The Impact of Oil Prices on the Real Exchange Rate of the Dirham: a Case Study of the United Arab Emirates

This study investigated the impact of oil shocks on the real exchange rate of the United Arab Emirates (UAE) dirham. Time series data were used for the period 1977 to 2007 covering four important oil shocks. Five variables have been used in this study, with the real exchange rate of the dirham as the dependent variable and the gross domestic product per capita, oil price, trade balance, and foreign direct investment inflows as the independent variables. In this study we used the Johansen-Juselius cointegration procedure, and conducted the Granger causality tests based on the VECM. Through this research, we found that a fixed exchange rate to the U.S. dollar is not an appropriate exchange rate regime for the UAE. This is because when the price of oil increases, and with a fixed exchange rate regime, this would lead to rapid growth in GDP and liquidity in the UAE economy. This in turn causes domestic prices to increase, which results in high levels of inflation.