Abstract:
The oil exporting economy is suffering from a high inflation rate mainly caused by its current monetary policy.
The rate of foreign exchange is one of the most important prices in any economy that interacts with the rest of the world. The exchange rate affects the price of a variety of imported goods and services in the domestic market and the price of domestic goods in the foreign market. Therefore, the exchange rate is a principal determinant of exports, imports, balance of payments, and foreign exchange reserves of a country.
In oil-exporting countries, foreign exchange revenues from oil exports are usually the main source of government income.When oil revenues or the exchange rate changes, the change affects government expenditures and budget. A budget deficit also affect money supply. The early 1990s were characterized by a surge of capital inflows to developing countries.  Interest in oil- exporting countries with emerging financial markets stimulated both direct and portfolio investment in these countries. However, some oil-exporting countries that experienced particularly large capital inflows exhibited problems that could reduce the positive effects of the capital flows.
A large capital inflow in a short period of time can lead to an appreciation of the recipient country’s currency. This appreciation may reduce the competitiveness of the nation’s export industries and cause a fall in output and rise in unemployment in these industries. A large rise in the capital account surplus will be accompanied by a large rise in the current account deficit. The capital inflow may also be associated with a rapid increase in the country’s money supply, which would create inflationary conditions. Therefore, in oil-exporting countries, the exchange rate affects not only demand for imports and exports but also government expenditures and the money supply through budget deficits. In such countries, exchange rate policies could be much more important for national economic performance than in countries where foreign exchange is not a large part of government revenues.
The objective of this paper is to examine that in the case of an oil-exporting economy, when devaluation of currency becomes necessary, whether a floating rate or a fixed exchange rate results in a lower rate of inflation. Using the methodological approach based on the statistical theory of Granger causality tests, the causal relationship between exchange rate and inflation is examined here using oil-exporting countries data. The results suggest that that under a floating rate policy, the growth of the exchange rate and of inflation rate was far less than the corresponding growth under a fixed rate policy. Therefore, a floating exchange rate could decrease the inflationary pressures and the growth of market exchange rate.