Exchange rate policy and international trade linkages and impacts

This thesis has studied the issue of exchange rate policy implications in relation to international trade. The dissertation consists of three essays focusing on the monetary union, exchange rates determinants, and industry specific exchange rates. The first essay investigates the impact of the proposed Gulf Cooperation Council (GCC) monetary union on trade volume using an augmented gravity model. I find that looking at the sector level, results suggest that the proposed GCC monetary union tends to increase trade among these countries only in sectors requiring low levels of processing. In the second essay, I examine empirically the determinants of exchange rate regime choices in the Middle East region. My findings show that factors of Optimal Currency Area and risk of currency crisis both increase the likelihood of fixing the exchange rate regimes; however, a larger economy decreases the probability of implementing a fixed exchange rate policy. In addition, there is evidence that the oil sector prefers the adoption of a fixed exchange rate regime, as this sector is a politically powerful sector that benefits from a stable currency. There is also evidence that politically unstable countries in the Middle East seem to be associated with flexible exchange rate policy. The third essay investigates empirically exchange rate movements in the Middle East region at the industry level. I use a first-differenced model to investigate the impact of exchange rate movements on outputs of six specific Middle Eastern industries using industry specific real exchange rate indices, constructed using Goldberg\u27s (2004) method. Employing a first-differencing technique, my findings show that the impact of the industry exchange rate variable interacted with the exposure to international trade is concentrated mostly on the food industry. The sector least affected by industry exchange rate variability is the transport industry. The explanation for the positive findings is that Middle Eastern firms are more likely to rely on imported intermediate products. Thus when there is an appreciation of their currencies, imported intermediate inputs and imported capital inputs become cheaper to local firms. This may lead final output of some industries to grow as a result of decreasing costs of production