Atul Deshpande, Lecturer, Skyline College, Sharjah, UAE

This research paper attempts to meet three objectives. First, is inflation and money supply relation very significant in a small open economy of the UAE? Second, what is the causal point for a relative stability of prices in the UAE as compared to other GCC countries? Third, is monetary targeting as a policy option to achieve overall economic stability a sufficient measure? The examination of these questions results in some interesting findings. The methodology used to examine our objectives covers historical overview and econometric techniques. Our first result confirms Monetarists' view that prices and money supply are highly correlated. In the economy of UAE, prices are relatively stable because of the stability of transactions velocity related to MI and the relation between prices and MI has been found to be more significantly correlated than the significance level of the relationship of M2 with prices though it is much more highly correlated than Ml. The inverse relation between prices and money supply has turned out to be very insignificant. Even the exchange rate shows a significant influence on prices although the data regressed on this variable cover only fixed exchange rates due to paucity of data on dollar versus dirham appreciation or depreciation covering a considerable period of time. Our estimation of demand for money function with real GDP and interest rates as the two determining variables of Md (Demand for Money) does not give us any significant relation with prices except the real GDP which has shown low correlation but high significance. Overall, it has been found that in a small open economy of the UAE monetary targeting has been successful in maintaining price stability with a fixed exchange-rate system. Nonetheless, in the long-run a fiscal policy accompanying monetary targeting should be the action plan for overall economic stability on the part of the government of the UAE.

Deshpande, A. (2005). On the Empirical Evidence of Price Stability and Money Supply Relation in the United Arab Emirates. Skyline Business Journal, Volume 1, No. 2, pp 25-32.