This article investigates empirically the determinants of inflation in Saudi Arabia using the quarterly time‐series data over the period 1962:1 to 1981:IV. The basis of this investigation is the monetary approach whereby the roles of both the money‐supply growth and the money‐demand growth are taken into account. Moreover, the potential effect of external monetary factors on the Saudi inflation is genuinely incorporated through the underlying money‐demand function. The proposed monetary model provides an adequate explanation of the Saudi inflationary process. Furthermore, the empirical results exhibit structural stability over time and do not suffer from simultaneous‐equation bias. The empirical results show that external monetary factors (particularly foreign interest rates) and inflationary expectations exert significant positive effects on inflation in Saudi Arabia. Importantly, the results also indicate that money‐supply growth has a quick and powerful positive impact upon the Saudi inflation with a unitary elasticity. Therefore, control over money‐supply growth appears an essential ingredient in any anti‐inflation policy in Saudi Arabia. Such monetary control can only be achieved in Saudi Arabia (and other oil‐exporting countries) through control over domestic government expenditures that have escalated particularly during the past decade.
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