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Faculty of Business and Economics, University of Pecs , Pécs , Hungary
The study examines the relationship between oil prices and headline and core inflation in Saudi Arabia from 2001 to 2022. To examine short- and long-run dynamic effects, the study employs Johansen cointegration and Vector Error Correction Model (VECM) approach. Our findings indicate the presence of long run equilibrium relationship only in the core inflation model, characterized by a significant and negative error correction vector. Short run effects are not significant. While in the long run, oil prices, M2 and imports have a positive effect on the dependent variables, whereas GDP has a negative effect. Granger causality results indicate a bidirectional causality between Imports and core inflation at 10% level, in addition to a unidirectional causality running from Imports towards money supply at 5% significance level. Variance decomposition results show that GDP, oil prices, imports and M2 coefficients explain 13.69, 0.622, 4.52 and 1.73 percent of the variability, respectively, emphasizing the primary influence of international oil prices and its effect on the imports to Saudi Arabia, in addition to the domestic economic conditions on core inflation. Although core inflation is less susceptible to external shocks, oil prices still play a significant role in the basket of goods and services. Developing strategic industrial policies not related to the fossil fuel sector is recommended to stimulate export-led value-added growth and target core inflation.
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