The double-digit inflation problem in Saudi Arabia and its Gulf neighbours is different from that of other emerging market economies. Although the rising price of imported food affects them all, the inflation problem in the Gulf region is exacerbated by their fixed exchange rate policy.

The peg to the dollar contributes to Saudi inflation in two ways. First, the dollar link forces the Saudi central bank to match US interest rates. As the Fed lowered its interest rate from 5.25 per cent last summer to 2 per cent now, the Saudis had to cut their interest rate. If they had not done so, investors around the world would have flooded Saudi Arabia with funds seeking the higher yield on a currency that is pegged to the dollar. While cutting rates was a good policy for the US as its economy weakened, it was a terrible policy for Saudi Arabia, which is experiencing an overheated domestic economy with rapidly rising inflation.