## 6. Impact of a 100 Basis Point Increase in the Federal Funds Rates on GCC’s Non-Oil Real GDP Growth

## Source details

**Canonical URL:** [6. Impact of a 100 Basis Point Increase in the Federal Funds Rates on GCC’s Non-Oil Real GDP Growth](https://www.imf.org/-/media/files/publications/wp/2019/wpiea2019304-print-pdf.pdf)

## Other formats

- [Markdown version](/-/media/files/publications/wp/2019/wpiea2019304-print-pdf.pdf.md)
- [Structured JSON version](/-/media/files/publications/wp/2019/wpiea2019304-print-pdf.pdf.json)

---

### I. Introduction and research question
- GCC monetary policy is sensitive to U.S. monetary policy because of pegged exchange rate regimes and the "trilemma" limiting domestic monetary autonomy.
- Research question: How do U.S. monetary policy changes transmit to non-oil real GDP growth in GCC countries, and how does the level of real oil prices affect the size of those spillovers?
- Key modeling approach:
  - Panel regressions with country fixed effects.
  - Explanatory variables: U.S. real interest rate (effective federal funds rate deflated by U.S. CPI), logged real oil price (log of simple average of Brent, WTI, Dubai deflated by U.S. CPI), interaction between U.S. real interest rate and real oil price, and U.S. real GDP growth.
  - Driscoll-Kraay standard errors used to control for heteroskedasticity, autocorrelation, and cross-sectional dependence.

### II. Mechanism: oil prices, liquidity, and monetary transmission
- Definition:
  - "Liquidity" = subset of central bank domestic currency liabilities vis-à-vis commercial banks that is readily available for payments purposes (essentially commercial bank excess reserves at the central bank).
- Oil price-driven liquidity fluctuations:
  - Higher oil prices → larger external and fiscal surpluses → increases in liquidity (higher excess reserves) → downward pressure on interbank rates and banks' funding costs → lower lending rates and stronger credit growth.
  - Lower oil prices → reduced liquidity → upward pressure on interbank rates → higher lending rates and weaker credit expansion.
- Implication:
  - Oil price-driven liquidity can weaken or amplify the pass-through of policy rates to market/interbank rates, affecting monetary policy transmission and thus non-oil GDP growth.

### III. Empirical findings (panel regression results and interpretation)
- Main empirical result:
  - The spillover from an increase in U.S. real policy interest rates to GCC non-oil real GDP growth depends on the level of the real oil price; higher oil prices weaken the adverse spillover.
- Point estimates:
  - At a real oil price of $35 a barrel (2019 prices), a 100 basis-point increase in the U.S. real policy interest rate leads to a drop in annual non-oil real GDP growth of a ⅓ percentage point.
  - At a real oil price of $30 a barrel (2019 prices), a 100 basis-point increase in the U.S. real policy interest rate leads to a drop in annual non-oil real GDP growth of almost ⅔ percentage point.
  - The spillover effect becomes statistically insignificant when the real oil price rises above $43 a barrel (2019 prices).
- Regression and specification notes:
  - Including the interaction (U.S. real interest rate × logged real oil price) yields explanatory variables significant with expected signs.
  - The interaction coefficient is positive, indicating higher oil prices reduce the negative impact of higher U.S. real interest rates on GCC non-oil growth.
  - Baseline sample: 1991–2017, 154 observations, 6 GCC countries; regressions include country fixed effects and Driscoll-Kraay standard errors.
- Robustness checks (summarized):
  - Results hold when excluding Saudi Arabia from the sample.
  - Results hold when replacing U.S. real GDP growth with world real GDP growth.
  - Results hold when using the Wu-Xia shadow Federal Funds rate during the zero-lower bound period.
  - Results hold after adding the real growth rate of government spending as a control.
  - Results are robust to different thresholds for defining a high oil price dummy (e.g., $50 threshold, $60 threshold).
- Additional quantitative highlights:
  - Identified breakpoint oil price (above which the spillover becomes insignificant): $43 a barrel in the baseline result.
  - The real annual oil price was below $30 a barrel (2019 price) for one-fifth of the time between 1990–2018.
  - Figure 6 (reported): impact on non-oil real GDP growth of a 100 basis-point federal funds rate increase ranges from about -0.66 percentage points at $30 to about -0.33 percentage points at $35 and approaches zero above $43.

### IV. Policy implications and conclusions
- Main implication:
  - The adverse impact of U.S. interest rate hikes on GCC non-oil growth is conditional on oil prices because oil-driven liquidity amplifies or dampens monetary transmission.
- Structural observations:
  - At historically higher oil price levels (annual real oil price above $43 since 2004), excess liquidity has been structurally higher, weakening monetary policy transmission and reducing U.S. spillovers.
- Practical conclusion:
  - At current oil price levels, the impact of changes in U.S. interest rates on non-oil growth in the GCC appear likely to be minimal.

