Inflation Rate Determinants in Saudi Arabia: A Non-Linear ARDL Approach

Inflation across the globe after the COVID-19 pandemic has shown some persistence and followed an upward trend well above inflation targets and beyond normal historical movements. The Saudi inflation rate followed similar patterns of global trends, surging significantly and persisting well above the pre-pandemic levels. This paper examines determinants of inflation in Saudi Arabia, considering internal and external factors, and evaluates whether inflation responds to common global shocks or is largely influenced by macroeconomic variabilities within the economy. Findings and analyses in this paper are based on both conventional Auto Regressive Distributive Lag (ARDL) and non-linear ARDL (NARDL) models using quarterly level data to capture short-run dynamics and long-run relationships between inflation rate and examined macroeconomics variables, namely oil prices real effective exchange rate, money supply, and government spending. Reported results reveal an asymmetrical relationship between oil price fluctuations and inflation rate volatilities in Saudi Arabia. Inclines in oil prices lead to higher inflation, while the decline in oil prices does not alleviate inflationary pressures, and these results are consistent both in the short-run and the long run. The influence of pass-through real effective exchange rate is also evident in transmitting global shocks to local consumer prices in the long run, where a depreciation in real effective exchange rate results in a higher cost of imported goods, exerting additional stresses on local inflation. For factors within the economy, findings indicate a substantial long-term inflationary effect of money supply on the inflation rate in Saudi Arabia, where a one percent increase in the money supply led to more than one-third increase in inflation in the long run. On the other hand, while the influence of government spending on inflation was statistically significant, its impact is less pronounced in explaining the inflation rate’s variations. The analysis reveals that the evaluated variables exert a stronger influence on inflation in the long run. This underscores the critical need for policymakers to consider the cumulative effects of these determinants when formulating effective long-term inflation stabilization policies.