of business cycles. These theories are Classical Theory, Keynesian Theory, Monetarist Theory, and the Real Business Cycles. In addition, a theoretical model is derived that is suitable for an oil-based economy. The model follows the set up of McCallum and Nelson (1999). Then, the empirical models of Structural Vector Autoregression (SVAR) and Error Correction Model (ECM) are implemented with three different specifications: Choleski Decomposition, Block Exogeneity and long-run Cointegration Model. The empirical models then are applied to sets of data from 1980 to 2002 for Saudi Arabia, Kuwait, Venezuela and Norway. The rationale of including other oil-exporting countries is to distinguish whether the shocks are country-specific, regional-specific, or global. Two sets of shocks are considered: international shocks and domestic shocks. Three types of international shocks are chosen: commodity-price (oil price) shock, international financial (interest rate) shock, and international real (output) shock. In addition, five domestic shocks which are non-oil output shock, oil production shock, price level shock, monetary shock, and exchange rate shock.;The findings reached in the study demonstrate that the international shocks are responsible for a high proportion of fluctuations in the economic activity in Saudi Arabia. Most importantly, the international financial shocks represented by the US interest rate and oil price shocks are the major sources of fluctuations in the Saudi Arabian economy. Domestically, the economy is mostly affected by the oil production and the non-oil output shocks for Saudi Arabia. These results emphasize that the Saudi Arabia's role in the international oil market and its fixed exchange rate regime have significant implications on the domestic economy. Thus, special considerations should be placed on designing the appropriate policies to lessen the dependency on the oil sector and strengthen the role of private sector to diversify the economic base, and provide an independent sound monetary policy to steer the economy from the fluctuations in the global economy. (Abstract shortened by UMI.)...