The causal relationship between changes in oil prices and the exchange rate in the Libyan economy

Abstract

The present study sought to investigate the causal nexus between global crude oil price volatility and the Libyan dinar exchange rate vis-à-vis the US dollar throughout the 1990-2023 period, employing a sophisticated econometric framework encompassing unit root tests, cointegration analysis, error correction models, and causality diagnostics within a Vector Error Correction Model (VECM) specification. The empirical analysis drew upon quarterly time series data spanning 136 observations. The empirical evidence demonstrates a unidirectional causal relationship flowing from oil prices to the exchange rate, with no evidence of reverse causality, thereby underscoring the Libyan economy's pronounced dependence on petroleum revenues. The estimated long-run elasticity coefficient stands at 0.5842, implying that a 10% appreciation in oil prices precipitates a 5.84% depreciation of the dinar, contrasted with a more modest short-run elasticity of 0.2145. Additionally, oil price shocks explain 44.16% of the variance in exchange rate movements over the long term. The study advocates for economic diversification, the establishment of sovereign wealth funds, the implementation of hedging mechanisms to mitigate price volatility risks, and enhanced transparency in reserve management to bolster macroeconomic stability.