Budget Deficits and the Behavior of the Real Exchange Rate: The Case of Saudi Riyal

Abstract. Using Autoregressive Distributed Lag (ARDL) approach to cointegration and error correction models,the paper empirically examine the relationship between budget deficits, among other macroeconomic variables,and the real exchange rate in Saudi Arabia for the period of 1970 -2006. The results indicate that there exists along run relationship between the real exchange rate and the variables under investigation. The findings of thestudy suggest that both nominal and real macroeconomic shock have direct effects on the real exchange rate ofriyal. The paper also demonstrates that external shock affecting oil market has important role in explainingfluctuations in the real exchange rate.