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The Bahrain Economy: A Var Analysis

ABSTRACT: The last decade or so has witnessed a significant growth in research studies applying Vector Autoregression (VAR) technique for macroeconomic modelling. A VAR technique pioneered by Sims and popularized by researchers such as Litterman and Doan is useful particularly when knowledge about "true" structural relations is absent. This study represents the first attempt to apply such a technique to Bahraini yearly data (1971 – 2002) for five key macroeconomic variables. The results of the study indicated that all key macroeconomic variables are interlinked and influence each other. Oil exports is pure exogenous and is unaffected by any other macroeconomic variable. There is an evidence of bi-directional money-income causality and uni-directional causality from Government expenditure to CPI.. Impulse response and variance decomposition analysis suggest that fiscal policy is relatively more effective in short-run and monetary policy is more effective in the long run. Both oil exports and money are the sources of variation in GDP in the long-run and Government expenditures is the source of variation in the short-run. The result also suggests that money and oil exports are the important sources of variations in CPI in the long-run and Government expenditures is important source in the short-run. Inflation is found to be a fiscal phenomenon in the short-run but monetary phenomenon in the long-run. This result supports the view of monetarists.

KEYWORDS: VAR MODELLING, MACROECONOMIC POLICIES, OIL EXPORTS, BAHRAIN


1. INTRODUCTION

Being pioneer of oil producer in the Arabian Gulf region, Bahrain witnessed the prospects of potential economic prosperity in 1932 with the discovery of oil. Although oil exports contributed significantly in achieving higher levels of GDP over past few decades, its volatile nature (because of oil prices) and gradually decreasing share in GDP provided a challenge of maintaining higher...

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