Estimating Optimal Inflation Rate in Saudi Arabia: Using Dynamic Threshold Regression Model

Abstract

This study evaluates the relationship between inflation and the output gap in Saudi Arabia. Specifically, it determines a level of optimal inflation for the output gap given the changes in the economic cycle. The novelty of this study’s research question is linking optimal inflation with the non-oil output gap in Saudi Arabia by constructing a dynamic threshold regression model. The estimation is carried out by using a yearly time series from 1981 to 2019. The variables used in our model are based on existing economic theories that have established a correlation between the GDP gap as the dependent variable and inflation, money supply, and total exports as explanatory variables. The results obtained in this study suggest the existence of a threshold level of inflation of which the turning point is located at 3 percent.