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The Case of pegging the Exchange Rate of Oil-Exporting Economies to the Dollar

High oil prices are again transforming oil-exporting economies. Economies that were declining when oil hovered in the $20s for most of the 1990s—and at risk of bankruptcy when oil dipped to $10 a barrel in 1998—are now booming. A new generation of skyscrapers is rising in the Gulf, in St. Petersburg, and in Moscow. Government reserves in oil-exporting economies are overflowing with the governments’ large cut from the oil revenues. Most oil-exporting economies now need an oil price of $40 a barrel to cover their import bill, including their bill for imported labor, but with oil trading above $90 a barrel, they still have substantial sums available to invest in the rest of the world. One feature of oil-exporting emerging economies, though, has not changed: their propensity to peg to the dollar. Apart from Kuwait, the oil-exporting economies in the gulf peg to the dollar even more tightly than China. Other oil-exporting economies peg to a basket, often one composed mainly of the dollar and the euro. Some economists and financial people believe that the oil-exporting economy should continue pegging to the dollar, while others argue against the peg, assuming that the oil-exporting economies would be better served by a currency regime that assures their currencies depreciate when the price of oil falls and appreciate when the price of oil rises. Both of the believers and the unbelievers of the peg make their arguments based on the following perspectives:

The Macroeconomic policies of oil exporting and oil importing countries

The believers on the peg assume that pegging to the dollar allows an emerging economy, especially one with weak economic and political institutions, to import the United States’ relatively stable monetary policy. This implies a more stable economy with low variations in the inflation rate, real interest rate and exchange rate. While the unbelievers on the...
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