*Source: IMF staff estimates and analysis in "6. Impact of a 100 Basis Point Increase in the Federal Funds Rates on GCC’s ___________11", wpiea2019304-print-pdf.*

### Chapter 3 — Major themes and analytical strands
### Major themes and topics covered
- The growing importance of financial spillovers from emerging market economies.
- Strengthening liquidity management frameworks in support of stability and growth in the GCC.
- Base rate pass-through and retail rate transmission in banks and building societies.
- Interest rate pass-through, monetary policy rules, and macroeconomic stability.
- The trilemma (monetary sovereignty, exchange rates, and capital controls) across historical and modern contexts.
- Financial stability, the trilemma, and international reserves.
- Monetary policy and the transmission mechanism in the GCC countries.
- Implications of changes in the US financial system for the monetary transmission mechanism.

### Key references and implicit analytical strands
- Cited works focus on:
  - Empirical investigation of interest-rate and base-rate pass-through to retail rates.
  - Historical and theoretical analysis of the trilemma and its policy tradeoffs.
  - Examination of liquidity management practices and frameworks in GCC contexts.
  - Consideration of international financial spillovers from emerging markets to advanced economies.
  - Assessment of structural changes in the US financial system and consequences for monetary transmission.

*Source: Chapter 3, wpiea2019304-print-pdf (Washington: International Monetary Fund).*

### REFERENCES ____________________________________________________________14

### REFERENCES ____________________________________________________________14

### Tables
- 1. Correlations Between U.S. and GCC Central Bank Policy Rates in Easing and Tightening Periods____________________________________________________________________5
- 2. Determinants of the GCC Non-Oil Real GDP Growth: Panel Regressions ____________10
- 3. Determinants of the GCC Non-Oil Real GDP Growth: Robustness Checks ___________13

### Figures
- 1. Policy Rates  ____________________________________ Error! Bookmark not defined.
- 2. GCC Current Account and Fiscal Balance, 2004–2018 ____________________________6
- 3: GCC Liquidity and Oil Prices Growth _________________________________________6
- 4: Saudi Banking System Excess Reserves  _______________________________________7
- 5. Oil Prices and Monetary Policty Transmission/ __________________________________7

*Source: wpiea2019304-print-pdf - REFERENCES ____________________________________________________________14*

### 6. Impact of a 100 Basis Point Increase in the Federal Funds Rates on GCC’s ___________11

### 6. Impact of a 100 Basis Point Increase in the Federal Funds Rates on GCC’s Non-Oil Real GDP Growth

### I. Introduction and research question
- GCC monetary policy is sensitive to U.S. monetary policy because of pegged exchange rate regimes; the "trilemma" implies limited domestic monetary autonomy.
- Research focus: How do U.S. monetary policy changes transmit to non-oil real GDP growth in GCC countries, and how does the level of real oil prices affect the size of those spillovers?
- Key modeling approach: panel regressions with country fixed effects using U.S. real interest rate (effective federal funds rate deflated by U.S. CPI), logged real oil price (log of simple average of Brent, WTI, Dubai deflated by U.S. CPI), interaction between U.S. real interest rate and real oil price, and U.S. real GDP growth as explanatory variables; Driscoll-Kraay standard errors used to control for heteroskedasticity, autocorrelation, and cross-sectional dependence.

### II. Mechanism: oil prices, liquidity, and monetary transmission
- Definition: "Liquidity" is the subset of central bank domestic currency liabilities vis-à-vis commercial banks that is readily available for payments purposes (essentially commercial bank excess reserves at the central bank).
- Oil price-driven liquidity fluctuations:
  - Higher oil prices → larger external and fiscal surpluses → increases in liquidity (higher excess reserves) → downward pressure on interbank rates and banks' funding costs → lower lending rates and stronger credit growth.
  - Lower oil prices → reduced liquidity → upward pressure on interbank rates → higher lending rates and weaker credit expansion.
- Implication: Oil price-driven liquidity can weaken or amplify the pass-through of policy rates to market/interbank rates, affecting monetary policy transmission and thus non-oil GDP growth.

### III. Empirical findings (panel regression results and interpretation)
- Main empirical result: The spillover from an increase in U.S. real policy interest rates to GCC non-oil real GDP growth depends on the level of the real oil price; higher oil prices weaken the adverse spillover.
- Point estimates highlighted in the paper:
  - At a real oil price of $35 a barrel (2019 prices), a 100 basis-point increase in the U.S. real policy interest rate leads to a drop in annual non-oil real GDP growth of a ⅓ percentage point.
  - At a real oil price of $30 a barrel (2019 prices), a 100 basis-point increase in the U.S. real policy interest rate leads to a drop in annual non-oil real GDP growth of almost ⅔ percentage point.
  - The spillover effect becomes statistically insignificant when the real oil price rises above $43 a barrel (2019 prices).
- Table 2 and specification notes:
  - When the interaction between U.S. real interest rate and logged real oil price is included, explanatory variables become significant with expected signs.
  - The interaction coefficient (U.S. real interest rate × logged real oil price) is positive, indicating that higher oil prices reduce the negative impact of higher U.S. real interest rates on GCC non-oil growth.
  - The baseline sample covers 1991–2017 with 154 observations and 6 GCC countries; regressions include country fixed effects and Driscoll-Kraay standard errors.
- Robustness checks (Table 3 summaries):
  - Results hold when excluding Saudi Arabia from the sample.
  - Results hold when replacing U.S. real GDP growth with world real GDP growth.
  - Results hold when using the Wu-Xia shadow Federal Funds rate during the zero-lower bound period.
  - Results hold after adding the real growth rate of government spending as a control.
  - Results are robust to different thresholds for defining a high oil price dummy (e.g., $50 threshold, $60 threshold).
- Additional quantitative highlights from regressions:
  - The identified breakpoint oil price (above which the spillover becomes insignificant) is $43 a barrel in the baseline result.
  - The real annual oil price was below $30 a barrel (2019 price) for one-fifth of the time between 1990–2018.
  - Figure 6 (as reported): the relationship between oil price (normalized to 2019 US dollars) and the impact on non-oil real GDP growth of a 100 basis-point federal funds rate increase shows the non-oil growth decline ranging from about -0.66 percentage points at $30 to about -0.33 percentage points at $35 and approaching zero above $43.

