Is a Fixed PEG a Fact of Life in the GCC?

Abstract

Authorities have been managing the quoted interest rate since the 2008/2009 financial crisis. And for many, positive interest rates have not created much of a concern.

Prior to 2008, a different world existed with positive interest rates. One characteristic of the interest rate - earned or paid - is the degree to which it may differ when quoted by a fiscal authority in a different region or country. For example, assuming all other factors are equal, if the interest rate earned on euros in France is three percent, and in Italy seven percent, an economist might conclude that the cost of living must be higher in Italy and the rate of inflation also higher, since interest rates quoted take into account the real rate of return plus a premium that reflects local inflation. A businessman, on the other hand, might assume that since higher rates in Italy are associated with higher risks, France would be a safer place to invest capital and conduct business.

Such conclusions become more complicated if one country fixes the rate of conversion of its currency to another country. This is known as “pegging the currency”.

This article will comment on the pressures that have arisen from certain members of the Gulf Cooperation Council (GCC) having pegged their currencies to the US dollar. It is in no way a commentary on actual policies adopted by the central banks of the countries, and, to the extent that these central banks are not independent of their governments, the policies of the government of the day.