Testing Monetary Policy Trilemma for Middle Eastern Economies under a Bayesian Panel VAR

Abstract

Abstract Middle Eastern economies follow the dollar-pegged exchange rate policy with an open capital account, and this poses a question regarding the autonomy of the monetary policy stance adopted by the regional central banks. In this context, the current research aims to evaluate the ‘monetary policy trilemma’ whilst using the Bayesian panel vector autoregression approach. In considering four variables, namely domestic interbank interest rate, domestic liquidity, oil price and federal funds rate, the present research finds that a positive shock in US federal funds rate increases the domestic interest rates in the Middle Eastern economies. Additionally, this research finds a negative relationship between the oil price shocks and the domestic interest rates, but, conversely, a positive shock in US federal funds rate induces a reduction in the oil price. The current project is unique, as it examines the monetary policy trilemma whilst considering oil price as a control variable in the system under a time-varying Bayesian panel vector autoregression specification. It provides insights that policymakers can use to determine the autonomy of the domestic monetary policy stance, so as to achieve the broader macroeconomic objectives of that policy.