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