A Factor-augmented VAR Analysis of Business Cycle and Inflation Synchronizations in GCC Member Countries

Purpose - Gulf Cooperation Council (GCC) member countries aspire to establish a Gulf Monetary Union (GMU) and adopt a single common currency (e.g., Khaleeji) despite temporary political differences. The key and most well-understood criterion for a monetary union is business cycle and inflation synchronization among member countries. This paper empirically investigates the strengths and nature of business cycle and inflation synchronizations among the six GCC member countries. Design/methodology/approach - Unlike previous GCC studies, this paper employs a factoraugmented VAR model that characterizes a large set of 37 foreign and domestic variables relevant to the six GCC countries simultaneously. The study identifies six common (global and regional) shocks, and examines how and to what extent these shocks affect each economy in the GCC region. Findings - The empirical results indicate that the GDP of each of the individual GCC countries shows well synchronized responses to shocks related to Chinese GDP, regional GDP, and global oil prices, which are the three main determinants of fluctuations in GCC GDPs. GCC inflation also shows highly synchronized responses to all different types of common shocks, except the oil price shock, probably due to heavy government subsidization. These results are different from what Eickmeier (2009) found for euro-area countries. Research implications or Originality - Overall, the evidence poses positively for the consideration of a regional currency union in the GCC region.