### IV. Policy implications and conclusions
- Main implication: The adverse impact of U.S. interest rate hikes on GCC non-oil growth is conditional on oil prices because oil-driven liquidity amplifies or dampens monetary transmission.
- At historically higher oil price levels (annual real oil price above $43 since 2004), excess liquidity has been structurally higher, weakening monetary policy transmission and reducing U.S. spillovers.
- Practical conclusion from the paper: At current oil price levels, the impact of changes in U.S. interest rates on non-oil growth in the GCC appear likely to be minimal.

*Source: IMF staff estimates and analysis in "6. Impact of a 100 Basis Point Increase in the Federal Funds Rates on GCC’s ___________11", wpiea2019304-print-pdf.*

### Chapter 3 (Washington: International Monetary Fund).

### Chapter 3

### Major themes and topics covered
- The growing importance of financial spillovers from emerging market economies.
- Strengthening liquidity management frameworks in support of stability and growth in the GCC.
- Base rate pass-through and retail rate transmission in banks and building societies.
- Interest rate pass-through, monetary policy rules, and macroeconomic stability.
- The trilemma (monetary sovereignty, exchange rates, and capital controls) across historical and modern contexts.
- Financial stability, the trilemma, and international reserves.
- Monetary policy and the transmission mechanism in the GCC countries.
- Implications of changes in the US financial system for the monetary transmission mechanism.

### Key references cited (authors, year, focus)
- ____ . 2016b. “The Growing Importance of Financial Spillovers from Emerging Market Economies.” Global Financial Stability Report, April 2016: Chapter 2 (Washington: International Monetary Fund).
- ____ . 2017. “Strengthening Liquidity Management Frameworks in Support of Stability and Growth in the GCC” (Washington: International Monetary Fund).
- Mizen, Paul, and Boris Hofmann. 2002. ‘Base Rate Pass-Through: Evidence from Banks’ and Building Societies’ Retail Rates.” Bank of England Working Papre No. 170 (London).
- Obstfeld, Maurice, Jay C. Shambaugh, and Alan M. Taylor. 2004. "Monetary Sovereignty, Exchange Rates, and Capital Controls: The Trilemma in the Interwar Period", IMF Staff Papers, Palgrave Macmillan, vol. 51(s1), pages 75-108, June.
- Obstfeld, Maurice, Jay C. Shambaugh, and Alan M. Taylor. 2005. "The Trilemma in History: Tradeoffs Among Exchange Rates, Monetary Policies, and Capital Mobility", The Review of Economics and Statistics, MIT Press, vol. 87(3), pages 423-438, August.
- Obstfeld, Maurice, Jay C. Shambaugh, and Alan M. Taylor. 2010. "Financial Stability, the Trilemma, and International Reserves", American Economic Journal: Macroeconomics, American Economic Association, vol. 2(2), pages 57-94, April.
- Prasad, Ananthakrishnan, and May Khamis. 2011. "Monetary Policy and the Transmission Mechanism in the GCC Countries." Gulf Cooperation Council Countries: Enhancing Economic Outcomes in an Uncertain Global Economy (2011): 47-63.
- Scharler, Johann and Claudia Kwapil. 2010. “Interest Rate Pass-Through, Monetary Policy Rules, and Macroeconomic Stability.” Journal of International Money and Finance, 2010, Vol. 29(2), pp. 236-261.
- Sellon Jr., G. 2002. “The Changing US Financial System: Some Implications for Monetary Transmission Mechanism.” Federal Reserve Bank of Kansas City Economic Review, First Quarter.

### Implicit analytical strands (as reflected by cited works)
- Empirical investigation of interest-rate and base-rate pass-through to retail rates.
- Historical and theoretical analysis of the trilemma and its implications for policy tradeoffs.
- Examination of liquidity management practices and frameworks in GCC contexts.
- Consideration of international financial spillovers from emerging markets to advanced economies.
- Assessment of structural changes in the US financial system and consequences for monetary transmission.

*Source: Chapter 3, wpiea2019304-print-pdf (Washington: International Monetary Fund).*

---


_Source: https://www.imf.org/-/media/files/publications/wp/2019/wpiea2019304-print-pdf.pdf_